Many happy returns, credit crunch

Only about half of the £250bn of toxic debt at the heart of the crunch has been fully recognised. Th

Until a year ago the word "crunch" was something associated with a chocolate bar or a competitive sports event. No one outside the esoteric world of the interbank market - where financial institutions swap loans - would have applied it to an economic condition. Twelve months on from 9 August 2007, the day the markets froze over, it has become a headline writers' favourite and part of the national dialogue.

If people want to discuss why the price of their home has fallen, why their job may be in danger, why they no longer feel comfortable with the bank they have dealt with for a lifetime, or why Gordon Brown's government has imploded, the blame is laid at the feet of the crunch.

Historically, credit crunches have been short-term events, temporary blockages in financial markets that, with a little care and attention from the central banks, are cleared in a matter of weeks or, at worst, months.

There was, for instance, a short-term credit crunch after the 11 September 2001 attacks that was swiftly dealt with by the then chairman of the Federal Reserve, Alan Greenspan, who lowered interest rates and flooded the system with cash. The credit markets took fright again in 2002 when the dotcom bubble burst, but after a few short weeks of panic they were up and running again. The main characteristic of the crunch of 2007-2008 is its sheer doggedness.

As the International Monetary Fund noted in a recent special report: "Credit risks remain elevated and systemic strains in funding markets continue despite official action." In other words, despite all the assistance provided by the Federal Reserve in the United States, by the Bank of England and the Frankfurt-based European Central Bank, the money markets are as fragile as ever.

A damaged system

This time, the crunch is firmly rooted in the financial system, rather than external shocks such as the Yom Kippur War, the Iranian Revolution or 9/11. This is what makes it similar to the Great Depression of the 1930s and the Japanese banking meltdown of the 1990s. And instead of being rooted in one economy or any single group of financial institutions, the crunch has been a global event.

The "originate and distribute" model of finance, under which loans are raised and packaged in one place and then sold on to other parties, means that there is probably not a financial player who has managed to avoid the toxic debt (based originally on US sub-prime mortgages) that has infected the whole system.

Each time the authorities appear to have resolved the problem another difficulty pops up. The saga began in August last year when the French bank BNP, a couple of German banks and Britain's Northern Rock found they could no longer raise funds on the interbank markets. Central banks (though not the Bank of England) stepped in with massive assistance and the markets - with the great exception of the UK - were calmed. It took a full-scale bank run to galvanise the Bank of England and the Chancellor, Alistair Darling, into action and £55bn of taxpayers' money to calm the crisis at the Rock. By Christmas 2007 an uneasy calm had descended.

Then, in March 2008, it started all over again with the collapse of the investment house Bear Stearns. Its failure and rescue by J P Morgan Chase brought credit markets to a shuddering halt and required a new round of assistance by central banks. The Bank of England did its bit through a "special liquidity scheme" that injected at least £50bn into the money markets.

Again, calm settled over the markets, only to be shattered in July with the crisis at Fannie Mae and Freddie Mac, the American mortgage intermediaries, which were bailed out by the US Treasury and Congress. An echo of their problems was heard on these shores with the rescue of a fundraising issue for the Bradford & Bingley by the six largest high-street banks, the takeover of Alliance & Leicester by Santander of Spain and a City operation to support a £4bn cash-raising issue by Halifax Bank of Scotland.

The crunch is still with us. The interest rates that banks charge each other for loans remain almost three-quarters of a point above official bank rates, indicating a degree of stress. Borrowing for house purchase and for businesses has been squeezed, bringing the housing market and commerce to a grinding halt.

Most worrying, however, is that the IMF estimates that so far only about half of the £250bn of toxic debt at the heart of the crunch has been fully recognised. That means many more months of misery and the possibility of a deepening slump until the full impact of the crunch of 2007 has been absorbed and normality restored to the money markets.

Alex Brummer is City editor of the Daily Mail. His book "The Crunch" is published by Random House Business (£11.99)