It is important to separate the crunch from the crash. The credit crunch led to, and preceded, the crash. However the consumer economy, especially, was over-leveraged and just waiting to collapse.
The credit crunch arose because house prices started to fall in the US. But this was compounded by several factors. Firstly lending institutions had over-lent to borrowers who could not afford to take out a mortgage; the trick was to disguise the actual level of repayment through very cheap instalments for the first 6 months or so. Then the mortgages were sold on; so those who had done the deal were no longer liable for anything if the house-owners defaulted, which they were likely to do if they could not afford repayments and the price of their house was falling.
On top of that, the mortgages were typically sold on after being mixed with other loan portfolios of a different risk profile, a practice that was rewarded with spectacular personal bonuses for the bankers involved. As a result it became impossible to discover which bank actually owned which mortgages, and particularly who had the mortgages which were not being repaid. But everyone knew that it was going to be a bank. The other banks knew this too, so they could not, with a clean conscience lend to each other since they could not know what the risks might be and whether they would be repaid. And all the banks were in this position. So no one bank trusted or wanted to lend to any other.
In the end, the banks became reluctant to lend to anyone. Initially banks did not want to lend to house-owners, since house prices were generally falling. However because of the cost of money to the banks, it soon became necessary to raise the cost of borrowing for all. The price of money (interest rates) rose. The result, a credit crunch: credit of any kind is hard to obtain and expensive. And banks started to fail.
This is now beginning to affect the ‘real’ economy, which is the one in which people make things other than money. It is harder for businesses to borrow even for short term working capital. And individual borrowers are starting to find their credit card payments are too onerous. But quite independently of the mechanism of the credit crunch, the real economy has been suffering – partly driven by the cooling of the Chinese economy and by rising commodity prices. The realisation of this, coupled with the nervousness created by the credit crunch, the computer-based automatic selling of shares and the practice of short selling, (that is selling shares you do not have) turned the fall in the stock prices of banks into a general stock market collapse.
But compared to the looming environmental crash, the economic crash is trivial…