What is the credit crunch?
Kent-based financial adviser, David Braithwaite, explains how the credit crunch started and what it really means.
Last year, we would have all thought that the expression ‘credit crunch’ was a type of breakfast cereal, but now it is a word on everyone’s lips. But why? What happened and how does it affect us?
Like most things here, it started in America. Various lending institutions have always lent money to people in the "sub prime" arena – in other words, people who didn’t have the best track record in their ability to repay loans. The assumption was that the loans could always be maintained and that prices would continue to rise.
No one really knows how much was lent on this basis, but when things started to go wrong, banks became wary about who they then lent money to. The result was less cash being lent – a lack of liquidity.
Banks also lend money to one another. However, once this "crunch" started to happen and because no bank knew who the next Northern Rock was going to be, they all began to play their cards close to their chests and stopped lending to each other, preferring instead to keep their own cash to themselves.
The result of this is the cost of lending rising way above the Government’s targets. At the same time our household bills have increased, from food to fuel, making everyone rightfully nervous.
Now here is my crunch. We have never had so much information available to us, from so many sources, but sometimes the headlines are all we see.
Let me give you an example. We read that the Government has ploughed billions into the economy to prop up our ailing banking system, but in order to make sense of this and decide if it is time to panic or not, we need to put it into perspective. The billions which have been ploughed in are undeniably big numbers, but it is the equivalent of someone who earns £25,000 per year giving up £625.
There is still plenty of money to go round, and what has been done so far is actually a drop in the ocean to the Treasury.
I’m not trying to make light of the demise many of us are feeling right now and certainly it is a sad sign of our times that various industries, and ultimately jobs, are at risk.
The good news is these economic times are cyclical, things will get better - we just don't exactly know when. We have seen the price of car fuel decrease, some foods are cheaper, and VAT has reduced to 15%. If you can afford to invest for the long term and have an appetite for a degree of risk with some of your money, there probably hasn’t been a better time to invest.
Have you also noticed the reduction in junk mail from people offering you credit and loans? Every crunch has some silver lining if you look hard enough.
last updated: 29/01/2009 at 15:09