Today marks a big day for the global credit crisis. It’s exactly one year old.

Or to be more precise, 24 July 2007 was when the world’s stock markets finally cottoned on to what was being brewed up in the murky world of US sub-prime mortgage derivatives. From within 1.5% of its high, the FTSE 100 dropped 6% in three days. By the end of the month, everyone working in the financial markets knew far more than they’d ever wanted to about the alphabet soup of CDOs, CLOs and SIVs.

Many of the supposed ‘experts’ said it would all be sorted out within a few weeks. But not only was that not even close, it was just about as wrong as you can get. Because what we’ve seen so far is just the starter.

In fact here in Britain, the real credit crunch is only just about to begin…

We may think things are tough now, but they’re about to get tougher.

So far, ‘all’ we’ve seen is a so-called liquidity squeeze in the money markets, as well as lots of banks incurring plenty of heavy credit losses. OK, property prices have tanked, but as we’ve been saying at MoneyWeek for longer that we can remember, the UK housing market meltdown is hardly a huge surprise, because prices rose so far into fantasyland they had to crash at some stage. The liquidity squeeze simply provided the pin to burst the bubble.

And while there have been loads of media tales about consumers cutting back and their borrowing limits being reduced, here in Britain our credit card borrowings are still up by 7.5% over the last year, according to yesterday’s figures from the British Bankers Association.

But now things are set to turn ugly.

It’s often said that credit is the lifeblood of capitalism. The amount of credit sloshing around in the system depends on two things. Firstly, the level of bank capital - broadly, that’s the total of money raised through share sales, etc., added to profits made – and secondly, the ‘credit multiplier’: somewhere between £8 and £10 of credit is created, i.e. lent out, for every £1 of banks’ risk-free capital.

Early estimates of credit crunch losses were a complete joke

Here’s where all those credit losses come in. We now know that the early estimates of the overall damage were a complete joke. The first guess from US Federal Reserve chairman Ben Bernanke was a ‘mere’ $50bn. Now we’re already up to over $400bn and counting. And we haven’t seen the half of it yet.

Globally, “banks and brokers will destroy somewhere between $1,000bn to $1,400bn of their own risk-free capital owing to losses on all forms of credit in this crunch”, says David Roche of Independent Strategy. This means that in theory, the planet’s credit should contract by something like 8-10 times the amount lost. In reality, it’s not quite that bad, because capital will be boosted by future profits and fund-raising exercises like rights issues, but even then, “you are left with a reduction of 5%-7% in global credit”.

That may not sound too horrendous. But Mr Roche reckons that for every $1 of GDP growth, we need $4-$5 of new credit, “so even a standstill in total credit outstanding is a credit crunch”.

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Source: Why Your Bank Manager May Be About to Turn Nasty