Your Guide to the Credit Crunch

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by Tom Heath

Over the last 6 months we have heard about a 'credit crunch' that is affecting the global economy. This credit crisis has resulted in many people struggling with their personal debt and seeking advice from debt management companies. This situation raises many questions for most people who do not work in banking and finance. This article provides a brief overview of this 'credit crunch' and how it will affect you.


What is the credit crunch?

The term 'credit crunch' refers to a condition in the global market where borrowing is difficult to obtain. Banks and investors become less willing to lend money to both individuals and corporations. This drives up the price of debt products like credit cards or loans.


What caused the credit crunch?

Since 9/11 and the dotcom crash, central banks lowered interest rates to allow the global economy to recover. This resulted in a boom in the 'sub-prime' mortgage market in the US. This means that debt products were sold in huge numbers to people on low incomes. Typically these debt products were sold at low introductory interest rates. At the end of the introductory period their interest rates, and repayments, rose significantly. Many of these people on low incomes have been unable to maintain their repayments. This has resulted in the repossession of a record number of homes. The banks then have to write off these debts, effectively losing most of the money lent out.


That happened in the US, why does it affect Europe?
Banks in Europe bought these sub-prime loans that were pooled into financial products called collateralised debt obligations.
These banks are now left with financial products that are worth less and almost impossible to sell.

How does this affect me?

The cost of borrowing will continue to rise. This means that if you currently have any debt, for example credit cards, loans or mortgages you will see your interest rates go up. If you do not have any debt but are applying for a credit card, loan or mortgage you will find it increasingly difficult to have your application accepted. This is due to stricter criteria regarding credit application approval.


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 Wall Street Crash of 1929. Others say that this is just a minor correction of the World's markets and the crisis will soon stabilise.

The latter may be hard to believe when you consider that a record number of people are seeking debt management, having their homes repossessed or are being declared bankrupt. It would appear that the effects of the credit crunch are going to be with us for some time to come.

Tom Heath has acted as consultant to various government and commercial organisations (including banks and debt management companies) regarding their preparations for a potential crisis in the financial markets. As well as a leading analyst of the the credit crunch he also runs his own debt management company.

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