Credit Crunch

A Credit Crunch occurs when the money that normally moves freely through the system and keeps the economy robust is suddenly in short supply. The current financial crisis has created an unprecedented credit crunch—banks have greatly reduced the amount of money they loan to each other because there is so much uncertainty about the borrowing bank’s ability to repay the loans.

This has the effect of making it more difficult for consumers to get mortgage loans, auto loans or small business loans.  The cost of those loans, when they are available, is much higher that normal.  

Credit crunches are usually linked to fears of a recession. Since it becomes nearly impossible for companies to borrow when lenders are fearful about bankruptcies or defaults, it results in higher rates.  This then leads to a slower economic recovery, or in the worst case, a prolonged recession which occurs as a result of the shrinking credit supply.

In October 2008, U.S. Congress passed a $250 billion bailout plan to jumpstart the economy and rescue banks and other financial institutions and to ease the credit crunch.

As of November 10 eight large U.S. banks have taken a share of the first half this money, with another 44 banks requesting a combined $47 billion. There are potentially hundreds of other banks lining up to file applications for the remaining $78 billion.

But a Federal Reserve loan survey noted that 85 percent of U.S. banks had tightened lending standards in the previous three months.  They are still restricting loans to small businesses and the real estate industry and putting limits on consumer credit lines.