Credit Crunch (definition)

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Top Contributors Toni Straka Avinash Patil Related Articles 2007 Credit Crunch 2008 Financial Crisis Apollo Group (APOL) Career Education (CECO) Central Bank

This article defines the term credit crunch. For information on the 2007 Credit Crunch, see 2007 Credit Crunch. For more information on 2008 fallout within the Financial Industry see 2008 Financial Crisis

A credit crunch is an economic condition in which investment capital is difficult to obtain. Banks and investors become wary of lending funds to corporations thereby driving up the price of debt products for borrowers. This also applies for individual borrowers as banks become more risk averse and try to optimize their loan portfolio. Central banks try to counter this risk aversion by lowering leading interest rates in order to keep money markets afloat.

Credit crunches are usually considered to be the predecessor of recessions. A credit crunch makes it nearly impossible for companies to borrow because lenders are scared of bankruptcies or defaults, which result in higher interest rates. The consequence is a prolonged recession (or slower recovery) resulting from the supply of credit having shrunk. This was the case in the Great Depression, when the Federal Reserve contracted money supply after the Crash of 1929, refusing to liquefy markets and thereby creating deflation.

The current Fed chairman Ben Bernanke, a scholar on the Great Depression, has in 2008 tried to alleviate the credit crunch by providing unlimited dollar amounts not only in the USA, but via swaplines with the European Central Bank (ECB), the Bank of England (BoE) and the Swiss National Bank (SNB). In their drive to un-seize frozen interbank markets both the Fed and the ECB have begun to allot unlimited amounts of newly created currency, expanding the size of their balance sheets by 50% in the first 10 months 2008. This bears the problem of monetary inflation running out of hand at a later stage.

Credit crunches significantly impact revenue for-profit education companies like Apollo Group (APOL), Career Education (CECO), ITT Educational Services (ESI), and others companies that derive the majority of their revenue from tuition charges. Private student loans account for significant portions of these companies' revenue, but during credit crunches banks are less willing to loan money to students and as a result, the education companies' revenues suffer.