Game of Trades: A Credit Crunch is Inevitable in 2023
While we’ve just seen the two biggest bank failures since 2008, investors haven’t been too worried about any further contagion. Even with European banks showing a strain right now, the sector has largely started to move on.
But events may be unfolding that could tumble out of control quickly. That includes the possibility of a credit crunch. While not as visible as the housing crisis, a credit crunch played a strong role in the 2008 market collapse.
Simply put, a credit crunch, or credit crisis, occurs when trust in the banking system is lost between banks themselves. Many banks loan out money overnight, or for other short-term periods. In a credit crisis, that dries up.
In turn, banks stop making or offering similar short-term loans to companies, many of which use that as a form of funding. General Electric (GE) nearly went under in 2008 due to its reliance on short-term overnight loans.
If we see further deterioration in the banking system, such a credit crunch could easily occur again. However, stocks don’t seem to have priced in that possibility yet.
Should that happen, the stock market would likely drop to new lows. And bank stocks would take a big hit. That includes the major banks, which provide the bulk of short-term credit.
Investors should be prepared for this possibility. It may take weeks or months before it plays out, however, just like in 2008. So be patient.