The years of easy money were fun while they lasted. Banks and credit card providers were so flush with cash that they could help virtually anyone — including many who had trouble juggling their bills — pay for whatever they wanted.
But the party’s over.
That’s been marked by the shuddering collapse of investment bank Lehman Bros., the sale of Merrill Lynch to Bank of America, the federal government’s $30 billion loan to foster the sale of investment bank Bear Stearns, its $200 billion injection to mortgage backers Freddie Mac and Fannie Mae, and its $85 billion loan to insurance provider American International Group.
We’ve entered a period of tight credit — which could mean jobs lost, retirement plans pruned, college deferred, and lifestyles diminished.
Across the nation, Americans know that something’s wrong.
Nearly one-quarter of adults — 23 percent — believe the U.S. economy is in a depression, according to a USA TODAY/Gallup Poll taken Monday and Tuesday. That’s nearly double the 12 percent who said so in February.
People haven’t lost hope. Nearly half — 47 percent — say they expect the U.S. economy to be growing a year from now. That’s roughly unchanged from the 44 percent who expressed the same view in the earlier poll.
But amid the rush of bad financial news, concerns are increasing.
Marilyn Landis, a longtime homeowner and businesswoman in Cleveland, recently saw how dramatically the financial world is changing when her credit card rate shot up to 27 percent from 3 percent after she bought $7,000 worth of new computers for her financial consulting firm.
Landis, a former commercial lender who says she has excellent credit, says her bank explained that her rate rose because she was closer to her credit limit. Meanwhile, Landis says she can’t get a home equity loan to expand her business because her home’s value hasn’t risen enough thanks to the mortgage crisis.
Her firm is still doing well, but Landis says she and many clients are increasingly fearful of the spiraling damage from the financial crunch, as more small- to-mid-sized businesses and thousands of their customers find their credit lines capped by banks.
“It’s like throwing millions of stones in a lake and watching the economic ripples,” Landis says. “That really worries me.”
The complications stemming from the credit crunch worsened Wednesday, as investors bailed out of stocks for the second time in three days, causing a net drop in the Dow of 812 points this week — more than 7 percent. On Wednesday, many investors saw the AIG bailout as a sign the government believes the nation’s financial system can’t withstand another shock.
Investors rushed to ultra-safe, three-month Treasuries, driving the yield to the lowest level since February 1941, says Bryan Taylor of Global Financial Data. Meanwhile, a popular measure of investors’ nervousness, the CBOE Volatility index, jumped 20 percent.
The new era of tight credit, and the government’s response to the crises in the financial markets, are touching Landis and other Americans in a range of ways:
If you’re in a 401(k) savings plan, you’ve had a jarring week as panicked investors reacted to the monumental reshaping of financial markets.
Even though the S&P 500 plunged more than 4 percent Wednesday, owning a basket of stocks, such as a diversified stock fund in a 401(k) plan, often is far better than owing an individual stock. Blue-chip General Electric fell 6.6 percent Wednesday, for example, and investment bank Morgan Stanley tumbled 24.2 percent
Most people don’t invest all their money in stocks. Of the $4.6 trillion in retirement accounts at the end of 2007 — the latest figures available — about 68 percent was invested in stocks, with the rest in money market funds and bond funds, which have risen modestly in value.
Nevertheless, it’s discouraging to shovel money into a retirement account and not see any growth — or to see balances decline. Analysts generally offer three tips to help ease the pain:
1.) Keep contributing, especially if your company matches your contributions.
2.) Don’t panic. If you move all your money out of stocks and into a money fund now, you run the risk of missing profits when the market recovers — assuming it does, of course.
3.) Rebalance. If you’ve set a targets for your investments — say, 60 percent stocks and 40 percent bonds — check your balances. If you now have a 50 percent-50 percent split between stocks and bonds, sell enough bond funds to get your asset mix back to 60 percent stocks and 40 percent bonds. You’ll be buying stocks low and selling high.
This appears to be a good time to put some money in the bank.
Banks, eager to build their cash reserves and faced with a tightening credit market, began to boost savings rates even before the recent turmoil.
Since the end of April, when the Fed last cut interest rates, yields on the average one-year CD have climbed to 2.4 percent from 1.9 percent, according to Bankrate.com. But yields at some banks are as high as 4.6 percent.
Saving has become an increasingly urgent priority for Monique Shankle, a former Enron employee and contracts advisor for an offshore engineering firm in Houston who has spent the past few years recovering from $60,000 in losses from her Enron retirement fund.
