What Is a Credit Crisis?

A credit crisis is a breakdown of a financial system caused by a sudden and severe disruption of the normal process of cash movement that underpins any economy. A bank shortage of cash available for lending is just one in a series of cascading ev𒐪ents that occur in a credit crisis.

Understanding a Credit Crisis

A credit crisis has a triggering event. Consider the potential impact of a severe drought where farmers lose their crops. Without the income from the crop sales, they can't repay their bank loans. Without those loan payments, the bank is short of cash and has to pull back sharply on making new loans. The bank still needs 澳洲幸运5开奖号码历史查询:cash flow for its ordinary operations, so it steps up borrowing in the short-term lending market. However, the bank itself has now become a 澳洲幸运5开奖号码历史查询:credit risk and other lenders cut it off.

As the crisis deepens, it begins to interrupt the flow of short-term loans that keeps much of the business community running. Businesses depend on this process to keep op👍erating as usual. When the flow dries up, it can have 💃disastrous effects on the financial system as a whole.

In the worst-case scenario, customers get wind of the problem and there's a 澳洲幸运5开奖号码历史查询:run on the bank until there's no cash left to withdraw. In a slightly more positive scenario, the bank stumbles through but its standards for loan approvals have become so constricted that the en💛tire economy, at least in this drought-stricken region, suffers.

The modern banking system has safeguards that make it more difficult for this scenario to occur, including a requirement for banks to maintain substantial 澳洲幸运5开奖号码历史查询:cash reserves. In addition, the banking system has become consolidated into a few giant global institutions, making it unlikely that a regional drought could trigger a system-wide crisis. But those large institutions have their own risks. This is where the government steps in and bails out institutions that are "澳洲幸运5开奖号码历史查询:too big to fail."

The 2007–2008 Credit Crisis

The 2007–2008 credit crisis 🦩is most likely the only severe example of a credit crisis that has occurred within the memory of 🌳most Americans.

The 2007–2008 credit crisis was a meltdown for the history books. The triggering event was a nationwide bubble in the housing market. Home prices had been rising rapidly for years. 澳洲幸运5开奖号码历史查询:Speculators jumped in to buy and flip houses. Renters were anxious to buy before they got priced out. Some believed prices wou♔ld never stop rising. Then, in 2006, prices hit th🍒eir peak and started to decline.

Well before then, mortgage brokers and lenders had relaxed their standards to take advantage of the boom. They offered subprime mortgages, and homebuyers borrowed well beyond their means. "Teaser" rates virtually guaranteed that they would default in a year or two.

This was not self-destructive behavior on the part of the lenders. They did not hold onto those subprime loans, but instead sold them for repackaging as 澳洲幸运5开奖号码历史查询:mortgage-backed securities (MBS) and 澳洲幸运5开奖号码历史查询:collateralized debt obligations (CDO) that were traded in the markets by investors and ins✅titutions.

When the bubble burst, the last buyers, who were among the biggest financial institutions in the country, were stuck. As the lo꧑sses climbed, investors began to worry that those firms had downplayed the extent of their losses. The stock prices of the firms themselves began to fall. Inter-lending between the firms stopped.

The credit crunch combined with the mortgage meltdown to cr𝓡eate a crisis that froze the financial system when its need for liquid capital was at its highest. The situation was made worse by a purely human factor—fear turned to panic. Riskier stocks suffered big losses, even if they had nothing to do with the mortgage market.

The situation was so dire that the Federal Reserve (Fed) was forced to pump billions into the system to save it—and even then, we still ended up in 澳洲幸运5开奖号码历史查询:The Great Recession.