Clarifying the Credit Crunch
By: Alan Gill
We hear about it everywhere now, everyone is talking about it and it’s even been added to the latest edition of the Oxford English Dictionary. Just so that you don’t miss out on the chat, here’s a quick (and hopefully simple) summary of what it’s all about....
What is a credit crunch? Basically, it’s a crisis caused by banks being too nervous to lend money to customers and to each other. Where they will lend, they charge higher rates of interest to cover their risk that then leads to more expensive mortgages, dearer credit cards, etc. Not good news for consumers!
What caused it recently? Years of debatable lending resulted in a huge debt mountain as people borrowed cheap money and ploughed it into property. Lenders were free with their funds, especially in the US, where billions of dollars of mortgages were sold to people with weak credit ratings. This worked well when interest rates were low, but as they began to rise, US house prices started to fall and borrowers began to default on their mortgage payments sparking trouble for everyone.
How did it turn global? The way the debt was sold on to investors gave the crisis global significance as the US banking sector sold mortgage-backed securities on to hedge funds and investment banks who decided they were a great way to generate high returns. When borrowers started to default on their loans, the value of these investments plummeted resulting in huge losses for banks globally.
How did this affect the UK? Many UK banks had invested large sums in sub-prime backed investments and have had to write off billions of pounds in losses. But it got worse. Investors became nervous about buying any investment linked to mortgages, no matter how high their quality. As fear spread it became impossible to sell these investments leaving a black hole in many banks and building societies' finances. The result: a credit crunch as lending dried up.
What has this meant for consumers? Good value mortgages have become more difficult to find as borrowing rates have soared. Lenders have become more choosy about who they lend money to by, for example, demanding bigger deposits. Stock markets have dropped dramatically as strife in the mortgage market has caused confidence to plunge. That's been bad news for millions of us saving into areas like pensions and ISAs.
It’s in these situations that saving money becomes difficult to do and we could all use any saving tips that anyone has to offer.
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