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What has been amazing about the credit crunch is the way that it has happened in such slow motion. The first problems for mortgage lenders emerged in late 2006 and 2007; aficionados will remember tracking the website Implode-O-Meter for a running total of those that failed. In June last year, two Bear Stearns hedge funds reported big losses on structured products linked to mortgage-related securities.

Even when the money markets froze in August 2007, most people outside the financial markets probably saw this as a specialist story. It took the queues outside Northern Rock in September last year to make it real. Only now, however, are we really seeing the true economic impact, with house prices falling rapidly, building workers being laid off and retailers reporting a fall in consumer demand.

But everything that is happening now is a consequence of the events of 18 months ago. The phenomenal returns achieved by investment banking in the early years of this decade are coming back to haunt us. In effect, they created a new market and had to invent - or fund - a new class of investors to buy it. As that effort unravels, the banks are having to restrict credit to other parts of the economy. And as consumers and companies feel the pinch, they are cutting back on their spending.

The new market was, of course, the structured products - such as collateralised debt obligations - that sliced and diced asset-backed securities into different tranches based on risk. This allowed banks to earn a fee for arranging the deal, and freed up their balance sheets for other, more lucrative, work than simply buying and holding mortgages. Their return on capital was much higher.

The problem was, that there wasn’t always a natural market for all parts of the CDO. Either the bits were too risky - and were shunned by cautious investors - or too safe - with not enough yield for risk-seeking investors. The answer was twofold: lend money to investors - such as hedge funds - to buy the assets and set up off-balance-sheet vehicles to buy the rest.

All was well when the asset prices were going up. Burt when they fell, either the assets came back on the banks’ balance sheets or they started to worry about whether their borrowers would pay them back.

The result has been a massive deleveraging. The effect on the credit markets was instantaneous. It took longer to have an impact on the equity markets. But that such an impact would occur was inevitable. The financial sector was worth more than 20 per cent of the US market at its peak and it has had to raise new equity at deeper and deeper discounts. The rest of the market’s impetus was driven by high commodity prices; great news for the oil and mining sectors but bad news for everyone else.

The implications of all this is that the crisis has much further to run. The feedback effects are well known - banks lend money against assets as collateral. As asset prices rise, banks are happy to lend more, boosting prices even further. When prices fall, banks demand their money back, driving prices even further down.

In addition, when economic downturns occur, profits fall further and for longer than most people expect. According to Dresdner Kleinwort, it took 139 weeks for equities to move from peak to trough in the early 1990s recession. At the low, earnings were falling 19 per cent on a year-on-year rate. So far this time, earnings are still showing a year-on-year increase.

Throw in the fact that consumers are seeing their housing and stock market wealth decline, their access to credit curtailed, their employment prospects deteriorate and their real income squeezed by higher fuel prices and we could be in for an extended period of gloom. We may be lucky if the tide turns as early as next year.