Analyse the causes of the Credit Crunch - Essay Example

What is also significant to understand that the current crises are not just the result of the subprime mortgage crises but encompass different other reasons which have necessarily increased the overall severity of the crises. Further, banks also started to repossess the homes taken as collateral against the subprime mortgage loans which resulted into the decline in the prices of real estate. Credit Crunch is defined as a sudden decrease in the available funds for the purpose of lending and as such the credit crunch that resulted into US and spread to other countries includes a drastic reduction in the credit extended to private sector as well as consumers.

The apparent reason for this credit crunch is subprime mortgage crises however; there are three major reasons that are often cited as the key reasons behind the overall credit crunch experienced by the developed world. Banks are considered as the main actors behind the current credit crunch episode due to their imprudent lending policies. Over the period of time, banks started to lend to those borrowers who had relatively high credit risk however, due to their higher credit risk, they also offered an opportunity to earn higher returns.

In order to increase their profitability, banks and other financial institutions therefore started to lend to subprime borrowers in mortgage markets. What is however, important to understand that the banks, in order to recoup their lost liquidity, started to bundle these subprime mortgage loans into mortgage backed securities and sold them in secondary markets. The problems aroused when subprime borrowers started to default on their payments and banks have to take other funds to payback their obligations against mortgage backed securities.

The process of securitization therefore further aggravated the situation. This is because of the fact that the funds that were available for the lending were used