Credit crisis

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A credit crisis, or "credit crunch" is a situation in which banks are reluctant to lend for fear they will have insufficient funds available.

The 2008 credit crisis stemmed from the 2007 meltdown of the U.S. mortgage-backed securities market that spread to banks and financial institutions around the world early in 2008, pushing them to tighten lending standards. The crisis has sent revenues and profits at global investment banks plummeting and has seized up the U.S. mortgage market.

1 Wealth Destruction
2 Regulators to the rescue?
3 Resources
4 References

Wealth Destruction

The International Monetary Fund estimated in April 2008 that the total cost of the credit crisis worldwide will eventually add up to near $1 trillion, with just over half that stemming from U.S. mortgage market losses.^[1] At that time the finance sector had booked $232 billion in credit-related losses and writedowns

Many media analysts blame the genesis of the crisis on the U.S. Federal Reserve and former chairman Alan Greenspan for holding interest rates below inflation for several years before 2007 and governing with too light a regulatory hand.^[2] More recently, the FBI apparently forersaw the epidemic of mortgage fraud and other crimes associated with the credit crisis but lacked the resources to head it off.^[3]

The crisis led to the fall of some of the country's largest investment banks and other institutions; Lehman Brothers went bankrupt in the summer of 2008, following a U.S. Treasury takeover of the mortgage giants Fannie Mae and Freddie Mac. Following that, the Fed extended an $85 billion loan to save AIG, the country's biggest insurance company, Bank of America took over Merrill Lynch, and Washington Mutual became the largest U.S. bank to fail.

Two of the largest remaining investment banks, Goldman Sachs and Morgan Stanley, announced on Sept. 21 that they were converting themselves into regulated commercial banks.

Regulators to the rescue?

In August 2008 current Fed chairman Ben Bernanke proposed an expansion of the Federal Reserve's regulatory powers to prevent similar credit crises from recurring by focusing on "potential systemic risks and weaknesses."^[4] But U.S. Treasury Secretary Henry Paulson wanted instead to deliver such powers to a separate regulator and leave the Fed in charge of finanacial stability only.

In September 2008, the U.S. government proposed a plan to end the credit crunch by spending up to $700 billion to buy distressed assets from financial institutions. Hank Paulson, the treasury secretary, and Ben Bernanke, the chairman of the Federal Reserve, argued that the bailout was necessary to avoid throwing investors into a panic. The plan was criticized by some as giving the government too much power and letting bankers off at the expense of the average taxpayer.^[5]