What is the CREDIT CRUNCH?! Any book recommendations?

Question

Hi. I'm a 16 year old economics student and I'm failing to understand what the 'credit crunch' exactly is.

The press always goes on about it getting worse etc.. but it never really explains the fundamentals:

- what happens 'normally'

- what went 'wrong' to cause the credit crunch?

- what is the goddamn credit crunch!

- why is all this a problem

- how will it be solved

If someone can explan all this in a nutshell (without the jargon) it would be great. Please note, I'm only a beginner. I don't understand advanced words like 'sub-prime' !

Many thanks - it would be great if you could recommend an EASY book on this as well.

Answer 1

In order to understand the current credit crunch.  You need to know and understand how money works in the economy.

Money is just a symbolic means of exchange that has no intrinsic value of its own.  The government can print infinite amounts of money at virtually no expense to itself.  Most of the money in today's banks are nothing more than electronic numbers stored in their computers.

And the way money works in today's economy is that banks are allowed to create money out of thin air and lend it to people in return for interest payments.  When these people repay their debts to the bank.  Then the principal amount that the bank has created out of thin air disappears back into thin air.   And the bank pockets the interest payment profits.

Of course, the government doesn't allow the banks to create infinite amounts of money.  According to banking rules, banks need to have some money to begin with in order to create more money.  I think the rule is 10:1.  Banks are allowed to create and lend out 10 times more money than they have on their books from their depositors and investors.

But the problem with a bank being leveraged 10 times the amount of money it actually has is that if people start defaulting on their loans.  Then only a 10% loss wipes out all the real money the bank has from its depositors and investors.  A 10% loss on its loans makes the bank insolvent and unable to lend any more and to give money back to depositors who occasionally do want to take money out of their accounts.

That's what the present Credit Crunch is all about.  The banks have lent out a lot more money than they have from their depositors.  But these banks didn't make sure that the people they were lending to could pay back.  Many people are defaulting on their loans.  And now many banks are on the virge of insolvency as a result.  Many of them are still able to give money back to account holders, as long as not too many account holders ask for their money back.  But most banks are now in no position to lend more money to others.  Which is bad for the economy.

Of course the government can change the rules.  It can print a lot more money at no expense to itself, pay everybody who is supposed to be paid, and for a very short time all the problems would go away.  But printing more money at will like that dilutes the value of the money people already have.  This dilution is called inflation because it results in higher prices for goods and services.  And it hugely annoys the people who have been working hard and saving their money.   Because some of that which they've been working for disappears into thin air.

Answer 2

credit crunch bare basics:

started with mortgage lenders giving loans to poor rated credit customers (i.e not prime, but sub-prime),

this started in America, inevitably the customers failed to pay (defaulted) and this meant many lenders lost great deal of cash (why did they lend it out? because the workers for the banks made Huge commission)

this spread to the UK via British bank holding on US markets, most notably Northern Rock which used a lot of our savings (deposits) very riskily which lead to queues outside the bank (bank-run)

the default in sub-prime mortgages put a squeeze on cash available to the financial sector known notoriously  as the credit crunch, this resulted in a vicious circle where consumers lost confidence in banks, resulting in banks having less money to lend out causing a fall in consumption and investment which accounts for over 80% of UK's wealth (GDP)

mortgage rates are higher and less readily available and so less house buyers which consequently results in fewer houses being built (investment) which affects the labour market which affects consumption

you can look at how the credit crunch affected inflation and interest rates set by the bank of england

to summarize: credit crunch (squeeze) basically means lack of money (basically) to satisfy several needy agents of the economy (agents:firms, consumers, government)

how to resolve: well, print money. And thats what the FED the equivalent of the UKs Bank of england (BoE) and the BoE are pumping money and cutting interest rate (US mainly) to restore confidence and most importantly provide   credit but at the cost of higher inflation.

hope this helps

books? the internet is your best bet, i think the Financial Times website has a timeline and diagrams.

Answer 3

There is no book for the credit crunch, it would be out of date by the time it was written, there is a website though..

http://www.thecreditcruncher.com

It's basically caused by bad lending/borrowing. It has been made worse with rising fuel costs and static wages. The outcome will be a slowdown in the economy which will result in job losses until the situation stabilises.

Answer 4

It is actually a contraction in credit, not a "crunch".

Basically, available credit is what the banks, credit card companies, and other lenders are able to offer their customers.

In America, they have been increasing the available credit for a very long time to the point where most people have more available credit than they should (can afford).

Since the housing market is faltering badly, available credit is contracting which means that there is a significant drop in available credit.