The first credit crunch was first recognised in 2007 but the origins of the problem date back to 2004 when U.S interest rates took a steep rise. People who could just manage to pay their mortgages before the interest rates took a turn for the worse, started to fail on financially upholding the mortgage contract. High-risk loans to those with bad credit history or none at all rose to staggering levels. These bad loans and other loans, bonds and assets are grouped into portfolios (Collateralized debt obligations) then sold to investors all over the globe. This lead to investors losing money and in turns, hesitant to buy more CDO’s. Banks are also hesitant to loan money to other banks; this causes the bond market to freeze.
The effect of the sub-prime mortgage crisis is quickly shown to have implications around the globe. Investment banks as far as Australia suffer losses. In an attempt to stop this from further damaging the economy the US and European banks come together to try and strengthen money markets by allowing funds to be used by banks. The interest rates were reduced to help encourage lending. Although the short term help was not enough as it does now solve availability of money to banks as they are still hesitant on lending to each other. UK Customers run on banks as they withdraw £2bn from Northern Rock, this leads to Northern Rock requiring an emergence loan. In the US, a near-collapse of Bear Stearns leads to a major crisis of confidence in the financial sector and the end of investment-only banks.
Once again trying to find a solution the US plans to borrow $700bn from world financial markets to bail out Wall Street’s debt and then sell the assets once the housing market is stabilized. The UK government launches its own bail-out by allowing £400bn available to eight of the UK’s largest banks and building societies.
Governments plan to nationalize banks from Iceland to France as economies around the world are affected by the credit crunch. Central banks in the US, Canada and some parts of Europe take the unprecedented step of co-coordinating a half-point percent cut in interest rates in an effort to ease the crisis.
Shares have risen and fell with the news of failures, takeovers and bail-outs. This partly indicates the investor’s confidence in the banking system. While bank shares have been taking a beating because of bad debts, retailers have also took a beating as consumer confidence is shaken by falling house prices and job insecurity.
On August 4th 2011 stock markets around the plunged, with more than £3 trillion wiped off shares worldwide. The crisis started when people feared that Italy and Spain would be unable to repay their massive amounts of debt. This caused borrowing even more costly but for a short period of time was reduced on July 21st when the euro zone government would agree to a new support package. But this was short lived as investors and creditors fears returned and Italy and Spain’s borrowing costs continued to dangerous levels.
Although it may seem to the general public that it has no relevance to them whatsoever. But they are seriously wrong. This will directly affect pensions and may also affect the confidence of companies investing and creating jobs. Also in the case of bank shares when they drop it may show their ability to borrow, when they can’t borrow; they can’t lend, and when they can’t lend; the economy weakens. The problem is that a number of excessive indebted rich western countries and there isn’t a straightforward solution. All this will be a certain outcome of shrinkage of government. This in turn will affect the public sector, such as less expenditure on healthcare, pensions and education.
Bank shares have been seeing turns for the worse for the past week with Barclays dropping by 17%, RBS by 20% and Lloyds by 24%. RBS posted a half-year loss of £1.6 billion, £733 million for misselling Payment Protection Insurance (PPI) and its £867 million for its loan to Greece.
Now, people are beginning to worry that there will be a possible second credit crunch as two of the largest economies (America & Euro Zone) in the world are showing signs of increasingly large amounts of debt.