Credit Crunch Since Summer 2007

The US economy affects the entire world economy as they partner with individuals and businesses around the world. This can be explained by Mitchell’s theory of the business cycle which emphasizes that the dynamic phases of the cycle in the economic activity can be explained by the augmentation and the squeeze of the profit margins which in turn affect many important variables. This is exactly how a chain reaction has taken place in the global financial markets which have been described as ‘multifaceted’ and ‘complex’. Excess liquidity, the ‘savings glut’ in global financial markets, inadequate asset/liability and risk management practices of financial institutions, the un-orderly proliferation or the increase in the delinquency rates of the subprime mortgages in the United States, led to the failure of several banks including a classic bank run in the United Kingdom.4 As the events unfolded, it led to a run on one of the leading investment banks in the United States.The credit crunch has been referred in the past to explain the curtailment of the credit supply in response to a decline in the value of bank capital, and also conditions imposed by regulators, bank supervisors or banks themselves that require banks to hold more capital than they would have held. What took place in the summer of 2007 was credit squeeze, according to Mizen.5 At that time the effect of credit was restricted to liquidity in the capital markets and the effective closure of certain capital markets that affected credit availability between banks. There was disorder in financial markets as banks wanted to determine the true values of assets that were no longer being traded in sufficient volumes to establish a true price. The financial institutions were aware of the need for liquidity but were not willing to offer it except under terms well above the risk-free rate. This credit crunch too will have global implications as international investors are involved. In fact, this will be more complex than earlier crunches because financial innovation has allowed newer ways of packaging and reselling assets. It has been intertwined with the growth of the US subprime mortgage market.