Credit is endemic in the developed countries of the world, it is the oil between the cogs of the economy, if you remove access to credit what will happen?
Firstly even a worst case scenario would not see all lines of credit dissapear, applying for credit would become a more rigourous process both on the high street and commercially. Interest rates may increase this would have a knock on effect of reducing spending power and increasing the cost of production. The first place this will have an effect is in the housing market, typically this is the biggest loan taken out by consumers.
It is a well know fact in the UK where demand for housing outstrips supply that cheap credit (low interest rates) increases peoples purchasing power and thus causes house prices to rise. The banks willingness to lend money or access to credit is another factor, in the UK banks have been lowering the bar and increasing the ratio of income multiples. Five years ago the standard income multiples used by all banks was 2.5 x joint salary or three times single salary. This lending criteria was introduced by banks as a straighforward sanity check to prevent customers over commiting themselves. Increasing this ratio as quickly and by as much as 4.5 times joint salary and five times single was a bold move by the banks. It is understandable why they did it, more and more of the customers coming to them were priced out of the market and could not afford to get on the property ladder. They were creditworthy but could not borrow enough cash to buy the house / flat they wanted, the solution was simple but the consequences of the solution may be unpleasant.
Second mortgages and remortgaging your house can be an effective way to finance a purchase, the security of your home will often mean a lower interest rate, however, some consumers have deluded themselves as to what they can actually afford. The increased security of lending against your property will also mean you can borrow more than an unsecured loan. Finance and mortgage companies will pay less attention to a customers credit history and ability to pay if they can offer some security (their house), in this situation responsible lending is less likely to occur.
So what is the worst case scenario for the UK housing market? Well a house price crash, fuelled by higher interest rates and consumers inability to obtain credit. This could easily lead to a recession due to people repaying their more expensive mortgages not having any spare cash to spend on fancy meals and in the shops. We could re-live the 80’s bust all over again. In the longer term this would probably be healthy for the economy by lowering house prices. The fundamental problem the shortage of good housing would not have been addressed, only the government can tackle this by removing some the restrictions preventing new houses from being built.