Analyse the causes of the ‘Credit Crunch'
In the world of business, every rise has an end. This is a phrase used by many businessman, economists, and bankers. This saying is reality nowadays with the present credit crunch or the “depression” as also known. But how did it begin? Was it due to a simple reason? The aim of this essay is to analyse the causes of the credit crunch that has hit every corner in the world.
The world was living in a so-called boom years from 2005-2008 every business was progressing in a very good shape, unemployment was falling which directly increased the nations annual growth. However August 9 2007 was the day where banks, petrified markets, and the property markets were blown to pieces by a shortage of credit. By that time, optimism was still around many people saying that this credit crunch would live as a normal business cycle collapse and would last for 2 or 3 quarters. This view was totally wrong as the world now entered the second year of the credit crunch.
One of the major effects of the credit crunch is the collapse of the Lehman Brothers which is the largest financial bankruptcy in US history. Since the sudden and shocking collapse of this organization made a dramatic meltdown in global finance, this shows how a major effect it was globally. After Lehmans, the crisis has spread in a very fast way especially on poor countries severely hit. The crisis estimated to have thrown an additional 100 million people into absolute poverty.
Moreover, before August 2007 consumers in the US and Britain were “living beyond their means borrowing money to buy houses and fund their spending habits” (Elliot, 2008). In the light of that, asset prices rose rapidly. But this was not a major problem that time since lenders gave loans in an easy way which is also a major cause for the credit crunch now. The bundled up the poor quality loans, mixed with some good quality mortgages, and sold the packages of debt in a process known as securitisation (Elliot, 2008). After all that risk started to come up but no one took it seriously as all where obsessed with the money they were making. The biggest threat was the fall in house prices. Banks then stopped lending
to one another, then sought to repair their finances by cutting back on lending to their customers. After these steps borrowing became harder and more expensive which is a classic definition of a credit crunch.
Mainly, credit crunch create a lot of problems through the world and for every home. But there are 3 major problems that they cause in every countries economy. To start off with the first, it is the shortage of consumer loans. The shortage starts when banks start seeing a decrease in their reserves due to bad debts. Moreover, due to the high cost of interbank, lending money to consumers fall this may cause house prices to fall, consumer confidence to drop, and decrease of profits for banks and share values.
The second problem will be the tighter credit standards. Due to the shortage of credit, the banks must increase the cost of mortgage products which will create a gap between base rates and bank rates. Furthermore, the cost of making a fixed rate mortgage will increase especially when existing borrowers finish off with their deals.
Last but not least, the third problem is the Mortgage Arrears Forecast to Rise. Due to mortgage rates rising and becoming stricter, several homeowners will face this complexity in their future. The rising of mortgage default is also based on the increasing energy price and low wage growth. Above on that the rising unemployment will even make a mortgage more complicated which is the last thing finance system need right now.
In Alan Greenspan's view, the credit crunch will happen again. Since the crises are different but have one fundamental source which is the long periods of prosperity which will happen over and over again. But how hard other crisis will come, totally depends on the issues next to the prosperity as Alan Greenspan believes.
To sum up, it is clear that the credit crunch didn't happen due to one reason; it had a series of occasions throughout a long time. Starting with the financial and how they were giving loans in an incorrect non controlled way. On the other hand the warning coming up without any one taking it into consideration, ended up with the bankruptcy of the Lehman Brothers which was the main effect and kicked off the real depression into the whole world.