Dictionary.com defines a credit crunch as: An economic condition whereby investment capital is difficult to obtain. Banks and investors become weary of lending funds to corporations thereby driving up the price of debt products for borrowers.’
Raising Interest Rates
The credit crunch that is currently sweeping the world has been caused by a long period of irresponsible lending to people or organisations that should have never been leant money in the first place. This results in lenders falling into debt when the loans are not repaid. What happens next is, banks and lenders then slash the amount of credit available, and increase the cost of borrowing by raising interest rates.
2007 Subprime Crisis
The current credit crunch has been caused by the 2007 US subprime mortgage crisis. The US housing market had market prices that were overinflated, and when the prices collapsed it created a financial crisis. Since all banks and financial institutions do business with each other in the global village, the collapsing US housing market directly affected foreign banks and lenders, because they had invested in some of the organisations in the US that had leant out the money in the first place to people or organisations who couldn’t afford the loans. So when the US market began to crash, the UK and European lenders and investors pulled back on the amount of credit available, and increased interest rates on all their current products to attempt to recoup the losses they had sustained elsewhere in the financial market.
Trying to Stablise
US and UK governments have recently been slashing interest rates in a bid to stabilise the market and have been encouraging financial lenders to pass the cuts onto customers and in turn encourage consumers to go out and spend money once again. There is fear that if the western world doesn’t pull itself out of this financial crisis that a long recession could happen, with the potential of a 1930’s – esque Depression being around the corner.
The outcome for this situation will only come clear with time. The question is, to spend our way out or save?
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