Credit crunch definition
A credit crunch occurs when there is a lack of obtainable credit in the market and the borrowers cannot find adequate finance. Usually such a phenomenon happens when the creditors are unwilling to invest more money or hike up their interest rates to such exorbitant levels that it becomes virtually impossible for the lender to borrow (Lamb, p. 243).
History of credit crunch
The 1932-53 crises called for reconstruction of Finance Corporation and the trigger was Great depression. The 1989-95 crises needed Resolution Trust Corporation and the trigger was savings and loan crisis. In other countries too, like Sweden (1992-96) and Japan (1996), the resolution was in form of Bank Support Authority in Sweden and Resolution and Collection Corporation in Japan and in both the cases, the trigger was fallout from a real estate bubble (FT Research, p. 1).
Causes of credit crunch
There are multi strata perspectives of history and history without these layers becomes meaningless academic foliage. These layers of history could be defined as perspective and perceptions related to politics, economic, sociology, cultural and religious. Without the intervention or analysis of these subjects and subsequent incorporation and investigation in accordance to these subjects history would be wrongly incepted. Therefore, to understand whether the present crisis has a purpose or not it is important to analyze these subjects within the perspective of economic history as a whole.
The present crisis originating in America is similar to the 1980’s savings crisis. The sub prime crisis grew from the saving and loan (S & L) balance sheets under the Carter Administration when funds in this account took a battering from high interest rates during the period This made Congress loosen regulatory standards in order to divert S&L funds into more profitable real estate stocks. Commercial real estate investments were riskier. To buffer this initiative, federally backed amounts up to $100,000 were deposited into insurance funds. This instantly had the effect of attracting yet more funds and what is more, encourage risk taking. All this made regulatory standards lax. S&L funds were free to choose between state or federal regulations. Predictably, states relaxed fiduciary regulations in order to attract these funds, because they stood to earn large fees by registering these funds. In the ensuing race to financial destruction, states lowered regulatory barriers even more. The brunt was taken by taxpayers. Consumers took the rap on other fronts as well (Wolfson, pp. 113-6).
For many months after August 2007, the financial market has been loosing, more than making, money. The consumers in USA have been living beyond their earnings. They have been constantly borrowing money to pay for their houses and sustain their everyday requirements. Most of the asset prices, like the cost of houses, have elevated rapidly, making it a huge burden on first time purchasers. The lenders have been practicing securitization, where they have clustered the poor-quality loans by mixing them with some good-quality mortgages, and selling the whole thing as a package of debt. They have also lessened the criteria for giving a loan.
Since the Great Depression of the 1930’s, the US Federal Reserve has taken its boldest action by taking more than $200bn (F99bn) of housing debt as guarantee in order to prevent the mortgage finance industry from collapsing and head towards an economic crisis. People have the opinion that the Federal Reserves has taken the right action by absorbing all the mortgage debts, which others do not want. This has a direct impact on the spread of Credit Crunch Crisis all over the world. It is a truly innovative move taken by them. According to Article 13 of the Federal Reserve Act, they are not allowed to buy mortgage bonds completely, but can roll over a loan indefinitely (Evans-Pritchard, p. 1).
In July this year, unemployment amplified more than in any other month for the last 16 years. This has heightened the fear of the people that the Credit Crunch Crisis and the associated slowdown in the housing market are going to have a serious impact on the labor market. The economic activities and failing business confidence has taken a toll on the labor market. The rise in the number of unemployed people is creating pressure on house prices due to which houses are being sold at a more low rates (Williamson, p. 1).
Last year in the USA, the number of people who worked in the finance industry accounted for a little over one third of the total income earned by the whole city, which is almost double the amount which was there 30 years ago. Current records say that if USA’s economic problems persist, in the state of New York alone more than 40,000 people in the private sector will loose their job and the state will loose over $3bn in tax revenues in the next two years. Experts believe that the banks and the other financial institutions all over the country need to lend money in order to make some. The value of property is being affected causing huge losses to the local property tax. The state, without the property tax, has to rely more on its income tax receipts. As the returns on the investments are being reduced for the employee pension funds, the employees will have to make a greater contribution towards it in the forthcoming years (Fletcher, pp. 188-90).
Heitfield pointed it out, “Financial regulators did not adequately distinguish between structured and unstructured credit exposures“. Alongside, “Investors, attracted to higher yields, relied on credit ratings, ignored exposure to systematic risk“. (Heitfield, 1) All these elements summed up to build up the current crisis.
Current situation
The most innovative plan to diminish the credit crunch has been to increase lending with the motivation tom restore liquidity to troubled markets and look after the demands of the inter-bank loaning facilities. The current crisis made the Federal Bank to decrease the interest rates on lent amounts and lengthen the time limit for the repayment of the loan (Cecchetti, 1).
Future
It is plain to see why market based financial systems are the superior method of economic growth. Laissez faire is an important cornerstone in today’s free world market, and it should stay that way. Banks are still regulated by the government, and obviously have been failing to keep up to par. The choice is obvious and hopefully the government begins to support private financial groups more in the future (Labaton, 1).
Works Cited
- Lamb, Davis; Cult to Culture: The Development of Civilization; (Wellington: National Book Trust. 2004)
- FT Research; History of Credit Crisis Over the World; The New York Times; 2008
- Wolfson, Martin H; Financial Crises: Understanding the Postwar U.S. Experience; M.E. Sharpe; 2007
- Evans-Pritchard, Ambrose; Fed takes boldest action since the Depression to rescue US mortgage industry; telegraph.co.uk; 2008; Web.
- Williamson, Mark; Soaring unemployment raises fears of credit crunch fall-out; The Herald; Newsquest (Herald & Times) Limited;
- Fletcher, R; Credit Industry: Beliefs and Knowledge; Believing and Knowing. (Mangalore: Howard & Price. 2008) p. 188
- Heitfield, Erik; Resecuritization: a Post Mortem; National Association of Business Economics Annual Meeting; Federal Reserve Board; 2008
- Cecchetti, Stephen. Federal Reserve Policy Actions in August 2007: Answers to More Questions. Brandeis University; Eurointelligence Advisers Limited. 2007.
- Labaton, Stephen & Andrews, Edmund L; In Rescue to Stabilize Lending, U.S. Takes Over Mortgage Finance Titans; NY Times; 2008.