WASHINGTON — Credit for consumers and companies alike was choking to a halt as the crisis on Wall Street intensified earlier this week. But when word of a government bailout for financial institutions began to circulate Friday, credit freed up — albeit under tighter rules.
Despite that heartening sign for the creditworthy, the economy remains fragile with consumer confidence flagging, spending down and unemployment at its highest level in five years. The turmoil on Wall Street could further slow spending, the economy's key engine.
Economists said the more stringent credit standards would be the most immediate effect of the financial crisis for businesses and consumers. Those with the weakest credit ratings and most questionable assets are likely to find loans more expensive and harder to get, while those deemed good credit risks could be largely unaffected.
The fallout from the financial crisis caused by the collapse of the housing market has slowly rippled outward. Since early this year, long before the dramatic developments of the last few weeks, Federal Reserve surveys of loan officers found that a majority of the nation's banks had tightened lending standards for a broad range of loans, slowing an economy that had expanded in recent years with the help of an increasing volume of borrowed money.
"The economy cannot regain its stride until the credit crunch passes," said Greg McBride, a senior financial analyst at Bankrate.com.
Borrowing and spending
The availability of credit is pivotal, as it propels a good share of the consumer spending that accounts for about 70 percent of the nation's economic activity. "The real fear here is that the turmoil could affect credit costs, which could affect borrowing and spending in the real economy," said Mark Gertler, a New York University economist.
As the crisis boiled earlier this week, some corporations found that their short-term borrowing costs suddenly soared, in some cases by as much as 40 percent. But as the crisis continued, some highly rated firms found it cheaper to raise money because investors sought to put their money in the safest investments they could find.
"There is a divide in which rates have spiked," said Ben Garber, an economist with Moody's Analytics. Companies that held assets whose values were hard to pinpoint and had lower bond ratings found themselves paying much more to raise money to cover their short-term expenses. At the same time, most highly rated corporations had few problems. "There is a general flight to quality," he said.
By Friday, the overall cost of short-term borrowing for companies began to ease. "The good news is if you had not seen the reversal in borrowing costs over the pasts two days you would have seen things like mortgage rates going up," and economic activity slowing sharply, said Jim DeMasi, chief fixed income strategist for Stifel Nicolaus, an investment banking firm. "The government action has provided some stability and has the potential to turn around a lot of negative trends."
Even before the financial crisis intensified, shoppers had been feeling squeezed by falling home values and rising costs of necessities such as food and fuel.
Thousands of financial industry jobs have disappeared, remaking the face of Wall Street and threatening to strain state and municipal budgets in New York and New Jersey.
While the credit crisis has been building for months, it has at times hit consumers with jarring abruptness.
Students who were approved for private school loans from College Door in Carlisle, Pa., which was backed by Lehman Brothers, learned several weeks ago that their loans would not be funded. Private student loan companies had been struggling for months as it became more difficult to sell loans and to borrow money to make them. A total of 33 lenders, including MyRichUncle and Wachovia, have suspended private student loan programs, said financial aid expert Mark Kantrowitz.
Credit limits slashed
Meanwhile, millions of credit card users have had their credit limits sharply reduced.
American Express spokeswoman Kim Forde said the company typically adjusts less than 20 percent of its customers' credit limits annually. Traditionally, 80 percent of those adjustments are to raise the limit, while the remainder are decreased. That ratio began changing in October and now sits at about 50-50.
Wayne Wilson, a pastor in Salt Lake City, was buying stamps in July when he learned that American Express had cut the limit on his card from $3,600 to $500. Wilson, who runs a not-for-profit group that helps the homeless and used the card for work-related purchases, was floored because he always paid off the balance. A survey earlier this year by Consumer Action, a San Francisco advocacy group, found that 18 percent of credit card holders surveyed had seen their limits reduced.
With the credit landscape shifting, consumer debt expert Robert D. Manning said, credit card statements are now required reading. "More than ever, consumers need to be vigilant because the banks are desperate for anything they can get right now," he said.
The financial turmoil is also wreaking havoc on consumers' already fragile psyches.
"When you look at all the data out there, the consumer for some time has felt like we've been economically challenged," said C. Britt Beemer, chairman of America's Research Group, a market research firm.
Federal tax rebates and economic stimulus checks helped pad shoppers' wallets in the spring and summer. But now those checks have been spent or socked away. The Commerce Department reported that retail sales fell 0.3 percent in August from the previous month, with particularly large losses in the building and electronics sectors.
The holiday shopping season, which is crucial to retailers, looks especially grim. Several forecasts released this week predicted that spending will grow at the slowest pace since 1991. "Consumers are in a cost-conscious mood and more focused on value than ever before," said Stacy Janiak, U.S. retail leader for consulting firm Deloitte.