Surviving The Credit Crunch: Credit In Chaos, How Did It Happen? (Illustrated Guide To The Credit Crisis)
Globally a 'credit crunch' is beginning to take place. This has been seen in the sub prime mortgage arena in the USA, and its effect is likely to continue across the globe in 2008. More and more homeowners are defaulting on their mortgage payments, and eventually going into foreclosure. This is equally as bad for individuals as it is for the global economy as a whole.
But what do all these fancy terms mean? And how is all this going down? Why did this happen? This is a very simplified look into the processes that caused the current financial crisis that is sweeping America and the globe. To answer the questions posed at the outset, let's look at the way the economy has been operating over the past few years.
People had been earning money, but not enough money to buy the things they really wanted, like houses and cars, and fancy televisions and other sweet toys.
In the past people would have had to have made do with saving the money they had and buying what they could afford, when they could afford it.
However, as the economy is a consumer driven beast, (consumer driven meaning that it relies on people to consume ie, buy things) it was considered better for the economy if people could consume more.
This is where the notion of credit evolved in the form of credit cards and mortgages. Banks would lend money at an agreed rate of interest to people who wanted to have the things that they couldn't afford yet . The idea was that people would borrow enough to get the things they wanted, and then have enough money in their earnings to pay back the loan.
However things very quickly soured when people began to see credit as a viable means of getting whatever they wanted whenever they wanted. People started buying groceries on credit, and putting things that they normally wouldn't have thought of purchasing on their credit cards. Banks would lend hundreds, oftentimes thousands of dollars to people who would go out to the stores and come back with high end consumer goods. The economy was booming. Everyone was happy because the consumption fueled more production, which fueled more jobs, which fueled more money, which fueled more credit (more credit than money).
People had not one, but 4 or 5 credit cards. In some cases people were paying off credit cards with other credit cards.
The problem was somewhat relatively isolated to consumer goods at first, but it soon spread to the housing market. Mortgages had almost always been a means to buying a house, after all, very few people could save up enough for such a large investment, but where mortgages were once strictly assessed and tightly controlled to make sure that people could really afford the homes they were purchasing, the consumer frenzy drove people to apply for larger and larger loans on larger and larger houses.
People began living outside their means in every way possible, and as the debt mounted, it became clear that there was not enough real money in the economy to make up all this debt. People had literally borrowed not just more than they had, but more than anyone had.
Banks tried to disguise this debt by selling it to offshore markets as investments, but soon it became clear that the people who had done all this lovely consuming couldn't pay off the debts, making the investments bad.
As more and more people began to default on their mortgage payments, a crisis arose. Not only could people not afford the homes they were in, but they couldn't sell them either, as there were so many other people in a similar situation. Where housing prices had always been on the increase, they began to fall in many areas, leaving the both the mortgage sector, and the economy crumbling.
Thus cameth the credit crunch.