Financial Crisis
The ongoing financial crisis which is initially referred as “Credit Crunch” or “Credit Crisis” has started from July 2007, and reached its disastrous pick on September 2008 by tumbling the financial system which has caused the economic downturn as Chain Reaction and affected the entire business chain. It may be cited as it was started in USA but the outcome has been resulted as Global Economic Slowdown, by which many rescue programs have been adopted and several conventions have been organized to look for inter-government joint programs to fight with crisis. The kick off of this turbulence might be addressed through the Subprime Lending and Housing Bubble, but in fact the US financial system already was exposed to the high leverage operations and was in weak credit risk position. Many developed nations have announced the Recession in their countries till end of 2008; many industries have seen decline in the consumption, the international trade has seen decline and unemployment has spread all over world.
Subprime Mortgage Crisis and Housing Bubble
The US Housing Bubble lead to the subprime lending program, which encouraged borrowers with low creditworthiness to enable home loans with less initial installment and terms that have resulted in highly risky program. It believed that steady appreciation of houses and increase prices will enable borrowers to sell the houses and pay off the installation even enjoy the little income. But this bubbling have lasted in December 2007, when the house prices began to fall down, the house owners started to delay in their installation payments, the foreclosure have increased and the banks started to shatter that had heavily invested in these Mortgage Backed Securities which are became less valued and illiquid, at the end the credit have tightened. MBS (Mortgage Backed Securities) are the financial products that generate mortgage payments and house price, that had encouraged major financial institutions and global players to invested greatly in these securities in the favoring US Housing Market, after the kick off the Subprime Mortgage Crisis the financial institutions have been bailed out to stabilize the weakening financial system. As of March 2007it was estimated that there are $ 1.3 trillion worth USA subprime mortgages. When the homeowners started to default in payment, it’s not only driven less income to the banks but also led fall of value of these assets sharply, it increased the solvency ratio and eroded the net worth of the banks and even resulted to the bankruptcy of the some banks. Even though the investors are insured by Credit Default Swap, the unstable financial system and high defaults have brought tightening to insurance agencies too.
The house prices fell 20% as of March 2008 against the pick in mid 2006. The decline of house prices resulted that the mortgage will be valued greater than the house value that pushes homeowner equity into zero or minus, which means that the house is not worth to own and to do high mortgage payments; this kept the foreclosure to rise.
Credit Crunch during Financial Crisis
The Credit Crunch is a moment when the financial institutions are unable to lend or do not have available amount to loan to the businesses, which results to the low working capital process and tightens the business operations and expansion. This condition forces banks to lend with high interest rate and hardens the enterprises to avail with fresh borrowings. During the Financial Crisis the banks were unable to lend and the unavailability of credit tightened day by day, the liquidity crisis off-shored even more bringing the scarce to the industries. At this vulnerable money market, banks have started to witness Bank Run where the depositors started to withdraw their money, and some banks forced to announce the bankruptcy. At the end of 2008 in US the consumerism fall sharply, the demand for working capital and business cycle required the retailers to reduce the prices of consumer goods which has resulted in deflation in the country. The 700 billion $ bailout program, that promised the inflow of fresh cash to the financial system and reaching to the hands of business units have appeared as a mirage, and till the end of 2008 the second rescue package started to be considered in this matter.
Liquidity Crisis during Financial Crisis
Liquidity is an asset which is easily converted within hours without causing the price differentiation with defined value; they can be either equity from stock exchange, securities, fixed income bonds etc. Primarily, the joint subprime lending program and Housing Bubble ended with up and downs, both the investors in Mortgage Backed Securities and borrowers with insolvency have came under tight spot as the prices of estates have slashed, even though if they wanted to sell off the determination of the worth became difficult, where these securities became illiquidity. The stock indexes have kept declining too, as the panic and requirement for cash drove the investors to liquidate their shares, the holders of equities too brought under the dilemma. The central banks have kept decreasing the interest rates to stimulate the economy but commercial banks continued to increase the interest rates, where the bonds are required to be devaluated. The business units keep liquidity in a hope to exchange them to satisfy their cash need, but when liquidity crisis has occurred it became one more problem. It was hard time neither the liquid assets nor the banks were able to finance the ventures to satisfy with working capital and inventory to operate business processes effectively.