Now, the 401(k) she has with her current employer has lost several thousand dollars in value. Fearing tough times, Shankle says she is saving more cash, hiding her credit cards and delaying the purchase of a new car.
“It’s like Enron all over again,” she says. “You’ve got to be prepared for whatever happens.”
At coffee shops and gas stations across the nation, people are wondering what the government has gotten them into as taxpayers with all the federal bailouts. “We just keep going deeper and deeper in debt,” says Milton Hubbard, 58, a pastor in Chanute, Kan. “At some point it is going to crash.”
There’s no telling how much taxpayers ultimately will pay for the recent federal efforts to stabilize the system. But things may look worse today than they will a few years from now.
Taxpayers made money after the government guaranteed loans of more than $1 billion to Chrysler in 1979. The auto company paid the loan back in full and the Treasury Department made a profit when it sold the Chrysler stock it got in the deal.
The Resolution Trust Corp., which was created in 1989 to dispose of the assets of failed savings and loans, cost taxpayers far less than initially feared.
“Often, (bailouts) end up being moneymakers,” says Jon Faust, director of the Center for Financial Economics at Johns Hopkins University. He says it’s likely the Fed will make a little money, break even or lose a little.
How would the Fed lose the entire $85 billion from AIG? “The only way that happens is if the economy really collapses,” Faust says. “But if the economy collapses that is the least of our problems. You’re going to wonder why you didn’t spend more.”
Those upset about the government actions need to keep in mind what would have happened if there had been no action, JPMorgan Chase senior economist James Glassman says. The economy could have slowed further, leading to less tax revenue and thus higher levels of debt. “If you don’t address the crisis, the real cost to the public can end up being far worse.”
Credit card users
Average credit card interest rates have fallen as the Federal Reserve has cut its short-term interest-rate target to just 2 percent. And yet, that doesn’t mean people are paying less for credit. Those who miss a payment, send their checks in late or exceed their credit limits can discover penalty fees as high as 32 percent.
Card providers likely will collect more than $19 billion from consumer penalty fees this year, up 5.5 percent from 2007, according to consulting firm R.K. Hammer.
Consumers are relying on credit cards more than ever, especially as it gets harder to land home equity loans. Revolving debt — much of it on credit cards — hit a record $969.9 billion in July. People are starting to use their cards for necessities such as groceries and gas, credit counselors say.
As the credit market gets tighter, that could be a big problem for consumers deemed to be bad credit risks, especially those who have mortgages that adjust to rising rates. Lenders are sending them fewer offers for new cards and trimming credit limits for the ones they already have.
The story’s different, though, for people with solid payment records. Credit card providers are giving them more cards, and allowing them to charge more, according to data from Equifax, one of the three credit bureaus.
“We’re not seeing (card) lenders doing a full-scale pullback at all,” says Myra Hart, senior vice president of analytical services at Equifax. In general, there seems to be moderate growth in overall credit available to consumers.”
Excesses in mortgage lending got the current mess started.
Delores Nettleton, 75, a retired elementary school teacher in Spokane, Wash., sees merit in the old ways of home lending.
“When I was a young bride and we were looking for a home, we had to have so much down and you could not go over a certain percentage of your salary,” she says. “If people had stuck to those rules we would not be in the situation we are in.”
But here we are, and lenders have taken a big step toward tighter lending rules since the steep decline in home values began in mid-2006.
Interest rates have been down lately: 5.82 percent last week on a 30-year fixed-rate mortgage, down from 6.06 percent the previous week, the Mortgage Bankers Association said Wednesday.
But banks are making it hard for many borrowers to take advantage of the lower rates by tightening lending standards. The bar likely will be raised much higher now that Freddie Macand Fannie Mae have been taken over by the government.
They “are on a mission to be sure every loan is perfect,” says Brian Koss, managing director of Mortgage Network, mortgage bankers in Danvers Mass. “It doesn’t matter what the interest rates are, if you can’t qualify.”
Nearly 50 percent of the nation’s 27 million small businesses say they’ve been “impacted by the credit crunch,” according to a July survey by the National Small Business Association trade group.
Bankers often want to keep lending to large corporate customers and, as a result, don’t have enough cash for small businesses, says NSBA president Todd McCracken. That forces small business owners to use high-interest credit cards as their main source of capital.
Predictably, many are postponing big purchases, not filling vacant jobs and cutting back on business travel and advertising. Spooked by the Wall Street meltdown, they’re moving personal and business-related cash to safer, federally insured savings accounts and CDs, McCracken says.