I wrote a brief explanation to the current credit crunch, breaking it down into 10 stages – including why It occured and who does it affect.
Some Common questions on Credit Crisis
Why Do US Mortgage Defaults Affect the UK?
The US mortgage companies funded their mortgage lending by selling their loans onto other financial companies. This is known as rebundling debt; ironically, it was aimed at making the debt appear safer because the risk was shared amongst other financial institutions. (This is one reason why US subprime loans got a triple AAA credit rating). Therefore, when US mortgage defaults occured, it wasn’t just US mortgage firms who were in trouble. Many big banks who had bought the mortgage bundles lost money. Also because of the crisis it has become more difficult and expensive to borrow money, financers don’t want to get burnt with buying any more bad subprime debt.
What is actually meant by Subprime?
Subprime was primarily used in the US, but, has quickly slipped into British English use. Subprime essentially means lending to people without perfect credit histories. For example, if you miss a payment or go overdrawn without authority, you get a negative credit rating. This means you will be classed as subprime. In practice subprime can refer to any type of risky lending. This could be people with bad credit histories, or people with irregular income.
- In the UK subprime is sometimes referred to as ‘bad credit’ payments.
- There can be different levels of subprime. For example, one missed payment could cause a credit rating of subprime. But, if your home was repossessed this is clearly a more serious form of subprime.
How Does the Credit Crunch affect me?
If you are a borrower you may notice that lending becomes a little more expensive as banks seek to recover their profit margins. (This may be offset by cuts in the Bank of England base rate) Some mortgage products have been withdrawn from the market. New first time buyers will find it more difficult to find a mortgage which requires only a small deposit.
How Long will the credit crisis last?
Not easy to answer. It could last well into 2009 and beyond. If the US goes into recession there is a chance of more loan defaults. Confidence in the credit markets may take a long time to come back.
See also:
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Marriner S. Eccles, was the Chairman of the Federal Reserve from 1934 1948
In his 1951 memoir Beckoning Frontiers, Eccles detailed what he believed caused the Great Depression.
Our current situation is eerily similar.
Eccles wrote:
“As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth — not of existing wealth, but of wealth as it is currently produced — to provide men with buying power equal to the amount of goods and services offered by the nations economic machinery.
Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
Ideally speaking, the current financial crisis would not last well beyond 2009. What I foresee is companies selling their products and goods at a lower price thus enticing people to spend. These companies might have to lay off a few employees and might start producing less but later on, they would be able to recover their costs and, before you know it, the financial crisis would be over.
I still dont understand why the credit crunch in US caused a credit crunch in UK? is it because banks in UK depend on US banks to borrow money?
[...] house prices. The credit crisis has reduced the availability of mortgages and therefore reduced demand for buying houses. Also [...]
credit crunch initially can last for ages because the economic analysis defines how high mortages were not taken initially……..there the central bank is highly indebted and interbanking loans is carried on and also the baserates and bank rates are very high…..am afraid this may continue for atleast 3 or 4 more years!!!!
[...] Credit Crunch – Why banks stopped lending to each other and the impact this had on financial markets and the wider economy [...]
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