End of Cheap Credit Hits Homes, Businesses
Tuesday, March 18, 2008
Mounting turmoil in credit markets could realign the finances of households and businesses, as banks scramble to bolster their balance sheets and jettison risky customers.
For consumers, it could mean fewer credit card offers. For home buyers, it will mean tougher mortgage conditions. For many businesses, it will mean a substantial increase in borrowing costs and possible postponement of capital spending plans.
"Clearly the market is going to be much tighter in terms of credit standards," said Tobias Levkovich, chief U.S. equity strategist at Citigroup.
For years, the U.S. economy has thrived on cheap credit as highly leveraged investment banks lent money to highly leveraged consumers. Now, with the collapse of Bear Stearns and the possibility of a recession looming, investment banks are also likely to take fewer risks and look for ways to reinforce their equity positions.
For a country of consumers addicted to debt, a possible sign of a change can be seen in places like the Web site Bankaholic.com.
Founded a year and a half ago by John Wu, who turned a project from his student days at the University of California at Berkeley into a rapidly growing business, the site offers a first stop for consumers shopping for credit cards and mortgages. About 750,000 people visit the site every month, Wu says.
But these days, Bankaholic finds that consumers are shopping more for savings accounts and certificates of deposit than credit cards -- and, to lure them in, banks have boosted their ad spending on the site. "Banks really need depositors to put money in them," Wu said. "They're desperate to get more money."
That could frustrate the Federal Reserve, which has been cutting interest rates to boost economic activity. But many banks aren't passing the lower money costs made possible by the Fed along to consumers or businesses. The interest rates on credit cards have dropped modestly at best, and 30-year mortgage rates have not declined substantially, Wu said.
"People have been expecting that credit card rates would come down. But because there's greater risk now in lending, credit card companies have been raising their rates a little bit as the Fed has been cutting," Wu said.
While most economists have long said that Americans need to borrow less and live within their means, the sudden, lurching nature of recent financial markets isn't what most of them had envisioned.
That turmoil in the credit markets could take a toll on U.S. businesses, too. Levkovich said that capital-intensive and small businesses would also end up canceling many projects in the coming months.
"If the cost of capital is going up and the return on that investment isn't changing, then fewer projects are going to get approved," he said.