Credit Crunch Hits Businesses First

Credit squeeze. Liquidity crisis.

Those phrases are being bandied about on Wall Street and in the financial press these days. The Wall Street Journal recently devoted two pages to the topic.

Seeing "a growing caution by lenders and unsettled conditions in financial markets," the Federal Reserve cut short-term interest rates again last Thursday.

The fear is that the international financial crisis is prompting many lenders to be so cautious that the United States economy will be forced into a recession. No new lending, little new business, fewer new jobs, declining profits.

"Risk, until recently an abstract, almost academic idea, has seemingly become the only idea," notes James Grant, who writes a financial newsletter.

So far, though, consumers have not been hit, the experts say. Just about as many credit-card solicitations slide through the mail slot. Home-equity and car loans are still easy to come by.

"There is still tons of availability there," says Pamela Martin, spokeswoman in Washington for the Robert Morris Association, a group of lending and credit-risk professionals. "Talk of a credit crunch is far overblown."

Economist Cynthia Latta takes the idea of a credit shortage only semi-seriously. "It is not clear banks are a lot less willing to lend," says the consultant with Standard & Poor's DRI, of Lexington, Mass.

What has happened is that some money-raising financial instruments are harder to sell, and some shakier businesses face less availability of credit.

The problem is "at the periphery," says Wall Street economist Henry Kaufman.

People with poor credit records, for instance, may have a harder time finding a mortgage for a new home.

Primarily, though, credit concerns are hurting some businesses.

Fewer young companies are able to make initial public offerings of shares.

That means more of these firms may seek loans from commercial banks, rather than from capital markets. It may give banks a chance to regain money business they have lost in recent years.

Banks' share of total financial-sector assets stood at 37 percent in 1980, only 24 percent in 1998. The share going to credit unions and savings-and-loans fell from 21 percent to 6.5 percent.

Sales of securities backed by assets, such as mortgages and auto loans, have exploded, taking away bank business.

More companies have been floating new bonds to raise money. New bond issues soared to $128 billion in 1997 from $14 billion in 1991.

But today, a huge gap has opened between yields on secure Treasury bonds and yields on more risky bonds, often called "junk" bonds. Interest rates on mortgages on commercial properties have risen. If the economy slows, those buildings may not stay occupied or pay off for their investors. Some commercial property deals will be postponed or canceled.

The market for loans to emerging markets - the Far East, Brazil, Russia - has dried up.

Managers of hedge funds and other highly speculative funds are having a hard time raising money. Indeed, one reason for the turmoil on the financial markets is that many stockholders have been unloading sour investments.

Many hedge funds had borrowed cheap Japanese yen to leverage their investments elsewhere in the world. When they wrapped up those loans in recent days, the yen fell and the US dollar rose.

The Fed is worried that overall the credit squeeze, though mild, will slow the economy too much. Mr. Kaufman predicts that the US will be "very close" to a recession by the middle of next year.

Ms. Latta of DRI doesn't see a credit crunch as enough to tip the economy into recession, though it will slow it down.

Ms. Martin worries that consumer fears of a slowdown will prompt them to cut back on spending, creating a self-fulfilling prophecy.

But the Fed is riding to the rescue.