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The Credit Crunch in the U.S.

By: Stephen Bishop Jr.
Published: November 2007

Unfortunately today our nation is faced with a credit crunch. So, what exactly does that mean for us, the average consumer? It means that the credit supply is decreasing. Credit card issuers and lenders have become more stringent with guidelines, and borrowers have tougher times getting financed. Higher interest rates result and economic activity slows down.

It all started around 2001 when the United States enjoyed a huge acceleration in the housing market. Extremely low interest rates combined with willing lenders encouraged consumers to purchase homes. Beginning late 2005, these property values began to decrease and homeowners were left with unaffordable mortgages. Working Americans found the value of their homes falling while their mortgage remained the same, and in some cases even increased. Since then, foreclosures have been increasing at an alarming rate, and home sales have continued to slow down.

Many Americans will do whatever it takes to achieve the classic American Dream: to own their own home with the white-picket fence and all. This is the major dilemma with the credit crunch in the United States; many people bought homes and now cannot afford their mortgages. Others saw the purchase of a home as an excellent investment opportunity, but in this case the value of their homes dropped and they are left to pay the same, or sometimes an increasing mortgage.

Adjustable-rate mortgages (ARM) were very popular during the housing market boom. These mortgages were given to people with less than perfect credit and allowed them to buy a home with a low mortgage payment. Today, with the increasing interest rates, those that believed ARMs were the way to go are having second thoughts. Homeowners that settled for a subprime mortgage loan are struggling with the rising interest rates. Lenders that were once willing to hand out these risky loans in order to tap into the increasing market are now more cautious than ever. Lenders face the ultimate fear; a no return situation on loans. Because of this fear, consumers are left with no where to turn when they need financial assistance.

It is important to point out that the main cause of the current credit crunch is due to defaults within the subprime mortgage market. These defaults in payments have caused many lending companies to go out of business. It is also necessary to mention that there are various types of subprime lending, aside from mortgages, including subprime credit cards and auto loans. With subprime lending comes more risk; Risk for the lender and risk the borrower. Unstable economic conditions, higher interest rates, less consumer spending, job cuts, wary lenders, and timid borrowers are all a part of the credit crunch.

There is hope for this bind our nation faces. Well, maybe not in the near future, but still hope. In September of this year the Federal Reserve lowered the federal funds rate by half of a percentage point. The federal funds rate has a tremendous influence on lenders, borrowers, and the economy because it has a hug effect on the interest rates paid on mortgages, credit cards, car loans and other forms of credit. More recently, the Fed lowered the federal funds rate by one-quarter percentage in a second attempt to help economic conditions. Also, lending rates to banks have been lowered in recent months. Along with cutting rates, the Fed continues to dispense cash into the U.S. financial system. By taking these recent actions the Fed hopes to provide some stabilization to the shaky U.S. economy. However, these actions, according to most experts, will not completely solve all the problems. The housing market is not expected to recover overnight, and will most likely be a long process.

So it seems many American consumers and businesses are crunched between a rock and a hard place but at least there is a small gleam of hope for our future.

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