Can anyone explain the credit crunch and how it came about in a nutshell?

Question

This is what I thought happened:

A US mortgage lender/investment bank (Merrill Lynch) gave low income households a mortgage at a rate of 120 %( sub-prime mortgages). hese woul work provided th economy stayed the same...but it didn't because a boom in the economy is usually followed by some kind of bust. These people couldn't afford to pay their mortgages..trouble for ML. Everyone gets suspicious...got UK thinking that banks here may have also infected themselves in sub-prime waters...that bank turned out to be Northern Rock. Theirshares plummeted, their customers fled..shareholders refused to let Virgin Olivant bid...govt might nationalise it...thats still going on...

Whilst first time buyers ( or any potential buyers with a bad credit rating) can't get mortgages because the banks are hoarding their money rather than risk bad debt. People looking to sell can't because there's no one to buy their property so the property market is at a standstill. Fuel prices have gone up due to political tension in the Middle East, food prices have gone up so people are less likely to shop for clothes, furniture etc so the retail sector is at a standstill apart from food...basically the whole economy is slowing down because some bank in America didn't understand some basic economics...

How accurate is this, because I have an interview with law firm next week and I need to clarify my understanding of this. Can anyone explain it better? My version seems a bit basic...

Many thanks!!

Answer 1

The credit crunch in the US was the result of the sub prime mortgage problems. About four years ago US Investment banks created an investment Bond using mortgages as its underlined security. Or prime mortgage bonds. So they need to buy mortgages from banks there and elsewhere to create more bonds for investors to invest in the US and all over the world. Initially due the housing boom and the robust housing market there those bonds were termed as AAA investment for investors. And as demand of the mortgage bonds increases by US,UK investors and the world all investors made profits when the price of the bond increases. In late 2006, when the housing bubble burst, house prices drops drastically and the housing market collapsed. Mortgage borrowers cannot repay their repayments of their mortgage and banks had to take foreclosures actions in order to recover their loans to them. Those investment bonds become sub prime mortgage. The bonds also became worthless as investors paniced and started to sell off their investments at any price and suffered heavy losses and some even loss everything. In the UK most banks also suffered huge losses because they bought the US sub prime mortgage and had to do write downs. But Northern Rock was directly involved with the US sub prime mortgage problems, because they sold their mortgages to those US Investment banks for them to turn them into bonds. It not only have to incured huge losses on those sub prime mortgages it also had to do its write downs. It had liquidity problem and when there was a run on it by its customers they had to sort help from the Bank of England in order to repay its depositors. The Bank of England had to bail it out and then nationalised it to prevent it from collapsing. This is all I know about the matter, hope this help.

Answer 2

youve pretty much hit the nail on the head and if you add much more detail it could get a bit long and boring

this isnt the first credit crunch and it wont be the last the economy will fix its self soon enough although it could be sped up a bit if the government tried to do more about it instead of wasting so much money that could fund a recovery :/

Answer 3

Putting the economic jargon aside for a moment - bankers are greedy people driven by their next bonus and with no thought to the consequences of their actions. Lending to people who couldn't afford to repay their mortgages in good times, let alone bad, was reckless. But they sold the bad risks on to others, who were happy enough to snap them up in the hope of selling on to others, and so it goes on. Until one day things start to look bad and people worry, and therefore decide not to buy up other people's loans and mortgages etc. Nobody in the banking system was managing this risk - they really did have their eye off the ball on this.

Now some banks have had their fingers burnt they are being far more careful in who they lend to. You can still get a loan if you are a good risk (e.g., borrowing up to 80% of the value of a fixed asset).

Why did it reach the UK? Because the gullible, greedy British bankers were all too eager to climb on the bandwagon and bought lots of dodgy US mortgages that were never going to be repaid, with the aim of selling on to others.

Considering the misery that this kind of thing heaps upon ordinary people, some of whom will lose their houses, and the rest just putting up with tighter credit and a slowing economy, this practice ought to be outlawed, and bankers more tightly regulated. Why it's not a crime is lost on me - how about "economic sabotage"?

Answer 4

Far more basic than that it is a bunch of people who wanted houses they could never afford without some Lender coming along and getting creative.

Now the govt' comes along and those poor babies just gotta' be helped out!

Answer 5

In a  nutshell. Fico score lending.

Back before all the fico score worship. Banks used manual underwriting for home loans. Back when Bankruptcy and debt was almost unheard of. Now with Fico score lending being the norm. Bankruptcy and debt have sky-rocketed.

Answer 6

basically right apart from Northern Rock has been nationalised and the main initial cause was greed rather than a poor understanding of economics, you can charge somebody with a poor credit rating higher interest, fine until it all goes wrong, then they can't, won't or don't pay back the loan and then your bank is in trouble. It then spreads around the world because that bank has borrowed the money from other world wide banks and they find that they can't pay back there loans either, hence the worldwide melt down