Coping with the credit crunch How the credit crunch began

Problems in the American mortgage market leapt across the pond to impact upon British borrowing

The 'credit crunch' has its roots in the long-term problems which developed in the American mortgage market in recent years. 

Defaults on loans made to high-risk US home buyers - known as sub-prime loans - hit the US housing and banking sectors hard in summer 2007. 

To further compound this problem, banks became less willing to lend to each other on a global scale as fears mounted. These fears were largely over who held those loans and how big the losses associated with them would be. This forced the European Central Bank to inject more than €200 billion into the European money markets in the space of three days in August 2007. 

How Northern Rock set the ball rolling in the UK

The credit crunch hit the UK in August 2007, with the full force of the impact felt when it was revealed that Northern Rock had applied to the Bank of England seeking emergency funding. This was exposed on Thursday 13 September 2007.

The bank was forced to look to the Bank of England for support because it had struggled to raise money to finance its lending to people in the form of home loans. 

While banks generally raise their lending money (used for mortgages) from customers putting their money into savings accounts, Northern Rock had been raising most of its money by borrowing from other banks and institutions. This left it more vulnerable than its rivals due to the slowdown in inter-bank lending.

A run on the bank

Northern Rock's share price dropped once the news broke, with people starting to panic and take out cash from savings accounts. Long queues formed outside branches as news reports of the crisis fuelled further alarm.

The government stepped in to initially guarantee that savers' money would be safe, and eventually in February 2008 took the decision to nationalise the bank after private bidders failed to secure a takeover.

Credit crunch dominoes

Northern Rock wasn't the last high street name to get into financial trouble in the months that followed. HBOS, parent company of Halifax and Bank of Scotland, was taken over by Lloyds TSB (now known as the Lloyds Banking Group), the Icelandic Landsbanki group collapsed, while Bradford and Bingley was nationalised and its savings arm sold to Spanish banking giant Santander.

And it isn't just banks that have fallen on hard times, with many chains disappearing from the British high street. High-profile, well-established names such as Woolworths, MFI and Zavvi have all closed down, with Fishworks, Whittard of Chelsea and Waterford Wedgwood also facing closure or being bought out.

The Bank of England base rate, as high as 5.75% in July 2007, has been slashed over the following 18 months, hitting just 0.5% in March 2009.

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