U.S. credit crunch
Alexander T. Hoffman 5.11.2009

“Credit Crunch” is an expression often used in the context of the currently ongoing economic crisis. A credit crunch according to Wikipedia is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks. The basic factor that lead to the actual credit crunch is the housing market bubble. So, how did we get in the current situation?

U.S. economic policy  

Since 70’s, the U.S. economy has been a consumer based economy. That means that the economic growth is based on consumer spending.  The main pillar of consumer spending is credit. Therefore, in order to sustain an economic growth, you have to have a policy that eases credit.  The policy that the U.S. used in the last decades for stimulating credit was repeatedly lowering the interest rate. The idea was that almost anyone with an average annual income to afford to get a credit for personal spending or to buy a house.

The housing bubble

Lowering interest rates allowed banks to borrow more money and as a result, offer more credits to the usual person to buy houses. As an immediate effect, the demand for houses was increasing and the supply couldn’t keep the pace. As a result, the house prices were rising and more and more investors were borrowing money from banks to build new homes and sell them in order to make profit.  Everybody was buying a house or investing in the housing market with money borrowed from banks and little by little, day by day, the bubble was created.  

The house prices and new homes supply became so big that the ordinary people cannot afford it anymore and the bubble was broken.

Almost everyone borrowed money from the bank to buy or build a house so, they had to pay the money back. The market surplus made the home prices to drop and people couldn’t pay back the whole credit.  Banks got with a lot of undervalued homes related to the initial loan.   They had to give the money back to the investors and the central bank. Because the home prices dropped, they had to give money from their wallets in order to pay back the loans. The liquidity in the market dropped and the credit crunch begun. The banks who made up to pay their loans and survived, now are borrowing money at a greater cost and with tight policies. As a result, the market got frozen and the financial crisis was born, a situation which we are living in today.

Resources:

• http://en.wikipedia.org/wiki/Credit_crunch
• http://en.wikipedia.org/wiki/Financial_crisis
• http://en.wikipedia.org/wiki/Real_estate_bubble

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