Skip to main content
Business

What’s a credit crunch? The feared bank phrase that may lead to a recession

Share

As the dust starts to settle following the collapse of Silicon Valley Bank and Signature Bank in March, economists are warning of cracks in the system that started spreading even before the failures. Under conditions of banking turmoil, some are worried credit tightening will become a credit crunch.

A credit crunch is a decline in lending activity driven by a shortage of funds. Or, as Moody’s Analytics Chief Economist Mark Zandi puts it, “the inability of households and businesses to get the credit that they need.” It’s a phenomenon that can have a big impact on the economy and its growth.

“I’m getting really nervous now that an economy that I thought was going to dodge recession is now at much greater risk of falling into one and it could be quite severe because bank credit is the lifeblood for small businesses,” Pantheon Macroeconomics Chief Economist Ian Shepherdson said during a CNBC interview.

Following March’s Federal Open Markets Committee meeting, Federal Reserve Chair Jerome Powell said the second and third largest bank failures in U.S. history “are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes.”

But the train was already on those tracks before the banks’ closures. Loan activity has been trending down due to the central bank’s aggressive actions to tame inflation. Over the last 12 months, the Fed raised its benchmark interest rate from near 0% to nearly 5%.

The latest Fed survey found roughly 44% of banks reported tightening standards for business loans in the first quarter of 2023. With the exception of the COVID-19 pandemic, it’s the highest share to say that since 2009 in the wake of the Great Recession.

“The possibility of the restriction of credit to be so significant that under almost any terms you can’t get a loan, that’s certainly a risk of something that may happen,” Zandi told Reuters.

The most recent example of a credit crunch was after the 2008 financial crash. Financial institutions had trillions of dollars in subprime mortgages that were essentially worthless. Banks that were able to weather the storm didn’t have the resources or risk appetite to lend at their previous pace. Even highly-qualified individuals and businesses struggled to get approved.

Access to capital fuels growth in the U.S. economy and that credit crunch significantly slowed expansion in the years that followed.

“The ‘08, ‘09 financial crisis is in a league of its own,” Zandi said. “What we’re experiencing now, it doesn’t feel very good, it’s very uncomfortable, but it’s nothing compared to what we suffered back in that crisis.”

The Federal Reserve is monitoring how commercial banks tightening credit will affect its policies moving forward.

“The key is we have to have policies to bring inflation down to 2% over time,” Powell said in March. “It doesn’t all have to come from rate hikes. It can come from tighter credit conditions.”

Reaching the Fed’s 2% inflation target without entering a recession, known as a soft landing, was already a challenge with the central bank’s limited, blunt toolset. But at least the Fed has control over those tools. A credit crunch could bring in a whole new set of unknowns.

“I’m much less confident in my optimism about avoiding recession than I was two weeks ago because of the banking crisis,” Zandi said. “There’s a lot of uncertainty here. How significant is this credit crunch going to be? How big an impact is that going to have?”

Reuters contributed to this report.


RELATED REPORTS

Tags: , , , , , , , , , , , , ,

ISAAC POOLE:

“IT IS LIKELY TO FOLLOW A GOOD OLE FASHION CREDIT CRUNCH PATHWAY.” 1:51}

RANDY WATTS:

“THIS IS GONNA BE EXACERBATED BY WHAT IS CLEARLY BECOMING A CREDIT CRUNCH IN THE BANKING SECTOR.”

JIM CARON:

“IS IT A CREDIT CRUNCH LIKE IN 2008 OR IS IT A CREDIT TIGHTENING.”

SIMONE DEL ROSARIO:

CREDIT CRUNCH COULD BE THE PHRASE THAT PAYS – IF YOU’RE BETTING ON A U-S RECESSION.

WITH RISING INTEREST RATES AND NOW BANKING UPHEAVAL ON TOP OF IT, IS THE U-S ON THE VERGE OF THE NEXT CREDIT CRUNCH?

MARK ZANDI:
A CREDIT CRUNCH IS THE INABILITY OF HOUSEHOLDS AND BUSINESSES TO GET THE CREDIT THAT THEY NEED.”

