The Global Credit Crunch: The Decimation of Investment Banking, Followed by a Series of Commercial Bank Failures and Subsequent Rescues or Nationalization in Both the U.S. and Europe, Are Just the Latest Developments in a Devastating Financial Crisis, Known as the Credit Crunch
James, Sylvia, Information Outlook
I have been following the progress of this credit crunch since it started. When it began last summer, it seemed to me very like a crisis I lived and worked through in the early 1970s in London at the beginning of my career. Known as the "lifeboat," the then-UK regulator of banks, the Bank of England, saved a group of British banks called the secondary banks. These rather odd financial institutions specialized in extending credit to borrowers that had taken out second mortgages (and so had lesser claims on the real estate collateral for the loans) on their properties. A financial bubble had happened. It was built on cheap loans and easier credit regulation based on real estate, which had artificially escalated in price during the years preceding the crisis.
To anyone who knew anything about consumer lending, the secondary mortgage borrowers would obviously have problems keeping up with two loans if conditions changed and interest rates rose substantially. The inevitable rise happened--cheap and easy money dried up and the secondary banks collapsed. Sounds familiar? Substitute the collapse of riskier sub-prime mortgages that started this crisis for those secondary loans, investment banks for the secondary banks and the root cause of the current crunch is exactly the same, as this long forgotten time in England. (1)
It took years for the secondary bank crisis to work through the system in the UK in the 1970s. There were some very depressing years to get through for everyone in business. Hence, my feelings of impending disaster in August 2007 when the first news came through detailing the problems with the sub-prime lenders' mortgage debt default in the U.S. Nothing seemed to get resolved quickly and growing ever more gloomy I wrote an article for Business Information Alert in January this year, (2) where I expressed my pessimism about the way the crisis was being handled and then an article for SLA Europe News in July, (3) where I expressed the need for information professionals to engage with their organizations and develop services. Much older and (I hope) wiser, this time I knew much more about the development of a whole range of new financial instruments and their weaknesses, now embedded in the financial system, that didn't even exist in the early 1970s that makes this crisis so potentially catastrophic and, in the words of most experienced financiers, "systemic" across all areas of the financial services sector all over the world.
Credit crunches are not like other financial crashes--for example, those that occur from time to time in stock markets or on a commodity exchange. Credit permeates every area of the financial system and the real world of everyday business. It is impossible to operate without a bank account and lines of credit, no matter what the size of the organization. When credit dries up and trust in banking is withdrawn, no one can work normally, and that is why it is so important for government to step in and stabilize credit crunch situations early and decisively. For over a year now, lending between banks has virtually completely dried up and so the "wholesale" bank-to-bank market for cash that underpins all commercial banking, known as the "money markets" have frozen. In these situations, banks can only use funds and deposits available from the central bank in their country or taken from their individual retail or commercial depositors and investors. So, central banks, mainly the Federal Reserve of the U.S., the Bank of England, Bank of Japan and the European Central Bank, have been actively providing money for the wholesale money markets in the past year by pumping funds from their countries' treasuries into the system.
Unfortunately, this solution simply hasn't been enough, and so in the first week of September 2008 we began to see the complete failure of wholesale banking, manifested in U. …