All About The Global Financial Crisis – Part 1

The phrase "credit crunch" has been firmly etched into the history books thanks to the countless media stories circulating around the globe over the past few years. This phrase is the name for the financial problems caused by banks in some western countries. The phrase, more accurately, is attached to the notion that many large banks are unable and unwilling to lend money. The lending market has ground to a halt and it is not an easy problem to solve.



The main cause of the credit crunch is sub-prime mortgages. Sub-prime mortgages are home loans that were approved to people with poor credit records and low levels of financial sophistication. The loans were secured against residential properties throughout the developed world, particularly in the USA although they were also issued in other countries such as the UK. After a large enough portion of these mortgages defaulted, the financial institutions who owned them suddenly realised they were worth a lot less than previously thought.



The financial institutions that own high rated bonds containing a percentage of sub-prime mortgages were, and still are, located throughout the world. This is why the problems created by this type of mortgage product, which were mostly granted in the USA, have spread to other countries. A pension company in Japan, for example, might own a bond from the UK that contains mortgages loaned to sub-prime borrowers.



This bond will lose its value thanks to the sub—prime mortgages going into default, so the Japanese pension company will suffer. When this happens the Japanese institution will become less inclined to buy more financial products containing sub-prime mortgages, thus helping to freeze the flow of credit throughout the world. Compounding the problem is that no other institution will buy the bond from the Japanese bank, so it remains on its balance sheet which negatively affects the company’s share price.



Through the above example it can be seen how a swathe of bad mortgages in one country can contribute to a credit crunch on the other side of the world. This scenario is the root cause of the credit crunch and, although it is still a relatively new phenomenon, an effective solution to the problem has yet to be found.



The credit crunch has caused problems that are unprecedented in history. Financial institutions that were previously thought to be worth hundreds of billions of dollars shut their doors and fired their staff. Large banks in the UK that have been around for centuries have been bought out by the government to prevent them from total collapse.



Of course many businesses around the world have ceased trading and forced their employees to become unemployed. Even companies as large as American automakers have had to seek financial help from the government.



The credit crunch is truly unprecedented and the world faces a major challenge to fix it up.



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