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Answered 2008-12-10 20:08:58

It severely limits to availability of credit. Banks must keep a certain amount of cash on hand, this is called cash reserves. This is normally 10%. That means for every dollar in cash that a bank has, it can lend out nine dollars. But due to the heavy losses that banks have endured the last year, their assets are severely depleted. That means for every dollar they lost, they had to stop lending out 9 dollars. Remember, the losses of the crisis are over a trillion dollars. So when banks experience massive losses like this, they stop lending out of either fear of defaults (resulting in them only lending to those with extremely good credit ratings). It would be a stretch, due to other factors, to say that means that banks have to lend out 9 trillion dollars less, so do not extrapolate that, it was merely used to show how quickly credit dried up.

In short, because banks now have less money to lend out, credit is very scarce.

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