My understanding is that the mortgage crisis of 2007 is an example of something like this going bad. Technically it was just Americans owing money to other Americans right? But I think how these things go bad is something like:
- Some loans start to default. Either randomly, or because the easy availability of credit encourages riskier projects.
- Conservative lenders get spooked and exit. Credit becomes a bit scarcer.
- This repeats in a cycle. Each round wipes out more businesses. At first it's mostly the obviously risky ones, but increasingly it's normal business with unlucky timing.
- People start to see the writing on the wall, credit markets lock up, and panic sets in. Major corporations find themselves unable to make payroll. Ordinary financial stuff like currency exchanges stop working, while everyone scrambles to figure out which intermediary banks might be insolvent.