The Credit Crunch – How it Happened

The makings of the credit crunch can be traced back to the early 21st century. It was at this time that house prices in the United States began their steep rise. The banks who were awarding mortgages to customers were no longer awarding mortgages in the same ways that they used to. Banks began repackaging mortgages and loans as bonds. These bonds were then sold on to third parties who believed that these were very secure bonds. In fact on many occasions the bonds related to mortgages belonging to customers who were very likely to default. This meant that the banks felt there was no limit to the money they could make by selling on these mortgages and because someone else owned the bond they did not have to worry about who they lent money to.

This theory worked fine when house prices were continuing to rise, however, when house prices began to fall and customers defaulted on their mortgages these bonds and loans went sour. The banks then starting writing down a lot of their losses but not disclosing their full exposure to sub prime debt. This meant that banks stopped lending to each other because no one knew who was safe and who wasn’t. IT is this inter bank lending which is the key to banks being able to operate and manage their day to day business. With this lending disappearing banks stopped being able to lend to customers and thereby perpetuating the fall in house prices.

In order to buy a house now lenders are looking for a deposit up front which is making it harder for first time buyers to get into the market. Governments are working hard to try and find means of getting banks to start lending again. This has included bail out measures to guarantee inter bank loans and boost bank’s balance sheets through purchasing shares. Ultimately this does not seem to be working as private investors are not giving their money to banks any more as they are worried about the solvency of the banks despite the fact that many are heavily nationalised. If this continues then it’s difficult to see and imminent end to the credit crunch.

Source by Thomas Barley

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