Credit Crisis in 30 slides

The Credit Crisis explained in 30 slides...….

........a Bank is a Credit Intermediary – or “Middleman” £ £ Bank Borrower Depositor

But rather than lending pre-existing money, it creates new money as interest–bearing credit….

… .which is then deposited back into the system

Now, if you think about it, a Bank’s true economic function.....

… is to guarantee that the borrowers’ credit is good…

Interest is charged for the use of the guarantee Interest Bank Borrowers

..from which Interest is paid to Depositors.. Interest Interest Bank Borrowers Depositors

..Default and Operating costs deducted... Interest Interest Costs Bank Borrowers Depositors

..and a profit to Investors normally results Interest Interest Costs Investors Bank Borrowers Depositors

Result: Banks create a Pyramid of Credit, on a base of Equity Bank Credit Bank Equity

Demand for Credit has been so high…

… .that Banks began to “outsource” their guarantee to rid themselves of risk.

… and thus allow their Equity to support more credit creation

Banks outsourced risk totally – through “securitising” debt and sale to investors….

… temporarily – with “Credit Derivatives” (a time-limited guarantee)….

… and partially – using credit insurance from insurers such as AIG

The Result was a bigger Credit Pyramid than Banks alone could sustain… Investor Equity Credit Bank Equity

… and an opaque “shadow banking system” of Investors holding “sliced and diced” risk… Investor Equity Credit Bank Equity

The extended pyramid of Credit funded the Mother of All Bubbles in US property prices...

....and in August 2007 the bubble started to deflate....

..but by now no-one knew where the Risk lay… Investor Equity Credit Bank Equity

Banks started to think, “if this is what our balance sheet looks like…..”

“… what does everyone else’s look like…..?”

… and stopped lending to each other.......

The problem is not shortage of money - liquidity – Central Banks can handle that….

… ..it is shortage of Equity - a Solvency problem – which Central Banks cannot handle…..

Bank Equity is being eaten away by defaults….

… and Investors will not recapitalise the shadow banking system…

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