Credit Crunch

Introduction

On the 9 August 2007, the Libor interest rate increased significantly above the base rate. This effectively caused a seizure in inter bank lending and thus a shortage of money. The increase rate was due to Banks re-pricing risk. Banks had woken up to the fact that some institutions may have suffered significant losses in the U.S sub-prime mortgage market and thus might go bankrupt. The problem was no one knew which institutions were exposed to U.S. sub prime mortgage losses and thus there was no distinction between the credit worthiness of each bank. In the U.K. a high profile casualty of this fear was the Northern Rock Bank.

Credit Crunch Explained

Housepricecrash
Index
Main Page
House prices
Differences in the house price indices
First Time Buyers
Buying a home
Buying to Let
Renting your home
Mortgages,Savings,Investing & Pensions
Economics
Topical
Northern Rock
Sub-prime
Credit Crunch
Quotes
Categories
Keywords
Articles
People

In the simple old days a person would put their money (savings) in to a Building Society (for safe keeping) and be paid interest, at say 5%. A person wishing to buy a house would then borrow the money (mortgage) from the Building Society and pay an interest rates above that of which the saver was getting e.g. 6%. However, this made money scarce and thus people found if difficult to borrow money and thus were unable to buy expensive houses or cars (they still bought them!).

In the complex world of today the Building Society is a rare thing and instead we have banks. These banks borrow money on the international money markets (therefore avoiding the problem of needing a saver) and lend it to the borrower. The assumption being that the borrower will return the capital and the interest due on the loan. However, put very simply, the US sub-prime crisis has shattered the confidence of the foreign lender that they will get their money back, and thus they are no longer willing to lend to UK banks who use the money to advance mortgages. Thus the banks, unless they can induce us to start saving again, will only have a small amount of money to lend to people wishing to buy a house. However, we now have so much debt to repay we cannot afford to save. Therefore it is vey likely that the amount of money banks lend for mortgages will reduce, thus reducing the number of buyers in the housing market, thus making it a buyers market! It seems inevitable that house prices will now fall unless the government can inject sufficent tax payers money in to the vacuum.

Letters

  • To the Daily Telegraph: Paying for American Sins "Let me see if I have this clear. British banks have lent large sums of money to US banks, which in turn have made a lot of loans to American citizens with little hope of getting this money back. Now that the British banks are out of pocket, they intend to increase my (and thousands of others) mortgages to compensate". - Phil Harris

See also:-