Credit crisis has Main Street watching Wall Street

Meanwhile, with investors less eager to buy up mortgage loans, lenders have tightened on borrowers. This is typical of any credit squeeze after a boom, but the recent boom was so big that the squeeze could put an unusual amount of downward pressure on home prices over the next year or more.

For most homeowners, their house is their most important financial asset. "This time, they will feel it more" than in past eras of financial-sector tightness, says Rajeev Dhawan, who heads Georgia State University's economic forecasting center in Atlanta.

Just as financial ease fed the housing boom, the end of the housing rush has blown back at financial markets, causing home prices to fall. But unlike in the past, the housing boom faded without the onset of a recession or a significant rise in mortgage rates; the surge in home buying and easy lending simply reached a point where too few buyers remained to sustain the momentum.

Now, as mortgage rates have edged upward, consumers face another financial head wind. More home buyers have been drawn to adjustable-rate loans, rather than loans with fixed rates, in recent years. As those loans reset, the pinch of higher mortgage payments is likely to push foreclosure rates higher, economists say.

The problem: many of the recent adjustable loans came with low "teaser" rates, but payments will reset much higher.

Meanwhile, lenders have grown pickier about whom they lend to, because it's no longer easy to resell the loans as mortgage-based derivatives. Countrywide Financial Corp., a large mortgage provider, summed up its own situation in a statement last Thursday: "[The] situation is rapidly evolving and the potential impact on the company is unknown." Those words might be echoed by many hedge funds and Wall Street brokerage houses.

Wall Street could remain a volatile place in coming weeks as investors try to sort out the scope of the problem.

The irony is that derivatives have been viewed by many as a tool for reducing risk, in part by spreading it around. But they did not eliminate risk. And, in a way, the risk was just repackaged.

"Things designed to reduce risk, at certain special times, have a way of not always going perfectly," says Peter Kretzmer, an economist at Bank of America in New York.

Despite the credit-market challenges, most economists expect that the fallout on Main Street won't be bad enough to send the economy into recession.

"I doubt it's going to ripple very much," says Mr. Hymans.

Mr. Kretzmer adds that, "Only really large changes in the valuation of securities and wealth matter" in terms of consumer spending. Most consumption, he says, hinges on two factors, "Do I have a job, and what is my income growth like?"

Unemployment remains low in the US. Most economies worldwide have been growing solidly. Perhaps most significant is that central banks have shown in recent days that they stand ready to calm credit markets if they appear to be freezing up. The Federal Reserve funneled $38 billion into the system Friday. In addition, some economists believe the Fed will cut short-term interest rates soon.

"They're clearly vigilant," but not panicked, says James Sarni, a managing principal at Payden & Rygel, a fixed-income mutual-fund company in Los Angeles. "I think they're doing the right thing."

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