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The Credit Crunch Explained

May 7, 2008
'Credit Crunch' is the name given to the global crisis that has been affecting the financial markets for the past year. The crisis is causing many people to get further into debt - the only winners appear to be the debt management companies. The crisis affects everyone - not just those working in the financial sector, so this article aims to break down the credit crunch for you into an easily digestible article.

So what exactly is the credit crunch?

The term 'credit crunch' refers to a condition in the global market where money borrowing becomes far less easy. Banks and investors become less willing to lend money to anyone, which drives up the price of debt products such as loans, credit cards and mortgages.

How did it happen?

Following past crises such as 9/11, central banks on both sides of the Atlantic lowered their interest rates to stimulate growth in the global economy. This resulted in many credit-unworthy people borrowing beyond their means. Debt products were sold in huge numbers to people on low incomes and typically these debt products were sold at low interest rates, but only for the early part of the repayment period. At the end of the introductory period their interest rates shot up, and repayments rose dramatically. Many people defaulted on their loans, and had their homes repossessed. With nothing to repay the loans with, the banks had to simply write-off these debts, which meant they had a lot less money than they thought

How does this affect the European markets?

European banks bought up the sub-prime loans, packaging them into financial products known as collateralised debt obligations.

Rather than realizing the return-on-investment they were expecting, the packaged debts have become worthless, and impossible to sell.

How does this affect the rest of us?

The cost of borrowing will continue to rise, which means that interest rates may skyrocket. Only the people with great credit ratings will benefit from great deals, the rest of us will need to tighten our belts or prepare for costly debt repayments.

The overall effect of the credit crunch differs depending on who you speak to. Some say we are on course for a global depression similar to that caused by the 1929 Wall Street Crash. Others say that this is just a minor correction of the global economic markets and the situation will soon stabilize.

The latter may be hard to believe when you consider that a record number of people are now looking for debt management advice to help them manage their repayments. With many central banks ploughing money into the system, however, the crisis could soon subside, but it's anyone's guess exactly what will happen next in the credit crunch saga.

The situation in the US can be used as an indicator as to what will happen in Europe. They are currently experiencing massive price rises of basic food stuffs and fuel. They are also experiencing one of the worst periods of home repossessions in US history.
About the Author
Andrew Redfern is an expert in debt management and has assisted many organisations and individuals resolve their debt problems. He also advises companies on strategies to minimize the effects of the credit crunch on their business. Andrew runs a debt management company and trains independent debt advisors on best practice.
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