A credit crunch which is also referred to at times as a credit crises or credit squeeze refers to a situation where borrowers are unable to attain loans. This arises as there is a reduction in the availability of lending due to a sudden tightening of economic conditions required to obtain financing. During these market environments the relationship between credit availability and interest rates is altered where either credit becomes less available at a specific interest rates which might be considered the current market. Many times, a credit crunch is accompanied by investors scrambling to a safe haven asset as they are looking for protection against exposure to riskier assets.
A credit crunch is generally created as a lack of liquidity which perpetuates through the lending community. The U.S. experienced a credit crunch in 2008 and 2009, as banks were having a very difficult time borrowing money from one another because they did not trust the market valuation of the holding many banks had in their portfolios. In the period leading up to the financial crisis, from 2005-2007, banks in the United States and globally took on risks that were directly correlated to the performance of the U.S. housing market. These risks were rated highly by many credit ratings agencies, but the collateral was based on the theoretical performance and the thesis that U.S. housing prices would move higher by 5% a year for decades. Once this balloon was popped, the markets took a nose dive.
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