Credit Crunch- Haven’t we heard enough of it in the past two years. It surfaced in the US during 2008 as a result of different instruments based upon the housing loan which ended up putting US through a recession and then engulfing the whole world economy.Well, just when the world was trying to recover from the economic downturn, we had another Credit Crunch, this time the culprit being the Eurozone Economy.Greece is taking the centre stage but Portugal, Italy, Ireland and Spain are equally at risk from the Credit Crunch.
What exactly is a Credit Crunch?
A credit crunch (also known as a credit squeeze or credit crisis) is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks
An economic condition in which investment capital is difficult to obtain. Banks and investors become wary of lending funds to corporations, which drives up the price of debt products for borrowers.
Getting Money Wise understanding,
There is no one out there who will lend me money primarily because no one trusts my ability to repay the loan given the economic conditions
The whole ecosystem of business revolves around Credit. Companies even countries borrow money for their day-to-day operations and then pay back that money with the revenue generated. But what happens when there is no one to lend them money- A Credit Crunch
How does a Credit Crunch Happen?
Now since it is clear as to what a Credit Crunch really is, lets revisit the housing loan debacle that occurred in the US and see if we can get the co-relation
Investment Banks created instruments based on housing loans by buying over house loans from lending institutions. The lending banks backed by the cash went on the aggressive in selling Housing Loans to people.So much so, that the due diligence was not performed to asses if the borrowers are worthy of repaying the loans. Well, the customer faltered in their payments. The investment banks were not getting the installments for their payments and then the whole value chain got sucked into having a lot of house loans without customers paying their installments.
We all know what happened after that. However, what this whole incident also created is a serious liquidity crisis in the market with the lenders suffering losses amounting to billions of dollars. Hence, they were not in a position to lend money at all.
Now, even with the economy slowly getting back to its feet, corporations needed money to operate and expand. Now, since the lenders were already standing on huge losses, they
- Did not have enough money to lend
- lost the trust on borrowers
What resulted is the whole market place devoid of any surplus cash to be borrowed. This catapulted into companies not being able to conduct their businesses and hence failing on payments of their earlier loans. Voila!! Back to how it all started
This was a laymen’s way of understanding What a Credit Crunch is and How A Credit Crunch occurs.
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