The Credit Crunch What Does It Mean To You.

By Chris Clare in Mortgages on February 22nd, 2008

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by Chris Clare

This article first discusses what the credit crunch actually is and then what impact it has on you the borrower. Whilst this article is written for the UK market it is fair that a lot of the issues dealt with here will have a very similar impact on people in many other countries as most of the issues do cross the geographical boundaries that exist.

Let’s start by explaining what the credit crunch actually is. The term, and the situation as we know it, began in the US, and was caused by two primary reasons. Firstly, the way money was being lent and also the way in which the lenders were procuring the money which they were lending have caused the problem.

Most lenders lend money they don’t have, now of course they can’t lend money they don’t actually have but they can lend money that is not exactly their own. A lot of lenders lend what is called securitised money this is where they borrow money from another source and then lend it to you and I. Securitised money is generally sourced from what is known as the money markets. Lenders basically go to these money markets and borrow vast amounts of money at a time, millions in some cases. The amount that they borrow in any one time is also known as a tranch of money.

Once the money in these tranches of money has been divided out amongst the lending company’s borrowers, the lender goes about getting more money to subsequently lend again, but the money that they have already given out is thereafter called the lending book. This lending book then has a value to investors. In a nutshell, institutional investors are looking to buy a loan so that they can cash in on the interest payable, but they don’t want the hassle of borrowing the money and giving out the loans in the first instance. These are normally pension companies or large investors, and certain lending books of high quality can be very valuable to them.

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.

Unfortunately, both possibilities have become reality in the US. Lenders have given out money to poor quality borrowers who have not properly paid back their loans, so the lenders are then stuck with bad debts. The knock-on of this is that the primary lenders are then cautious about giving out more tranches of money, and so the amount of money available to borrow is drying up. Because the secondary lender cannot acquire more money to lend, this then has a detrimental effect on their lending books. Because their lending book is of poor quality, it is difficult and almost impossible to sell on to an institutional investor as they don’t want to take on a bad debt which they may never make, and indeed may lose, money on.

All this has had a corresponding effect in the UK and it is evident that many of its lending companies main source of business relies on securitised lending. Although this is not a reflection of the UK’s more stringent methods of lending, it does show the caution with which the international money markets are treating the whole process of borrowing and lending.

The situation in the US is causing untold damage to the money lending industry in the UK and there is no doubt that many corporations could be destroyed by it. This may seem a world away from Joe Public, but as lenders tighten their belts on lending requirements in order to keep a high quality lending book, we will continue to find it more difficult to borrow money.

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