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The global credit crunch is one of the most serious financial crises in 2007-2009. Economists assign a number of factors that contributed to the credit crunch. This article deals with causes and effects of global credit crunch.

Causes of credit crunch

• US housing bubble : One of the primary reasons of the financial crunch was the US housing bubble, as high default rates followed immediately thereafter. An increase in loan incentives helped people to take out difficult mortgages with the intention of refinancing them in future. However, with the rise in the interest rate and sudden drop in housing prices, it made it difficult for homeowners to refinance their mortgages.

• Sub prime lending mechanism : The increase in the amount of sub prime lending was also an important factor that contributed to the economic crisis. Major US investment banks along with other government sponsored enterprises (such as, Fannie Mae) also played an important role in high risk lending.

• Predatory lending : Predatory lending was also an important factor that contributed to the global credit crunch. Predatory lenders advertised loan products at 1-1.5% interest rate and allowed minimum payment on an Option ARM. It is a complex mortgage product where a homeowner is allowed to make payment at temporary initial rate for a certain time period; even after the initial rate period ends, the borrower retains the option to make payments at the same interest rate. This is what led to negative amortization and the worst part was that the consumers failed to notice it at the beginning.

• Easy credit conditions : During 2000-2003, Federal Reserve lowered the Federal Funds Rate in order to soften the collapse effects of the dot-com bubble. However, during 2004-2006, Federal Reserve increased the Fed Funds Rate significantly. This increased the ARM (Adjustable Rate Mortgage) rates, thus making it difficult for the homeowners to repay their loans.

• Deregulation mechanism: According to critics, deregulation was also a cause of the global financial crisis. The regulatory framework failed to keep pace with the financial innovation; the laws were changed and enforcement weakened in certain parts of the financial system. Shadow banking system is worth a mention in this regard as it played a key role in the lending business.

• Over-leveraging : In the years preceding the global credit crunch, US households and financial institutions became increasingly indebted, which led to the collapse of the housing market. It worsened the economic downturn even more.

• Commodity bubble : Housing bubble was followed by commodity bubble. Oil price nearly tripled from USD 50 in 2007 to USD 140 in 2008. It resulted in a relatively larger share of consumer spending towards gasoline. It created downward pressure on the economic growth of the oil importing countries, as the wealth flowed to the oil producing states.

Effects of global credit crunch

Recently, International Monetary Fund has released an estimation, which states that there will be a $945 billion loss in the global scale in the next 2 years. It has also estimated that only the housing market will experience huge loss amounting to 565 billion US dollar. Along with this, loans tied to credit cards and commercial estate will also experience huge loss in the coming years.

The present financial crunch of 2007-2009 has affected each and every country all over the globe. Even smaller countries are experiencing the effects of the credit crunch that primarily occurred in US and Europe.