Are Credit Causes of Economic Bubbles?

From time to time, people still remember the economic crisis that hit Latvia particularly hard. At the heart of the crisis was the economic bubble – a sharp acceleration in price growth. Likewise, the term ” economic bubble ” refers to the process of price rising faster than the fundamental value of an asset.


The economic bubble can be divided into five stages

The economic bubble can be divided into five stages

Initially, there are sporadic and sudden changes, such as wars or high yields, and thus profits, or new technologies. This is followed by the second phase of the economic bubble, in which many members of the public become so-called “newcomers” and start to increase prices significantly. In the third phase, everyone is starting to see themselves as a business manager, and so is the number of businesses, investments, etc. At this stage, the public is also starting to become massively involved and active. As a result, the economic bubble is entering its fourth phase, or the crisis phase. The most important indicator of the crisis is that prices are no longer rising. As a result, those who are in the business of selling have already sold all their assets, while those who are not yet aware of the economic bubble are only now beginning to sell their assets desperately because they have realized that their price is too high to be sustainable. At this point, prices are also starting to fall and the public is starting to look for the ‘culprits’. This is followed immediately by the final stage or fracture. Unfortunately, such economic bubbles can grow over the years, and it is quite difficult to identify when they really started.


The reasons for the economic bubble are considered to be credit

The reasons for the economic bubble are considered to be credit

At that time, the number of cash loans in Latvia started to grow rapidly. Even though the lending activity is increasing again after the crisis, the situation has changed. During the pre-crisis period the lending market was disorderly and distorted. There was no single credit bureau. Although the Bank of Latvia set up a credit or debtors’ register in 2008, the information available to lenders was limited. Creditors kept individual credit registers, but there was no reciprocal exchange and settlement of customers’ credit obligations. Consequently, loans during Latvia’s crisis were the cause of the economic bubble, as lenders were not able to assess their potential customers due to the lack of a unified lending area and the lack of a single credit bureau. The creditors did not have information on the other credit obligations assumed by the borrower, so the loans were granted. The customer’s solvency could not be verified; the credit history, unless it was within a single lending company, was unknown. The people themselves, the borrowers, were irresponsible and borrowed money from the lenders without assessing whether they would be able to repay the cash loan on time. Similarly, the main collateral was the collateral. In the event of a loan repayment problem, in order to avoid losing his property, the borrower turned to another creditor, who, without knowing his existing credit obligation, issued a new loan with a bad credit history. In this way, the borrower gradually fell into the credit trap until there was no longer any creditor to borrow. Lack of credit disorder, lack of single credit liability information are also the main reasons why credit can be seen as an economic bubble.


Currently lending Latvian is already much more controlled sector

credit loan

These are made and various amendments to the law, was established in LNKA (Latvian non-bank credit lending Association), composed of existing members (more than 80% of Latvian creditors) comply with more stringent limits than those set by national legislation. Although credit may still be the cause of the economic bubbles, much has been done in Latvia in recent years to prevent a repeat of the difficult situation that occurred during the global economic crisis. At present, almost every creditor rigorously checks the income of borrowers – certificates from the SRS and employers are required, and sometimes it is necessary to present bank account statements of recent months -; there are restrictions on both the timing of cash loans and stricter age limits. Be sure that the lender checks the potential customer’s credit history, as debtors information is now available and verifiable. The restrictions also apply to the creditors themselves, who require a license that has to be re-registered each year.

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