The credit crunch began through mortgages being offered to people who didnt deserve it (ie high risk of default).
The investment banking industry builds products that rely on the returns of these mortgages. The default level increased and banks had assest they bought for $X and were worth no way near X. Because of the complexity of these products (CDO's) the banks accepted writedowns and stopped lending to keep the cash flow in case of further write downs.
For a mortgage lending bank -
The interest rate has decreased so mortgages have become more attractive but because of the lack of confidence in mortgage markets, the firms are reluctant to give new mortgages.
As a result the percentage of new mortgages has decreased.
Furthermore with the drop in housing prices anyone who defaults on the their mortgage will give the bank an asset (the house) which is worth less than the mortgage they issued in the first place - as such the mortgage banks will loose money.
Either way the credit crunch has led to reduced business and profits, and in extreme cases - bankruptcy (Northern Rock)