Will it be harder to get credit?

In ordinary times, there's nothing earthshaking about the collapse of a hedge fund or two. Such events are hard on the relatively small group of investors involved, but don't threaten the wider availability of money in the economy.

The problem today is: Nobody can say whether these are ordinary financial times.

In fact, as some investment funds reel from mortgage-loan losses, what analysts can agree on is that financial markets are operating today in untested waters. The rise of "derivative" securities – complex investments derived from other assets such as mortgage loans – means that even insiders can't quantify the risks or say where they lie.

All this doesn't mean that an all-out credit crunch, in which years of easy credit give way to a drought of borrowing and investment, is likely. But the threat is there.

"Clearly there's a risk" that a tighter financial climate could spread beyond the arena of low-quality mortgage loans, says Nigel Gault, a US economist at Global Insight, an economic forecasting firm in Lexington, Mass. "It's unknowable because of the way the financial markets operate now.... Risk is much more widely spread around the financial system than it used to be."

Mr. Gault predicts that what's happening now is a shift back to normal after a period of easy money, in which many lenders seemed too complacent.

"It's a necessary process. Risk became quite severely mispriced," he says.

Losses for investors

But the process can be stressful.

•This week Standard & Poor's and Moody's, two leading New York credit-rating agencies, said they were putting vast swaths of residential mortgage debt under review. It could portend downgraded ratings and, ultimately, losses for the firms and investors who hold those loans.

•Already the declining value of subprime loans has been causing losses for investors that include many hedge funds. Bear Stearns has recently moved toward a $3.2 billion rescue of a hedge fund it owns, where mortgage derivatives – investments derived from home loans – went bad.

•Banks, facing pressure from now-wary investors in mortgage derivatives, have been tightening their lending standards for riskier borrowers.

All these events are focused on the housing market, and particularly on the debt of home buyers whose own credit quality was less than "prime."

But some observers worry that this hints at worse things to come.

The availability of home loans has been a vital underpinning of America's economic expansion since 2001. More broadly, this has been a global expansion built on credit – from leveraged buyouts to ordinary business borrowing.

Through large investors and investment firms, all these debt markets are somewhat interconnected. So the risk is that trouble in one sector could spur doubts about the stability of others.

"The subprime crisis is not an isolated event…. It will not remain confined to a Petri dish," William Gross, a widely watched bond-fund manager at PIMCO, wrote this month. "The willingness to extend credit in other areas … should feel the cooling Arctic winds of a liquidity constriction."

Still, Mr. Gross and other analysts stop short of forecasting a full-scale crisis.

In fact, although the news from credit-rating agencies seemed to rattle stock traders earlier this week, markets have appeared resilient since then. In trading Thursday morning, investors pushed the Dow Jones Industrial Average above its record high, set back in early June.

Times of crisis

In a true credit crunch, even borrowers with solid finances find it hard to get loans – and economic growth suffers as a result. This happens only rarely, because since the Great Depression central bankers have been ready to open monetary spigots when a crisis warrants.

In 1998, for example, the Federal Reserve rode to the rescue when the collapse of Long Term Capital Management shook global financial markets. Then in 2001, after the dotcom stock bubble burst, the Fed kept monetary policy in a loose mode for several years.

"People are still saying there's too much liquidity out there," says Brian Horrigan, an economist at Loomis Sayles in Boston, an investment firm that runs several bond mutual funds. But if some blame the Fed for throwing gasoline on a hot housing market, Mr. Horrigan notes that back in 2002, the Fed had legitimate worries that the economy would fall into recession due in part to a dearth of business investment.

Since 2004, the US and other nations have seen central banks tighten up a bit, but by some measures monetary policy still doesn't look tight.

Still, the credit cycle is turning, perhaps in a good way, many analysts say.

Failed investments, like those tied to Bear Stearns, can send a tough but healthy message to others: Buyer beware.

Recently, investors have been thinking harder about whether they want to lend money to private equity firms that have been on a buyout spree involving companies such as Chrysler.

And the often murky realm of derivatives has gotten a wake-up call. Derivative securities repackage debts in creative ways, and are then are parceled out among a wide range of Wall Street investors. Some investors, it appears, assumed that had virtually eliminated all risk.

"Hopefully we are shifting towards more normal, more realistic pricing of risk," says Gault.