CREDIT CRUNCH

Credit Crunch

Credit Crunch

Financial crises have intervened the operation of financial markets over years. Most noticeably the great depression in 1929-30, the 1970s inflation crises and the banking crises in the 1990s created havoc in the financial markets causing severe disruption. The current financial crisis which emerged in 2007, although the roots were sown much earlier, has been one of the toughest and probably the biggest that financial markets have ever encountered. Referred to as the credit crunch, the impact of the crisis has not only been on the banking sector but on the real economy as a whole potentially leading to long and deep recession. The credit crunch has been blamed for the more general economic downturn and everyone around the globe has been affected by it. The most obvious effect would be the slow-down in the housing market.

It seem that the cause of credit crunch is being blamed on thousands of borrowers who took out loans that they could not afford and fail to pay for in the long term, eventually abandoning the payments altogether. This leaves lenders having debts on trillions of dollars sitting in their books.

It believed that the credit crunch that we are been experiencing is cause by the ill lending decision making by the financial institution itself, where mortgages loan were being offered to people who really did not considered qualify for a mortgage (i.e. high risk of default).

To understand what had happen, first we need to know how the mortgages are funded and how they are funded. The financial institution got too much money available due to people depositing money into their saving account. The banks have keep certain percentage of the saving money as `capital reserve' and the rest are use to make investment and to loan it out to people and organisations in order to make profit by charging interest on all the money they lend.

The financial institutions generate in more creative ways and strategies of finding more and more potential borrowers, and had made number of loan increased with less regard to ability to repay. People who were considered a "good" risk already got a financing / mortgage loan were offered to get another loan. The banks even lowered their standards for those people who have low incomes to apply for loans. The consumers have been bombarded with advertisements offering easy loans for housing, large electronic items and other luxuries items which often spurred more by envy rather than needs leading consumers applying to refinancing against home equity, forsaken saving and used credit cards as cash. In the 1980s, they had regulation changed in order for the banks and the building societies could substantially upgrade the amount they lent (in some cases at >100% of the current value of the property) to customers with poor finances/credit histories. At that time the economy was stronger; it was a boom year for the banks and building societies as they were making huge ...