Credit crunch

Credit crunch …

We spent all of the previous week talking about the credit crunch, and we heard an interesting presentation from Dima about this problem. Let's summarize it: What is it mean, how does it occur and what is the final effect of it on the economy? Let’s have a look.

Credit crunch, what does it mean??In simple terms, it is the extension of the recession of the economy. Credit crunch is the situation where the rates for borrowing are raised, making it more difficult, maybe impossible for people, or companies to borrow money. There can be three reasons to explain this:

- The fear of the lender in a time when there are too many bankruptcies

- The increase in the rates of the State Bank

- The sub-prime

What does sub prime mean? Sub-prime is the money borrowed to buy houses (mortgages) from people who can’t pay back the money. The borrowers may be poor or unemployed people. Most of the sub-prime is borrowed by immigrants, but otherwise, the rates of borrowing are very high, and it can make a big profit for banks if they are lucky. Even though banks know that it is a risk to lend money, they still do it.

And finally, when the recession occurs, the price of houses falls dramatically and for people borrowing money, it is nearly impossible to give the money back to the bank… It caused an enormous loss for the bank. This situation caused the collapse of one of the biggest banks, the 158 year old bank in Wall Street – The Lehman Brother, in September 2008. Overall, a credit crunch can do a lot of damage to the economy by reducing the economic growth through decreased capital liquidity and the reduced ability to borrow. Or it will make the recovery of an economy slower.