Credit crunch explained - What's caused the global credit crisis?
Author: Richard Greenwood
The newspapers are full of articles on the on-going credit
crunch. Oil prices are up, inflation is definitely up and
there is a global credit crisis. What are the reasons
behind this?
We keep hearing about the term 'subprime lending'. There
are people out there, who do not qualify to get a loan at
market rates on account of their low income levels,
inability to meet the required down payment, employment
status and credit history. Such borrowers have been able to
obtain finance from banks on account of the boom time in
the housing sector in the US. These borrowers obtained
mortgage in the belief that they would be able to obtain
refinance on favorable terms at a later date. In fact, it
is understood that the subprime mortgage lending in the US
was to the extent of $ 1.3 trillion as at the end of March
2007.
The housing bubble in the US burst as prices dropped. With
ARM rates being set higher, foreclosure and defaults
started. The chickens had come home to roost with 30% of
this lending having turned delinquent on account of
inability to repay. Mortgage lenders like banks and
financial institution were affected first. In fact,
subprime lending has caused losses to the extent of $379 in
these institutions as on May 2008. Many of these lenders,
through the process of securitization, have passed on
rights to receive mortgage payments and the related
default/credit risk to third parties who have invested in
this type of lending through 'Collateralized Debt
Obligations' (CDO) and 'Mortgage-backed Securities' (MBS).
Institutions, corporates and even individuals who have
invested in CDO or MBO have lost significantly on account
of the decline in the underlying asset value. Stock markets
across the world have taken a beating.
Lenders have reduced their lending on account of the
aftershocks of the subprime crisis and its rather unclear
consequences on financial institutions. On the other hand,
corporates have not been able to get funding support for
issuing Commercial paper. This has led to what is now
termed as 'credit crunch'. Credit is needed badly, but
lenders are not willing to lend in the aftermath of the
subprime crisis and this has brought about a liquidity
crisis in the corporate finance sector.
While Central banks all over the world are taking suitable
remedial measures to make funds available to member banks
for on-lending to good borrowers and lend a boost to the
Commercial Paper segment, the subprime crises has put many
economies on a downward spiral. This is because less credit
availability combined with high interest rates leads to
reduction in investment and reduced consumer spending.
These are needed for fueling economic growth.
Another factor that is understood to have caused the credit
crunch is the Iraq war and spiraling oil prices. The budget
deficit in the US is the highest at this point of time and
this need to be reined in.
The subprime crisis has underlined the fact that the world
is now truly global with happenings in one country
affecting the economies of others. Economies of countries
are linked. This has been proved in no mean measure by the
subprime crisis.
About the Author:
Richard Greenwood writes on finance issues for bank
comparison website http://www.compareyourbank.com.au - the
website compares bank accounts, personal loans and
investments from leading banks.
Author: Richard Greenwood
The newspapers are full of articles on the on-going credit
crunch. Oil prices are up, inflation is definitely up and
there is a global credit crisis. What are the reasons
behind this?
We keep hearing about the term 'subprime lending'. There
are people out there, who do not qualify to get a loan at
market rates on account of their low income levels,
inability to meet the required down payment, employment
status and credit history. Such borrowers have been able to
obtain finance from banks on account of the boom time in
the housing sector in the US. These borrowers obtained
mortgage in the belief that they would be able to obtain
refinance on favorable terms at a later date. In fact, it
is understood that the subprime mortgage lending in the US
was to the extent of $ 1.3 trillion as at the end of March
2007.
The housing bubble in the US burst as prices dropped. With
ARM rates being set higher, foreclosure and defaults
started. The chickens had come home to roost with 30% of
this lending having turned delinquent on account of
inability to repay. Mortgage lenders like banks and
financial institution were affected first. In fact,
subprime lending has caused losses to the extent of $379 in
these institutions as on May 2008. Many of these lenders,
through the process of securitization, have passed on
rights to receive mortgage payments and the related
default/credit risk to third parties who have invested in
this type of lending through 'Collateralized Debt
Obligations' (CDO) and 'Mortgage-backed Securities' (MBS).
Institutions, corporates and even individuals who have
invested in CDO or MBO have lost significantly on account
of the decline in the underlying asset value. Stock markets
across the world have taken a beating.
Lenders have reduced their lending on account of the
aftershocks of the subprime crisis and its rather unclear
consequences on financial institutions. On the other hand,
corporates have not been able to get funding support for
issuing Commercial paper. This has led to what is now
termed as 'credit crunch'. Credit is needed badly, but
lenders are not willing to lend in the aftermath of the
subprime crisis and this has brought about a liquidity
crisis in the corporate finance sector.
While Central banks all over the world are taking suitable
remedial measures to make funds available to member banks
for on-lending to good borrowers and lend a boost to the
Commercial Paper segment, the subprime crises has put many
economies on a downward spiral. This is because less credit
availability combined with high interest rates leads to
reduction in investment and reduced consumer spending.
These are needed for fueling economic growth.
Another factor that is understood to have caused the credit
crunch is the Iraq war and spiraling oil prices. The budget
deficit in the US is the highest at this point of time and
this need to be reined in.
The subprime crisis has underlined the fact that the world
is now truly global with happenings in one country
affecting the economies of others. Economies of countries
are linked. This has been proved in no mean measure by the
subprime crisis.
About the Author:
Richard Greenwood writes on finance issues for bank
comparison website http://www.compareyourbank.com.au - the
website compares bank accounts, personal loans and
investments from leading banks.
