Liquidity

The liquidity of an investment is how easy it is to turn it into cash. Some assets owned by banks cannot be turned into cash very easily, but are instead valuable over time. These assets are no good in times of urgency when real money is needed. When banks find themselves in this situation, strapped for cash, banks can go bankrupt. 

Deleveraging

Deleverage occurs when a company decreases the amount of money it borrows. It is considered high risk when companies increase leverage.

In the past investment companies have borrowed more money than required, when investing in a product. They do this so they can potentially make more money, if they put more in - even if it means borrowing the money to do so (increasing leverage). However this can lead to losing more money than originally invested. During a Credit Crunch this is too risky and with most unwilling to lend more money, investment companies practise deleveraging.

Unwind

When big banks trade with oil, gold or any other valuable product most traders agree to sell or buy the product by a future date. Traders do not actually want to see barrels of oil arrive at their offices, so it is very important to ‘unwind’ your position during the time agreed. To unwind you must carry out the opposite of your first trading transaction. For example if you pay $50,000 for 500 barrels of oil to be delivered in January you must sell $50,000 for 500 barrels of oil to be delivered to a specific location in January.

In regards to the credit crunch the US Government, now responsible for the bankruptcy of Lehman Brothers, will have to ensure all of these types of deals are unwound by their due date, otherwise they can expect to see truck loads of oil and gold and whatever else traders dealt with delivered on their doorsteps.

Investment bank

There are two types of bank - commercial banks and investment banks. Investment banks provide financial services for businesses, government and very wealthy people. 

Traditionally if an investment bank gets into trouble the government would not lend a helping hand. However, if a commercial bank, like Northern Rock or HBOS, looks set to go bust the Government will step in, in order to make sure ordinary people do not lose their savings.

Securitisation

Whether it is a stock, bond or mortgage debt, securitisation turns the item in question into a security. Once it becomes a security it is assigned a value and traded.

For example, if a mortgage debt is made into a security and a bank decides to buy it, the bank who buys this security will receive income when the original home-buyers make their mortgage payments.

In regards to the credit crunch, securitisation has proven a problem for several banks that have traded in this way, because they did not realise the original home-buyers were at a high risk of not paying.

Chapter 11

Chapter 11 refers to a chapter of the US Bankruptcy Code. A code that allows businesses who find themselves unable to pay those they owe money to (creditors), to ask the bankruptcy court for protection from creditors. 

Dead Cat Bounce

A term regularly used to describe the temporary rise in otherwise poorly performing shares on the stock market. The term is used mostly by those on the trading floor.

Short Selling

Short selling occurs when a share trader borrows shares from banks and sells them immediately, so if the price falls the trader can buy the shares back at a discount rate and keep the difference. Under normal circumstances it’s a legitimate trading technique – but under the current volatile market conditions, the Financial Services Authority (FSA) believes it has been undermining confidence in financial markets. Short selling was largely to blame for the devaluation of HBOS shares. Read more: Short Selling of Financial Stocks Banned.

Financial Services Compensation Scheme

Consumers with savings of £50,000 stored in authorised financial services firms have their money protected by the Financial Services Compensation Scheme (FSCS) - an independent body, set up under the Financial Services and Markets Act 2000 (FSMA).

Under the current climate Government, in an attempt to restore consumer confidence, has upped the compensation limit from £35, 000. Read more: Government to Extend Saver Guarantee to £50k.

Libor
Libor stands for the London Interbank Offered Rate and is used by banks world wide to determine the rate at which they lend to each other - whether that’s receiving or giving loans (including 24 hour - 5 year loans). Libor rates are set daily and released at the same time everyday - 11am London time.

Throughout the credit crisis the Libor rates have increased, revealing a reluctance banks to lend to one another. The fact it could not get credit from other banks was the main reason that Northern Rock collapsed.

Add your own credit crunch definitions by using the Comment on This Article bow below.