Banking failure caused a credit crunch.

So the credit crunch will not ease quickly.

Today s crisis marks the end of economic growth fueled only by credit.

People are skeptical for understandable reasons, and in the case of the credit crisis, angry.

In today s credit crunch, as in the Great Depression, central banks lend at practically zero interest rates.

At the beginning of the current credit crunch, many historically minded people picked 1907 as the key precedent.

Excessive rural credit was one of the important causes of bank failures during the Great Depression.

By loosening credit in this way, they recovered, one after another, from the Great Depression.

STANFORD, CALIFORNIA The current credit crisis has led to scaled back projections for growth around the world.

At the same time, the ECB has gained considerable credibility from its handling of the global credit crisis.

George Soros s recent book on the credit crisis is a good example of this line of thinking.

Moreover, money markets, especially in Europe, remain traumatized by the festering global credit crunch.

The mortgage crisis and the credit crunch have led to bailouts for the banks and the nationalization of housing finance and insurance.

But, partly because several African countries have escaped the hang over from the global credit crisis, more investors are focusing on business opportunities there.

The international balance of payments remains in surplus, and there is still a net capital inflow despite the global credit crunch.

The credit crisis exposed the flimsy foundations of the sustained growth that the US and Europe enjoyed during the past four to five years. While many had noted the extraordinary wealth transfer to oil producing states and China, the implications of this were not fully appreciated.

The immediate problem is a credit crunch not so much in China as in the United States and Europe, where many small and medium size importers cannot get the trade credits they need to buy inventory from abroad.

The credit crunch will last much longer if we keep zombie banks alive despite their massive and continuing losses.

Credit Where Credit is Due

Indeed, just as microeconomic problems in the financial sector triggered a credit crunch and fueled a global recession, so microeconomic factors hold the key to recovery.

Hansen predicted that capitalism would suffer from a permanent underinvestment crisis. Banks would scale down their balance sheets in proportion to their reported equity losses and exacerbate the credit crunch from which the world is already suffering today.

True, the US Federal Reserve has tried to prevent a recession by cutting its interest rates. But the Fed cannot endow the banks with new equity capital and prevent a credit crunch.

public provision of credit to the solvent parts of the corporate sector in order to avoid a short term debt refinancing crisis for solvent but illiquid corporations and small businesses

The European Central Bank managed to relieve an incipient credit crunch through its long term refinancing operation (LTRO), which lent over a trillion euros to eurozone banks at one percent.

Thus, banks losses on their toxic assets and their capital needs will be much larger than recently estimated, which will worsen the credit crunch.

If today s credit crunch has historical parallels, they are closer to nineteenth century normal crises like 1837, 1847, or 1857.

Another 1.5 trillion is needed to bring banks capital back to pre crisis level, which is needed to resolve the credit crunch and restore lending to the private sector.

Everyone who borrows or interacts with the credit system in any way would suffer a shock that would make the crisis of 2008 look small.

On the contrary, the Bank s current policy of fighting inflationary pressures by slower growth, a stronger euro, and the credit crunch seems just about right for the time being.

Rural Credit

Credit

Banks and credit card companies have become much more cautious about extending credit.

If nothing nasty happens losses on mortgages, commercial real estate, business loans, and credit cards the banks might just be able to make it through without another crisis.

The supply of credit, in other words, resulted from the demand for credit.

Credit histories cannot be shared, because a credit bureau is just getting started.

Sixth, while regulatory reform that increases the liquidity and capital ratios for financial institutions is necessary, those higher ratios should be phased in gradually to prevent a further worsening of the credit crunch.

Credit risk is best hedged through diversification across uncorrelated credits.

Innovation Crisis or Financial Crisis?

Those economies that are dependent on exports to the US and Europe and that have large current account surpluses (China, most of Asia, and most other emerging markets) will suffer from the G7 recession.

Credit stopped flowing.

Unfreezing Credit

(a) Credit and security structure

Limited access to credit

By pumping in whatever liquidity the financial sector needs to alleviate the credit crunch, the ECB is effectively maintaining a deflationary bias for the financial sector, whereas it has announced an inflationary bias for the rest of the economy.

But the likelihood of another crisis is quite small, and its adverse impact would be far less devastating this time around, as there are no more massive credit or asset bubbles to burst.