Origins Of The Credit Crunch

Credit Crunch

The ‘Credit Crunch’ has affected everybody in the UK from banks to individuals, read details and information on the origin of the credit crunch, its impacts, current solutions and lots more...

Origins Of The Credit Crunch

Get a Free Quote What led up to the Credit Crunch?
Although the phrase ‘credit crunch’ has only been in common use by the media since August 2007, the origins of the credit crunch can be traced back to problems in the US sub-prime mortgage market, dating back to the period between 2004 and 2006.

What Caused the Credit Crunch?
At a time of relatively low interest rates, a number of US banks offered mortgages to borrowers with little or no income and poor credit histories (i.e. sub-prime borrowers). These loans and other bonds and assets were then packaged into financial products called Collateralised Debt Obligations (CDOs) and were sold on to financial institutions around the world. These CDOs were often then sold on again in a variety of guises to other investment banks.

Rising Interest Rates
When US interest rates rose and property prices fell, sub-prime borrowers began to default on their loans with the result that investors began to rack up losses. Because of the way in which these CDOs had been packaged and sold on, different financial institutions found themselves exposed to the same debt. This led to investors becoming unwilling to risk taking on further CDOs.

As the scale and multiplicity of the problem became clearer, financial institutions became concerned about the level of their competitors’ exposure to the problem and hence became increasingly reluctant to lend to each other.

Did any Specific Event Trigger the Credit Crunch?
Opinion is divided, but by July 2007, several US sub-prime lenders had filed for bankruptcy and the magnitude of the problem was becoming ever more apparent. The global nature of the problem became obvious in August 2007 when the French bank, BNP Paribas, suspended withdrawals by investors from two of its funds because it was unable to value the assets that they contained due to a ‘lack of liquidity’ in the market. This particular event is generally agreed to have been the start of the credit crunch as it is now perceived.

Central banks including the US Federal Reserve and the European Central Bank released billions of dollars worth of cash into the money markets to increase liquidity in an attempt to maintain inter-bank lending, but this strategy had limited effect.

Fallout from the Credit Crunch
As the extent of exposure to the US sub-prime mortgage market by financial institutions around the world has been revealed, a number of spectacular banking casualties have emerged, including Bear Stearns and Lehman Brothers in the US, Northern Rock and Bradford & Bingley in the UK, not to mention the whole of the banking sector in Iceland.

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