The Credit Crunch

Unless you've been living on another planet for the past year, you've probably heard about this global financial crisis the “credit crunch”, you've probably heard about the negative impact its having on the worlds largest economy (the US) and therefore the world economy. Banks and financial institutions mainly in the US and UK are having to be rescued by governments.

Just exactly what is a “credit crunch”?

A credit crunch happens when banks begin clinging to their money rather than lending it out. The result of this is that fewer people are able to get loans, credit cards and mortgages so things that we would buy if we had those credit facilities – such as houses, cars, holidays and so on – are no longer an option.

House prices fall because no one can get finance to buy them, inflation rises because shops are having to spend more to make the same profit and it all spirals out of control.

Why did it happen?

The USA led the way for the crackdown on credit because their mortgage market went into a severe slump. The US had a massive subprime mortgage market and houses where rising in value so fast lenders couldn't keep up with the demand, these lenders saw an opportunity to make more money by lending to people with low incomes or bad credit histories. These borrowers were a greater risk so the lenders could charge more in interest, they weren't too worried if people couldn't pay, because of the rising houses they would be able to reposes or foreclose on the house and get their money back. But then it all went horribly wrong as more and more of these people found they couldn't afford to pay their mortgages more and more houses were put back on to the market, this made prices drop and the banks started losing money.

Banks from all over the world had invested in this market and they all started to lose money, others just couldn't get the money to lend to their own customers. The international money markets don't work as many believe, most people think when they go to the bank for a loan or mortgage it is the bank themselves that put up the money, this is not the case the bank borrow the money they lend you from pension funds and investment banks like Lehman Brothers.

Due to the sub prime crisis these usually sources have either dried up, can't or won't lend, many banks won't even lend to each other because their not sure who's share price is going to tumble next. The result of this is that only people with exceptional credit history are able to get loans, credit cards and mortgages.

Should I be worried?

That largely depends how much you rely on credit, whether you hold any shares in any banks and equally as much on how good your credit history and credit score are. It’s still pretty easy to get a mortgage in the UK but only if you have a flawless credit history.

People who don’t are going to find the going a lot tougher, whether that’s for a mortgage or a credit card or loan.

What’s going to fix it?

There are many factors and circumstances that must all fall into place before this situation improves. For instance the rate of inflation needs to fall along with interest rates, the stock market needs to be more buoyant, overseas economies particularly in America need to be stronger and we need more disposable income and better pay to enable us to buy more goods and services. In the main, it’s nothing we as individuals can do; it’s all dependent upon global finances and the cost of oil which has started to come down in recent weeks.