The Impact of a Housing Price Bubble on the Intensity of the Recent Credit Crunch: Evidence from Different Countries

Abstract

For almost two years international financial markets have been under great pressure, originating with the sub-prime mortgage episode. This, in turn, was triggered by the downturn of the US housing cycle and spread quickly into third countries in the form of severe losses and an increasing lack of confidence. Market liquidity dried up almost instantly and banking sectors around the world suffered great financial distress. It became increasingly difficult for many financial intermediaries to refinance operations as overall loanable funds reduced. This process started a chain reaction in which bankers reduced exposure to loans. As a result, getting loans became more difficult for consumers and businesses, with lenders preferring to hold a very liquid position rather than risk facing a wave of bankruptcies and mortgage defaults. Consequently, interest rates skyrocketed and clear signs of an imminent severe credit crunch spread throughout the economy.¹