Last Updated: Sunday 17th March, 2013
The credit crunch is a term which has recently become part of our everyday speech and media - but do we really understand what it means, and what's caused it?
Well, the 'credit crunch' has become a bit of a catch-all term for the general debt problems that the economy is experiencing. It refers to the absence of available credit in the market, and effects both businesses and individual consumers. The problem has started because the banks across the world are increasingly reluctant to lend to each other, as it becomes clear that many of them have been investing in, packaging up, and selling on risky sub-prime mortgages, originating in the American housing market. The crash of the sub-prime loan market has meant that financial institutions have huge exposure to bad debts, which they may never recover. It will take a long time to understand just how individual institutions are affected, and to what extent, but in the meantime they are highly reluctant to lend to each other and available credit has dried up, as they seek instead to increase and retain all their deposits and shore up their balance sheets.
This absence of inter-bank lending means that consumers are also affected. Banks are reluctant to lend to customers as they don't wish to take on more credit risks, particularly with the economy dampening and the risk of defaults increasing.
Alongside these problems with available credit, the global economy has also taken a battering. As credit lines dry up, companies are starting to be affected - as credit is the lifeline of any business
- and risk folding, which will bring about an increase in unemployment. We've seen a number of large banks across the world go bankrupt - or being rescued by the government. There has also been rampant inflation from soaring oil prices and increased food production costs. Added to these combined problems, in the UK there is a huge problem with personal debt. as much of the apparent affluence and growth of the past few years have been fueled by rising personal debt and illusory wealth in the property prices. All of these issues have a knock-on effect on the economy which is now becoming increasingly stagnant, and in real danger of slipping into a global recession.
However, the global governments are now working together to try to stave off a global recession by pumping money into the global stockmarkets and getting the banks fulfilling their function of lending again. The American government has pumped Ј700 billion of capital into their markets and the UK has recently announced that it will be putting Ј50 billion into the troubled markets, with the government buying up preference share stakes in Britain's struggling banks and planning to part-nationalise these institutions.
What this will mean is as yet unclear, but it's very likely that a part nationalised UK banking industry will be far more regulated and strictly monitored than it has been in recent years. We as consumers are also like to see some real changes over the next few years - but for now it's a case of sitting tight, getting personal finances in order and effectively riding out the storm as well as you can!