The global credit crunch has been hitting world headlines for the past year but what exactly has been the cause of the crisis and how will it impact you as a consumer?
Turn on the TV news during the finance section and the odds are they may be talking about the current global credit crisis. While there is no shortgage of talk about the the crunch it's easy to loose sight of how it started and what the causes are.
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. Borrowers of these home loans took them up thinking they would be able to refinance them at competitive rates in the future. 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.
As prices began to fall the US housing bubble truly burst. 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. The losses to the banks have been heavy with subprime lending said to be responsible for $379 billion as of 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. All this has resulted in what is now being called the 'credit crunch' or 'credit crisis'. 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.
The subprime crisis has had a significant negative impact on many of the worlds major economies. This is depsite central banks taking corrective measures. 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.
It's been said before that when America sneezes the rest of the world catches a cold. The subprime crisis has really proved this and how in the age of a global economy a national economic issue will quickly become a global one. Economies of countries are linked. This has been proved in no mean measure by the subprime crisis.
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