“How did the recent credit crunch affect Financial Markets and institutions?”
The current financial crisis, also known as the ‘credit crunch’ has created turmoil in the economy since it first began in 2007. It is the first major financial crisis the economy has experienced since the ‘great depression’. The credit crunch refers to an unexpected shortage of finances for lending; consequently it would be difficult for businesses and people alike to obtain loans, as there would be an increased unavailability of funds.
The credit crunch was instigated when investors lost confidence in the value of scrutinised mortgages, as there was a sudden increase in defaults on subprime mortgages. Consequently, this lead to a liquidity crisis that required the United States Federal Reserve, European Central Bank, and the Bank of England to provide a considerable cash injection of capital into the financial markets. The mortgages were primarily in the US, but the resulting deficiency of finances had spread throughout the globe. Furthermore, this had a detrimental effect on other financial markets, thus having damaging consequences on many banks throughout Europe and the US. In addition economic growth showed a great downfall, with the increase in commodity prices influencing inflation to rise considerably. The inadequacy of the originate-to-distribute model to new mortgages that has been implemented over the years was held responsible for the unexpected change in financial environment, however a majority considered that after enjoying a credit ‘boom’ over many years, a credit ‘bust was due. This was further supported by the different stages of financial development, as the economy previously experienced an increase in monetary and global aggregates, a long-term era of low interest rates, and high priced assets.
To further understand what caused the credit crunch, an understanding of the foreign exchange market, the bond market, and the equity market must be taken into...