What is Global Credit Crunch

Lately we have been hearing a lot about the 'Global Credit Crunch'. This Credit crunch started in the American Mortgage Markets. So lets begin by trying to understand how the mortgage market works in America:
Like in other countries, American home buyers approach banks and non banks for money. To lend to the home buyers, these banks and non banks get hold of money in two places :
Access to deposits: This is however only applicable to the banks and not the non-banks.

Global Credit Market: This is used by both non-bank lenders and the bank lenders. The bank and non bank lenders basically borrow from other international bank lenders and mortgage funds. These international bank lenders and mortgage funds in the global credit market are lending in the hope that the money will be paid back (with some additional interest). And the borrowers assume they can pay back to the global credit market because the home buyers they are lending to will pay them back.

So if everything was proper it should work like this:

• Home Buyers Approach Lenders For Money
• Lenders Borrow Money From International Bank Lenders Plus Mortgage Funds
• Lenders Use This Borrowed Money To Lend To Home Buyers
• Home Buyers Pay Back Bank And Non Bank Lenders
• Lenders Now Pay Back To International Lenders Plus Trusts

The US mortgage lending market has been very relaxed for a few years now. Credit has been readily available for home buyers. There was no proper credit checking.It has been very easy for people without good credit history to get loans.

So the above five step scenario is now a bit different:

• Home Buyers Approach Lenders For Money
• Lenders Borrow Money From International Bank Lenders Plus Funds
• Lenders Use This Borrowed Money To Lend To Home Buyers
• Only some Home Buyers Pay Back Bank And Non Bank Lenders. Since no proper credit checks done there is a huge number of defaults.
• Lenders Cannot Pay Back All the International Bank Lenders Plus Trusts
The major outcomes as a direct result of this are -
• The Banks have tightened their lending to home buyers. The credit check process is now more stringent.
• Since not all the of credit has been paid back to the global credit market (due to defaults), the global credit pool has considerably reduced. This has resulted in a huge credit crunch. Banks and Non Bank Lenders from across the globe access the same credit pool...Hence they are all facing a crunch - a global credit crunch.
• Due to reduction in the credit pool the costs of borrowing for all banks across the globe has increased....(when there is less money you have to pay more to borrow). So the banks and non-bank lenders will now pass on this additional borrowing costs to their mortgages by increasing the interest rates. Hence all home owners with home loans will be affected.
• Due to reduction in the credit pool the costs of borrowing for all corporations across the globe has increased....(when there is less money you have to pay more to borrow). Corporations cannot pass on their increased credit costs across to anyone - The only outcome for corporations from this is a drop in their profits. This is the reason why the share markets have not been performing well since the Global Credit Crunch started.

So what are the lessons for common investors here?

Even if you have ignored the previous paragraphs and are reading only this one its good enough. This is a time to be very cautious. The interest rates are going to rise - So resist the temptation to borrow for unnecessary items. This is a good time to return to saving for purchases rather than just financing them with debt.