The credit crunch in USA is sparked by sub-prime mortgage in which loans for housing were sanctioned by banks to large number of borrowers having shady credit worthiness, which ran the highest risk of defaulting. When the crisis occurred depositors ran to bank in London to withdraw their money, warned the construction company to stop construction and cautioned economists about the shrinking prospect of the economy…
Lenders were also looking for borrowers even with lesser creditworthiness but new house buyers. Interest rate was already slashed from 5% to 0.75% in 11 installments. They were ready with exotic offers such as 'interest only' loans or 'option adjustable rate' mortgage (option ARMs). These loans were attractive because of low down payment but later the payment was to skyrocket. Banks wrote in average1% of option ARMs all mortgages in 2003 that went up to 15% by 2006. In certain American communities the option was one in every three mortgages written. By 2006 brokers were accountable for 80% of all mortgages originated. Brokers advocated hard for the option ARMs because that was highly profitable for banks and high commission fetching for the brokers. Banks had another advantage to bundle up many mortgages to sell them to investment funds; hedge funds, which used these as collateral for highly leveraged loans. The mortgages bundles were highly unregulated and not properly verified for credit worthiness. Investors who were holding these mortgage- backed bonds were at risk of losing high as a result of home loans given to people with poor credit profile. Since 2001 banks' credits have gone up 83% to$14.9 trillion and the total mortgage debt is up106% over the last six and a half years. There were millions of sub-prime mortgages in USA with reports of about two million of them expected to lose homes to foreclosure according to Pittman 2007.
Global economy will have negative repurcussions of the credit crunch in USA. IMF has alreay revised it growth forecast on account of the credit crunch by cutting the growth rate of UK to 1.6% down from 1.8%, and by cutting down the euro zone growth to 1.4% from 1.6% ad that of US itself from 1.5% to just 0.5% (IMF world Business outlook) This makes UK to sustain the higest growth rate in the face of crdit crunch. IMF has revised its forecast about the growth of emerging economies down to 6.7% in 2008. This is just 0.2% down which appears egligible with a view to 1% reduction in growth of US economy. This is a correction in IMF estimate of the past when it forecasted major impact on developing economoies of the credt crunch in US.0.8% ...
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Banks and investors become wary of providing funds to financial institutions thereby forcefully increasing the cost related to debt products for borrowers. This also affects for individual borrowers as banks become more risk averse towards their loan portfolio.
These concepts, methods, processes and trends of the profession are described in sections 3.1 to 3.4 and the results of the literature review are concluded in section 3.5 3.1 DEFINITION OF THE CREDIT CRUNCH A credit crunch is defined by Bernanke and Lown (1991) as a decline in the supply of credit that is unusually large for a given phase of the business cycle.
This combination has been a growing problem in the past few decades. The origin of the global financial crisis can also be linked to the bursting of the oil price and housing bubbles, and excessive low interest rates among the key nations in the global economy.
Bail Out of the US Banks and the World Economy
The government premise was that it was imperative to extend the bailout package as it intended to save the economy and the credit crunch was really making things worse at a global level. On the one side a section of the society was really concerned about the fact that those financial institutions that were responsible for the economic debacle were being bailed out.
The major causes could be termed as excessive liquidity, excessive lending, excessive leverage and excessive risk taking by the banks and other financial institutions. The global credit crisis posed a greater threat to UK Economy. It is estimated that almost 20,000 people will be losing their jobs alone in London's Financial Service Industry.
According to the report the credit crunch will lead to a fall in stock markets in the US. International organizations may witness a drop in their stock prices. The credit crunch may lead to greater fluctuations in exchange rates and interest rates and this will mean that international organizations need to rethink their risk management policies.
24). According to Clair and Tucker (1993), a credit crunch occurs due to an unusually large contraction of credit.
When an economy is driven to credit crunch due to a decline in the growth of credit, it is difficult to analyze whether the cause is a shift in the demand
Treasury secretaries and finance ministers worked late into the night looking for a way to grease the wheels of commerce and get the credit flowing again. The greatest economic minds in the world were at a loss to explain the crisis
Credit crunch is marked by decreased corporate cash flows that lead to an increased demand for funds to perform the expenditure of companies, as in the case of a decrease in personal savings that will lead to an increased requirement for funds to run a household.