The Causes of Credit Crisis

Blog 1 – The causes of the credit crisis – you will need to look in the months of July to September 2007.

The causes of the credit crisis are linked to different factors. The crisis first started in the United States where its economy had been pretty stable over the past decades. The crisis in the U.S. was sparked by the mortgage crisis for homes. Houses in the U.S. are on sale at their lowest costs. Loans were borrowed constantly and numerous debtors never met the responsibilities or requirements of the agreement made on “subprimes.” The loans were at a higher risk therefore the consequences were bound to be harsh. The rate for the share of subprime mortgages signed up by many Americans was high and led to believing that financing for the buyer of loans was to be easier to pay for in shorter terms. Although a turning point occurred when house prices suddenly started shooting down after 2006 and on. When the prices for houses go down, covering the debt becomes uneasy since an increase of people started to buy loans without really applying to them legally also known as defaults. Defaults increased so high that it reached around $300 billon in credit affecting directly the lenders of mortgages who had no real safety regarding possible crisis. In the U.S. Mortgage payments are broadly used now days and there are consequences such as citizens not being able to meet their payments or the rates for mortgages increases. When house prices go down, refinancing is not met and therefore a credit crisis occurs being part of the economic cycle. When loans suddenly become more expensive it is known as a credit crunch. Due to the decline in the house prices, banks and borrowers make the access to buying loans more difficult and set them at a higher rate. A prediction of America’s economy was negative therefore banks took action in putting some restriction and security regarding the loans in order not to hinder the banking system which involves the rest of the world. Interest rates are raised as well as a result and first by the main central bank affecting all others. The credit crisis spread as banks work together internationally. It is like a ripple effect started first in the U.S. For instance, recently the UBS Swiss bank in Zurich for the first time faced a full year net loss resulting from the loss of 18 billion dollars in the US subprime mortgage crisis.

Another factor is weak monetary policies within the central banks. Lending became too easy and now banks are trying to straighten up and strengthen the policies. Which is why lending today is difficult. Globalisation also plays an important key role since banks are all inter connected causing a ripple effect. Therefore everyone suffers in the end. As illustrated above how Zurich lost a lot of money after the U.S. Central banks also went wrong by keeping the interest rate at a low rate too low to recover any losses. The low interest rates from 2001 to 2003 helped nourish to house market. But the consequences had to occur where borrowers find themselves in debts and lenders not being able to lend as much as they could. Central banks also lacked responsibility regarding the financial changes in their systems. Banks emphasized on inflation and other short terms outcomes rather than long term outcomes such as losses due to credit. The only reaction is to increase rates. Liquidity risks were also not taken into strict account.

Numerous investors issue loans to people. Going through lenders is easier since they are high risk takers and do not require as much as a bank would. If the asset of what the mortgage is covering decreases in price then losses will occur for the banks and investors. An important key component to credit crisis that occurred in the U.S. was partially do to lending to an important part of the population and the immigrants such as African Americans, Mexicans, and others. They applied for mortgages not knowing the consequences which led to serious debts. Those populations were not properly informed about the risks and rules and often apply for them thinking that they will make enough money the pay it back since most of them have a small allowance.

Before credit losses occurred the economy was doing well such as low inflation, increase house prices and other increasing positive factors led lenders to take higher risks. The outcomes were too good at one point and due to the credit cycle had to fall straight down. In conclusion, a lesson has been learned for the future.

Giverny Lowe