The global
credit crunch that started in August 2007 has demonstrated that London can no
longer be seen in isolation from financial markets in New York, continental
Europe or elsewhere. Some economies were not hit immediately by the US
sub-prime mortgage problems, the freezing of the money markets and the
subsequent confirmed recession. By the end of 2008, however, the impact was far
more widespread than a year earlier. Switzerland, Japan and some emerging
markets such as India were among those who took a later hit.
The collapse of the US housing market was the initial cause. Lending criteria had slackened for borrowers and many mortgages sold were sub-prime, which means they were granted to borrowers with a bad credit history.
Back in 2007, even borrowers with a solid credit rating were a risk, given that the properties they bought had in many cases slipped into negative equity, a proven catalyst for repossession.
Financial markets exposed to sub-prime mortgages felt the impact and this eventually froze the lending market. Banks were exposed to complex structured derivatives, known as collateralized debt obligations, which were backed by packaged slices of exposure to levels of risk in US sub-prime mortgages
The credit crunch exposed the huge risks that financial institutions had taken, typically off balance and using heavy leverage. In good time it seemed clever and made many of them a fortune. Let me borrow from the words of Chuck Prince, the former of Citygroup, in July 2007, in saying that so long as the music went on, everybody danced. As was inevitable, the music stopped.
The US played the biggest part in triggering the global credit crisis but, given the State of some Western economies, and the reckless state of UK and Europe particularly had been exposed to sub-prime mortgages. In think that central banks play a crucial role in restoring financial stability. There are some observers, such a Jim Rogers, who think that central banks should not interfere with the workings of the market and should let failed companies go under.
In the 2007-09 credit crisis, central banks have intervened with an unprecedented speed, innovation and coordination. They will have to face a lot more yet.
The Federal Reserve and European central banks have led the way. In general, the approach has been to pump extra money into financial markets and, increasingly, into the real economy. So far, this has prevented more major financial institutions from collapsing. It has not yet restored public confidence.
