How hard will tight credit hit?

The era of easy money is drying up – hitting Wall Street and its deal­makers first.

Last week, the prospect of fewer mergers and acquisitions caused the stock market's sharp drop. The Dow Jones Industrial Average fell 585 points for the week, the largest weekly point loss in five years. Even a positive report on the gross domestic product in the second quarter – up at a 3.4 percent pace – failed to stem the stock sell-off.

Now, economists are watching credit markets carefully to see if tighter lending standards for wheeler-dealers will spread to Main Street, where credit is still readily available. According to the Federal Reserve, consumer credit grew by 6.4 percent in May.

So far, credit is available for companies with strong balance sheets. It's private-equity groups, used to virtually restriction-free lending, that are finding it more difficult to obtain loans. By one estimate, buyers are in the market for about $200 billion to provide long-term financing for acquisitions.

"Maybe they can't get the big Wall Street deals done at the cheap interest rates they used to get," says Michael Swanson, chief economist at Wells Fargo Banks in Minneapolis.

The reduction in merger activity could eventually have an effect on the economy, says John Silvia, chief economist at Wachovia Corp. in Charlotte, N.C. "The main impact on Main Street will be a decreased ability to finance economic growth," he says. "At the margin, there will be less investment in equipment and software and less ability to fund home mortgages and commercial activity."

The actual impact on the GDP may be only 0.1 or 0.2 percent in 2008, estimates Mr. Silvia. But it may also mean that the softness in the housing market continues longer than anticipated. "Economists are going to start to downshift their economic expectations for next year," he says.

However, it may be too early to start reducing GDP estimates, Mr. Swanson believes. "If you tie equity performance to GDP, you're putting the cart before the horse," he says, adding, "If the economy does well, the earnings and dividends will follow, and the market will follow that."

Even though the economy rebounded in the second quarter from a weak first quarter, economists were not that impressed. Combining the numbers for the first half of the year results in an average GDP of 2 percent. "That's relatively lackluster," says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla.

In addition, consumer spending slowed from a 3.7 percent pace in the first quarter to a 1.3 percent rate in the second quarter. Much of this slowdown may be the result of a second-quarter drop of 0.8 percent in disposable income, after a rise of 5.9 percent in the first quarter. "We had a huge increase in gasoline prices, and wage growth was stronger in the first quarter," says Mr. Brown.

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