Sharply rising interest rates -- which already have made the cost of buying a home nearly prohibitive and have caused chaos in the nation's bond markets -- are taking their toll in other areas of the economy as well.
Faced with state usury laws that limit the amount of interest they can charge, many banks and financial companies are cutting back sharply on the amount of credit they grant consumers. And when these financial institutions, or retailers, do extend credit, they are making only marginal profits or losing money on the loans.
Businesses are seeing their profit margins cut by the higher costs of funds: The prime rate is 17 3/4 percent today, a full one and one-half percentage points higher than it was a week ago. t
Like some consumers, some small businesses do not have the leverage to get bank lines of credit, and thus may find it difficult to get loans to finance their inventories as the Federal Reserve Board tries to put the squeeze on the extension of credit in an attempt to fight inflation.
For the past several months the federal government -- and for that matter the nation -- has focused its attention on the country's ballooning rate of inflation.
But as the interest rates rise even higher -- an 18 percent prime rate within the next few weeks would surprise no one -- the upshot will be falling profit margins and a strangling of consumer demand that could lead to bankruptcies and a severe recession of the sort that was anticipated, but never materialized, in 1979.
The pain of higher rates so far has been felt most directly by businesses that are interest sensitive such as finance companies and credit card operations, and by businesses such as housing an automobiles in which financing consumer purchases is the key to the sale.
Automobile dealers, for example, are being squeezed by both the rising costs of financing the cars they keep in stock (the so-called floor plan) and by the inability of many potential buyers to qualify for a loan.
Edward J. Lynch, who owns Wisconsin's biggest Chevrolet dealership, said that in February 1979 his floor plan cost him $28,000 to finance through General Motors Acceptance Corp., the finance arm of General Motors Corp. Last month, although he had reduced his inventory from 800 to 600 vehicles, his floor plan cost him $55,000.
Lynch said he had his best February ever for car sales. "We sold 280 vehicles last month (most of them small, gas-efficient cars such as the Chevette or Citation). It was the best February we ever had. With those kind of sales we should have made $45,000 to $50,000. Instead the dealership was marginally profitable," Lynch said.
Lynch said he could have sold another 60 cars, but the deals fell through because of the higher down payments and stricter credit requirement imposed by GMAC (which finances car buyers as well as dealers). "Those deals wouldn't have fallen through a year ago," he said.
Banks have stopped making car loans in Wisconsin, as they have in many other states, because of usury ceilings on consumer loans. GMAC stays in, even at a loss, because of its affilitiation to the auto parent, but is much less willing to make a loan, he said.
Vincent Sheehy, who owns Sheehy Ford in Marlow Heights, said interest was the biggest expense increase he faced in 1979. At 17 3/4 percent, which is what Ford Motor Credit Corp. charges him today for his floor plan, Sheehy said it costs him about $250 a month for each car he has in stock.
Retailers are feeling the pinch, too.
Robert Mulligan, executive vice president of Woodward & Lothrop, said the costs of financing the retailer's inventory are rising rapidly and customers are maintaining higher balances on the credit card accounts they have with Woodies.
Woodies is well-heeled enough to sell commercial paper (essentially corporate IOUs) which enable the company to pay about half a percentage point less than the prime rate for its money. Still, with an interest ceiling of 18 percent on credit card balances, retailers lose money on credit cards.
Mulligan said Woodies tries to cut costs as much as it can in other areas of the company's operations and keep its inventories as low as possible. "We run the risk of losing some sales" by not always having goods in stock, but that is a risk "we have to take," he said.
Nevertheless, because most of the higher interest rates cannot be passed along to customers, the high cost of money "is eating into our profit margins," Mulligan added.
Roy Garofalo, vice president for investor relations at F.W. Woolworth & Co., said that in an attempt to cut down on the cost of financing customer purchases, the giant retailer has been encouraging consumers to use Master Charge or VISA cards rather than Woolco credit cards.
That may not make the bank credit card companies happy, he conceded, but it has helped Woolworth hold down financing costs a bit. Like most other retailers, Woolworth is doing its best to hold down inventories.
Because Woolworth operates extensively abroad and because it relies less heavily on big-ticket items such as refrigerators (which consumers usually buy on credit) than many other nationwide chains or department stores, "We haven't felt the interest rates quite as badly as some others," Garofalo said. "But it's a matter of relative degree of pain. It's hurting our margins, too."
To try to earn a little more interest than they used to -- and still remain within the limits of usury ceilings -- many credit card issuers are recalculating the timing of the interest charge, eliminating what amounted to interest-free grace periods.
Nearly all credit card issuers -- like GMAC on auto loans -- have made if more difficult to get credit cards and are granting smaller credit lines than they might have in the past.
Citicorp, the parent of New York's largest bank, has cut off credit cards to the 14,000 customers of its NAC credit card operation that have charge authorizations below $300. Citicorp said these customers have the highest incidence of repayment delinquencies. All told, there were 770,000 NAC card holders in the Washington-Baltimore area.
All these actions by retailers and credit card operations to hold down the amount of interest they grant consumers also will make it more difficult for many customers to buy goods and services.
So far, although interest rates have risen to record levels, money has been available, albeit at high cost. Consumer lending has been hit because of usury ceilings, but for businesses willing to pay the price -- and most have been so far -- funds have been available.
But as companies unable to sell their bonds turn to their bankers, and as bankers find it harder and more expensive to get funds because of Federal Reserve monetary policy, small companies especially may find it nearly impossible to get financing of any sort.
"I wouldn't want to be in a small retailer's shoes right now," said the chief lending officer of a major bank.
"We could be seeing the makings of a classic credit crunch," where some borrowers cannot get funds at any price, said George Baker, the top lending official at Continental Illinois National Bank.
Not all companies feel the sting of higher interest rates with the same intensity as others.
Energy companies' prices are rising rapidly, and their profit margins are widening rather than shrinking.
Other companies, whose need for funds is usually related to capital expansion, can cancel or postpone projects rather than move into the long-term bond market, where interest rates are not much below the prime rate.
The bond markets have been in disarray for about two months, not a long enough period to disrupt capital spending plans seriously.
"But give us another six months of these markets and continuing rupture in consumer demands, and a lot more companies will go back to the drawing boards," said another bank official. "Then you could see a big recession."