SIMONE DEL ROSARIO:

I’M NOT SURE I COULD SAY IT BETTER. A CREDIT CRUNCH REFERS TO A SIGNIFICANT DROP IN BANK LENDING ACTIVITY DRIVEN BY A SHORTAGE OF FUNDS.

MARK ZANDI:

“THE POSSIBILITY OF THE RESTRICTION OF CREDIT TO BE SO SIGNIFICANT THAT UNDER ALMOST ANY TERMS YOU CAN’T GET A LOAN THAT’S CERTAINLY A RISK OF SOMETHING THAT MAY HAPPEN. IF THAT DOES, THAT’S A CREDIT CRUNCH. WE’RE NOT THERE YET, BUT THAT’S CERTAINLY A POSSIBILITY GOING FORWARD.”

SIMONE DEL ROSARIO:

A PRIME EXAMPLE IS WHAT HAPPENED IN THE WAKE OF THE 2008 FINANCIAL CRASH.

FINANCIAL INSTITUTIONS WERE ON THE HOOK FOR TRILLIONS OF DOLLARS IN WORTHLESS SUBPRIME MORTGAGES.

BANKS THAT SURVIVED IT DIDN’T HAVE THE RESOURCES TO BE OUT THERE MAKING A LOT OF LOANS. EVEN HIGHLY-QUALIFIED FAMILIES AND BUSINESSES STRUGGLED TO GET CREDIT.

ACCESS TO CAPITAL IS WHAT FUELS GROWTH IN THE ECONOMY. SO THE CREDIT CRUNCH DRAGGED ON GROWTH FOR YEARS TO COME.

MARK ZANDI:

“THE ‘08, ‘09 FINANCIAL CRISIS IS IN A LEAGUE OF ITS OWN. WHAT WE’RE EXPERIENCING NOW, IT DOESN’T FEEL VERY GOOD, IT’S VERY UNCOMFORTABLE, BUT IT’S NOTHING COMPARED TO WHAT WE SUFFERED BACK IN THAT CRISIS.”

SIMONE DEL ROSARIO:

LOAN ACTIVITY HAS ALREADY BEEN ON THE DECLINE BECAUSE OF THE FEDERAL RESERVE’S FIGHT AGAINST INFLATION.

WHEN INTEREST RATES ARE HIGHER, PEOPLE ARE LESS LIKELY TO TAKE OUT LOANS AND SPEND MONEY.

JEROME POWELL:

SO THE KEY IS WE HAVE TO HAVE POLICIES, GOTTA BE TIGHT ENOUGH TO BRING INFLATION DOWN TO 2% OVER TIME. IT DOESN’T ALL HAVE TO COME FROM RATE HIKES. IT CAN COME FROM, YOU KNOW, FROM TIGHTER CREDIT CONDITIONS. 30:04}

SIMONE DEL ROSARIO:

A POTENTIAL CREDIT CRUNCH CAN BE AN UNPREDICTABLE ALLY IN THE FED’S INFLATION FIGHT.

ON THE HEELS OF TWO OF THE BIGGEST U-S BANK FAILURES IN HISTORY…MANY EXPECT BANKS TO FURTHER LIMIT LOAN ACTIVITY.

BUT EVEN BEFORE THIS DISORDER, IT WAS ALREADY HAPPENING.

IN A FED SURVEY ABOUT 44% OF BANKS REPORTED TIGHTENING STANDARDS FOR BUSINESS LOANS THE FIRST QUARTER OF 2023.

MARK ZANDI:

“THERE’S A LOT OF UNCERTAINTY HERE. HOW SIGNIFICANT IS THIS CREDIT CRUNCH GOING TO BE? HOW BIG AN IMPACT IS THAT GOING TO HAVE.”

“I’M MUCH LESS CONFIDENT IN MY OPTIMISM ABOUT AVOIDING RECESSION THAN I WAS TWO WEEKS AGO BECAUSE OF THE BANKING CRISIS.”

SIMONE DEL ROSARIO:

ACHIEVING DISINFLATION WITHOUT A RECESSION WAS ALREADY A TOUGH TEST TO PASS WITH THE FED’S BLUNT TOOLS.

BUT AT LEAST THEY HAVE CONTROL OVER THOSE TOOLS. A CREDIT CRUNCH COULD BRING IN A WHOLE NEW SET OF UNKNOWNS.