The aim of this article is to define the credit crunch and explain how it may have an affect on you as a borrower. Although it is compiled with the UK market in mind, due to similarities between the different countries within the European and world markets, the effect it may have on the individuals within these markets will likewise be similar.



First of all lets discuss what is the credit crunch? The credit crunch that most people have heard about first started in the US. It was primarily bought about by two situations, the first of which was the way in which money was being lent and secondly how the money was derived by the lenders making the loans.

When lenders loan money it is invariably not out of their own pockets, in that it is not exactly their own money. This sort of money is known as securitised money. It is money that has been borrowed from somewhere else before being loaned on to the public. The source of this money comes from what is known in the business as money markets. Vast sums of money are borrowed from these money markets by the lenders, sometimes millions at a time. The money borrowed from the money markets by the lenders is called the tranch of money.

Once that tranch of money has been lent to borrowers, they then set about borrowing more but what has already been lent is known as a lending book. That lending book has a value to institutional investors. Institutional investors are people such as pension companies or large investors who want to own loans lent to others that are going to be repaid but don't want to go through the hassle of actually lending it in the first place and dealing with the end user. Lending books depending on their quality can have quite a high value.

It is the quality of these lending books that plays such an important role as to why we have a credit crunch at all. Ideally, a lending company would obtain a tranch of money for lending at a set rate. They would then lend this money to their borrowers at a percentage higher than that, and would therefore be making a profit. However, there are two significant possibilities which can ruin this ideal situation. The first is if the secondary lender lends poor quality money to the public. That is to say that some or all of that money has not been paid back and so is not effectively there to lend. The other possibility is if the money being distributed by the primary lenders, the distributors of the tranches of money, runs out.

Both these scenarios have occurred in the United States. Erratic payment and non payment of loans obtained by the public have left the secondary lenders with a trail of bad debt on their lending books which have in turn led the institutional investors to leave the markets. This has a subsequent effect on the secondary lenders in that there are less institutional investors to borrow money from and the ones that remain will be far more scrupulous in scrutinising the loan books before putting their money forward, and so continues the downward spiral. The secondary lenders need money to borrow and continue on but the investors are not willing to invest in what they can perceive from the loan books to be bad debt and therefore bad investment opportunities.

This situation has made a huge impact on lending and borrowing in the UK insofar as that the majority of lending companies in the UK operate on the securitised money method of doing business. Although we are much more restrained with regards to our money lending/borrowing practises, the international money markets simply aren't lending money like before and we are all feeling the effects of that.

This has also had an enormous impact on the UK lending sector as a whole with some of its famous institutions facing collapse. With the lending sector tightening its belt and the companies scrutinising their loan books it is a simple fact that present and future policy changes to safeguard their loans to the public the crunch comes down to us.