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A credit crunch (also known as a credit squeeze or credit crisis) is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks. A credit crunch generally involves a reduction in the availability of credit independent of a rise in official interest rates. In such situations, the relationship between credit availability and interest rates has implicitly changed, such that either 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.e. credit rationing occurs). 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).

In the case of a credit crunch, it may be preferable to "mark to market" - and if necessary, sell or go into liquidation if the capital of the business affected is insufficient to survive the post-boom phase of the credit cycle. In the case of a liquidity crisis on the other hand, it may be preferable to attempt to access additional lines of credit, as opportunities for growth may exist once the liquidity crisis is overcome.

A prolonged credit crunch is the opposite of cheap, easy and plentiful lending practices (sometimes referred to as "easy money" or "loose credit"). During the upward phase in the credit cycle, asset prices may experience bouts of frenzied competitive, leveraged bidding, inducing inflation in a particular asset market. 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.

Often it is only in retrospect that participants in an economic bubble realize that the point of collapse was obvious. In this respect, economic bubbles can have dynamic characteristics not unlike Ponzi schemes or Pyramid schemes.

As John Maynard Keynes observed in 1931 during the Great Depression: "A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him."

See also

• Austrian Business Cycle Theory
• Financial crisis
• Minsky moment

Bibliography

• George Cooper, The Origin of Financial Crises (2008: London, Harriman House) ISBN 1905641850
• Graham Turner, The Credit Crunch: Housing Bubbles, Globalisation and the Worldwide Economic Crisis (2008: London, Pluto Press), ISBN 9780745328102

References

1. Is There A Credit Crunch in East Asia? Wei Ding, Ilker Domac & Giovanni Ferri (World Bank)
2. Rowbotham, Michael (1998). The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics. Jon Carpenter Publishing. ISBN 9781897766408.
3. Cooper, George (2008). The Origin of Financial Crises. Harriman House. ISBN 1905641850.
4. Ponzi Nation, Edward Chancellor, Institutional Investor, 7 February 2007
5. Securitisation: life after death

• Credit
• Debt
• Economic problems
• Financial crises
• Terms and concepts of the 2000s United States housing bubble