The Credit Crunch Cuts Deeper and Wider

Despite lofty commodity prices and signs of inflation, tight credit continues to torment investors and economists. Can U.S. exports save the day?

by Ben Steverman

On Wall Street, the yearlong credit crunch continues to hog headlines. For example, the future is still in question for investment banks like Lehman Brothers (LEH) and mortgage financiers (BusinessWeek.com, 8/22/08) Fannie Mae (FNM) and Freddie Mac (FRE).

Some retail banks have cracked under the pressure: On Aug. 22, Kansas bank Columbian Bank and Trust Co. became the ninth U.S. financial institution to fail during the current credit market difficulties.

Still, the loudest complaints on Main Street relate to rising commodity costs and inflation, especially expensive fuel and food. Gasoline prices have become a key issue in the Presidential campaign. U.S. consumers are spending less as retailers and restaurants struggle.

Stuck on Credit

So have inflation worries finally replaced credit conditions atop the list of investors' biggest concerns? Is the credit crunch finally waning? Not a chance.

An August survey of economists conducted by the National Association for Business Economics did show an uptick in worries about energy prices and inflation, to 16% and 15%, respectively. However, 46% of economists said the credit crunch and the state of the financial system was their top worry.

"The more persistent threat is going to be the credit crunch," says First American Funds chief economist Keith Hembre. As the economy weakens and the unemployment rate rises, inflation pressures should ease, he says.

But the credit crisis is like a bad song stuck on repeat: Each time it plays, the tune grows more annoying.

The Wrong Momentum

More than a year of credit troubles has passed, with financial firms reporting hundreds of billions of dollars in losses from credit investments gone sour. Yet the crisis persists. It may be getting worse.

"The longer this draws out, the more difficult it's going to be to get the economy rolling again," says Gary Wolfer, chief economist with Univest Wealth Management & Trust.

Though pricey gasoline hurts in the short term, many economists say they worry more about tightening credit. If businesses and households can't borrow money, economic activity inevitably slows.

"Banks are reluctant to lend," says Michele Gambera, chief economist at Ibbotson Associates. Stuck at high levels are the interest rates banks charge other banks, as well as those they provide mortgage-seeking home buyers. In many cases, private equity firms can't borrow to launch leveraged buyouts.

Best Not to Need Credit

"Everyone is tightening credit," says Robert Ellis, a banking expert at financial consultancy Celent.

Credit-worthy home buyers or corporations can still get loans—even if many need to jump through more hoops. "I'm sure Warren Buffett can get a good home loan at any time," quips Gambera.

But if you're struggling financially and really need credit, there's a good chance you won't find it. Subprime home buyers with poor records have been frozen out of the mortgage market, and strained financial firms are having trouble finding lenders or investors.