The Credit Crunch What Does It Mean To You.
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by: ChrisClare
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The credit crunch is becoming a pressing issue not just in the UK but globally, and this article seeks to shed a little light on what it actually is and the impact it has on every one of us. Although this article is directed at the UK market, we are becoming more and more a global economy, and it helps to know what the credit crunch means to all of us as borrowers.
Let's start by explaining what the credit crunch actually is. The term, and the situation as we know it, began in the US, and was caused by two primary reasons. Firstly, the way money was being lent and also the way in which the lenders were procuring the money which they were lending have caused the problem.
Most lenders lend money they don't have, now of course they can't lend money they don't actually have but they can lend money that is not exactly their own. A lot of lenders lend what is called securitised money this is where they borrow money from another source and then lend it to you and I. Securitised money is generally sourced from what is known as the money markets. Lenders basically go to these money markets and borrow vast amounts of money at a time, millions in some cases. The amount that they borrow in any one time is also known as a tranch of money.
The lenders then proceed to borrow more money but the tranch of money that they have already borrowed is accounted for in what is known as a lending book. This lending book attracts great interest from institutional investors. Institutional investors can vary from single large investors to pension institutions who are keen to own repayable loans but would rather use intermediaries than deal with the people requiring the loans themselves. The value of these loan books to both the lender and the investor is dependent both on their size and the quality of the loans within.
It is the quality of these lending books that plays such an important role as to why we have a credit crunch at all. Ideally, a lending company would obtain a tranch of money for lending at a set rate. They would then lend this money to their borrowers at a percentage higher than that, and would therefore be making a profit. However, there are two significant possibilities which can ruin this ideal situation. The first is if the secondary lender lends poor quality money to the public. That is to say that some or all of that money has not been paid back and so is not effectively there to lend. The other possibility is if the money being distributed by the primary lenders, the distributors of the tranches of money, runs out.
Both these scenarios have occurred in the United States. Erratic payment and non payment of loans obtained by the public have left the secondary lenders with a trail of bad debt on their lending books which have in turn led the institutional investors to leave the markets. This has a subsequent effect on the secondary lenders in that there are less institutional investors to borrow money from and the ones that remain will be far more scrupulous in scrutinising the loan books before putting their money forward, and so continues the downward spiral. The secondary lenders need money to borrow and continue on but the investors are not willing to invest in what they can perceive from the loan books to be bad debt and therefore bad investment opportunities.
All this has had a corresponding effect in the UK and it is evident that many of its lending companies main source of business relies on securitised lending. Although this is not a reflection of the UK's more stringent methods of lending, it does show the caution with which the international money markets are treating the whole process of borrowing and lending.
This has also had an enormous impact on the UK lending sector as a whole with some of its famous institutions facing collapse. With the lending sector tightening its belt and the companies scrutinising their loan books it is a simple fact that present and future policy changes to safeguard their loans to the public the crunch comes down to us.
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