Global Credit Crunch MOMENT OF ‘THE TRUTH’

A month after the banks stopped lending to each other there was a run on Northern Rock — the first to affect a UK high street bank since Overend Gurney in the s. A year later, Lehman Brothers collapsed in the US — triggering shockwaves through global markets. No longer an MP but now a Labour peer, Darling reckons it could happen again — but not for a long time. Mervyn King, with whom Darling had a sometimes testy relationship during the crisis, agrees. Like most of those in the eye of the storm a decade ago, King thinks the financial system is in much better shape, but would be even healthier had Darling fully nationalised RBS and forced all the leading banks to take bailout cash, as happened in the US.

Even so, he said, banks were stronger and individuals now had to take greater personal responsibility for their actions. He does not, however, think we are on the verge of another collapse. But he does believe there should be more scrutiny of shadow banking — where fund managers, insurance companies and hedge funds conduct bank-like activities with less regulation. Lord Turner reckons the authorities in Beijing could contain a financial crisis — but the inevitable slowdown in the Chinese economy that would follow would prove costly to the rest of the world.

Credit becomes less available at any given official interest rate, or there ceases to be a clear relationship between interest rates and credit availability i.

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Many times, a credit crunch is accompanied by a flight to quality by lenders and investors, as they seek less risky investments often at the expense of small to medium size enterprises. A credit crunch is often caused by a sustained period of careless and inappropriate lending which results in losses for lending institutions and investors in debt when the loans turn sour and the full extent of bad debts becomes known. There are a number of reasons why banks might suddenly stop or slow lending activity.

For example, inadequate information about the financial condition of borrowers can lead to a boom in lending when financial institutions overestimate creditworthiness, while the sudden revelation of information suggesting that borrowers are or were less creditworthy can lead to a sudden contraction of credit.

Easy credit conditions sometimes referred to as "easy money" or "loose credit" are characterized by low interest rates for borrowers and relaxed lending practices by bankers, making it easy to get inexpensive loans. A credit crunch is the opposite, in which interest rates rise and lending practices tighten.

Easy credit conditions mean that funds are readily available to borrowers, which results in asset prices rising if the loaned funds are used to buy assets in a particular market, such as real estate or stocks.

In a credit bubble, lending standards become less stringent. Easy credit drives up prices within a class of assets, usually real estate or equities. These increased asset values then become the collateral for further borrowing.

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This can then cause a speculative price " bubble " to develop. As this upswing in new debt creation also increases the money supply and stimulates economic activity, this also tends to temporarily raise economic growth and employment.

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Economist Hyman Minsky described the types of borrowing and lending that contribute to a bubble. The "hedge borrower" can make debt payments covering interest and principal from current cash flows from investments. This borrower is not taking significant risk. The writing was on the wall for Northern Rock from the moment the markets turned sour on 9 August.

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Its business model relied on it being able to borrow money from other banks and investors, and that was no longer possible in the panic-stricken conditions of August , when none of the banks trusted each other. It was taking too many risks and had no alternative sources of funds if the markets dried up. They relied on at least half their financing from selling mortgages. Alistair Darling , the chancellor of the exchequer, was also on holiday on 9 August, in Majorca. There was one man and a dog in charge of financial stability. He asked for a list of which ones might be vulnerable.

Credit crunch

The man in charge of Northern Rock was Adam Applegarth, whose aggressive expansion plans for the Newcastle-based lender had made him a stock market darling. Since the run on Northern Rock, regulation and supervision of banks has been strengthened. Andrew Bailey, who played a crucial role in unravelling Northern Rock, said one of the lessons was to understand what banks were actually up to.

Now chief executive of the Financial Conduct Authority, Bailey said: Northern Rock operated what Bailey described as warehousing.