Defining the Credit Crunch

Wikipedia: Credit crunch
Credit crunch is a term used to describe a sudden reduction in the availability of loans (or "credit"), or a sudden increase in the cost of obtaining loans.

"Booming home prices gave Americans the confidence to spend more than their income but now the game is over. The micro-story is more dramatic. Record-low interest rates in 2001, 2002 and 2003 did not lead Americans to invest more - there was already excess capacity. Instead, easy money stimulated the economy by inducing households to refinance their mortgages, and to spend some of their capital. It is one thing to borrow to make an investment, which strengthens balance sheets; it is another thing to borrow to finance a vacation or a consumption binge. But this is what Alan Greenspan encouraged Americans to do." - Joseph Stiglitz

Timeline: Global credit crunch
After a two year period between 2004 and 2006 when US interest rates rose from 1% to 5.35%, the US housing market begins to suffer, with prices falling. Default rates on high risk loans to clients with poor credit histories - rise to record levels.

How the French invented subprime in 1719
Imagine the following: a collection of debts owed by a highly leveraged borrower with a bad credit record is magically transformed into marketable securities. How is this miracle performed? It is through the power of financial innovation.

It could be the story of subprime mortgages in the US; but it is not.

It is, in fact, the story of government debt in France in the early 18th century. In 1719-20, a financial whirlwind even more dramatic than anything witnessed today swept through France. Shares in the Compagnie des Indes, or the Mississippi Company, rose 1,000 per cent and then fell by 90 per cent in less than two years.

The story illuminates current events.

Facts and Figures
Banks and other financial institutions could lose $1 trillion from the credit crisis as mortgage-backed assets have lost most of their value. Underlying the financial market wobbles is a real decline in US house prices nationwide for the first time since the 1930s. Stock markets around the world - from Shanghai to London - have plunged, while in the US the Dow Jones industrial average has made big losses.