Credit crunch 2: is this Lehman Brothers all over again?

"WE ARE experiencing a credit crunch." So said a spokesman for Number 10 following a coordinated action yesterday by the world's major central banks to make it cheaper to borrow dollars. So, is this really as bad as the collapse of Lehman Brothers, the event synonymous with the 2008 credit crunch?

What is a 'credit crunch'?
A credit crunch arises when financial institutions are unable to borrow money at any interest rate. This can happen, as in 2008, when banks suddenly realise they could lose money on bad debts - or if there is a perception that it is too risky to lend money.

What has caused the new credit crunch?
The latest credit crunch, if that is what it is, follows rumours that a big European bank had been frozen out of credit markets. Whether true or not, the suggestion was enough to make investors dive into safe havens. One-year German bonds were in such demand that the yield on them fell into negative territory. This essentially meant investors were so worried about the financial crisis they were prepared to pay the German government to look after their money.

The key problem is that nobody wants to lend to European banks. Months of political turmoil in Greece and Italy and a failure by EU leaders to tackle the problem of spiralling government debt has led to fears for the very existence of the euro.

What are the central banks doing?
The Bank of England, the Federal Reserve, European Central Bank, and the national banks of Canada, Switzerland and Japan announced yesterday that they would lend an unlimited amount of US dollars, and cut the cost of borrowing them by 0.5 per cent.

Has it worked?
Stock markets across the world rallied after the central banks' announcement, suggesting investors' fears have been allayed for the moment. However, EU leaders are meeting on December 9 to discuss the eurozone debt crisis. If they fail to come up with a plan at least as headline-grabbing the central banks', we could be back in credit crunch territory.

What might happen next?
It is worth recalling what happened after the last credit crunch in 2008.

Dan Greenhaus of BTIG brokers, believes that what has occurred over the past 24 hours is "eerily similar to 2008 in some respects". He observes that back then, central banks' attempts to make credit available "engendered a meaningful market rally".

Business Insider points out that when central banks announced a global interest rate cut in early October 2008 - a month after Lehman Brothers filed for bankruptcy protection - America's S&P 500 index rose by nearly 12 per cent in one day.

By March the following year the S&P had crashed to a 13-year low. ·