As more homeowners run into trouble making loan payments, it is
not just borrowers and lenders who are at risk, but the US economy
The danger is that banks will feel impelled to tighten credit
standards too much, possibly extending beyond mortgages to other
forms of consumer and business lending. This could slow both
business investment and consumer spending at a time when the economy
is already in a stretch of below-normal growth.
Worry about a possible "credit crunch" was one reason that stock
prices took a dive Tuesday. The Dow Jones Industrial Average fell by
2 percent, to 12075.96, after the Mortgage Bankers Association
reported that the percentage of loans entering foreclosure hit 0.54
percent in the final quarter of 2006, a record high and a jump from
0.46 percent three months before.
At the very least, this appears to portend more difficulty in the
housing market. Banks have already been tightening standards on home
loans - especially in the troubled category of subprime loans, which
are aimed at the least creditworthy borrowers. Whether it prompts
banks to tighten credit more broadly remains to be seen.
"If they tighten up on commercial and [business] loans, then that
would really spell a problem" for the economy, says Rajeev Dhawan,
director of the Economic Forecasting Center at Georgia State
University in Atlanta.
"Housing activity will be weak for this year," he says, and he
expects that consumer spending will also take a hit from a chill in
This elevates the risk that the economy could enter a recession.
But Mr. Dhawan believes the Federal Reserve will cut interest rates
in late spring, particularly if Fed policymakers see signs that the
economy is being squeezed by a lack of credit. That should be enough
to avert a period of outright decline in economic activity.
Still, a tougher road for the economy, even with no recession,
means a tougher time for consumers and for the stock market.
Real estate is the main item on most homeowner balance sheets,
and the perception that home values are declining or unstable could
affect the psychology of spending.
"Our biggest concern is that any tightening of lending standards
in the mortgage market - even if confined to lower-quality borrowers
- is going to constrain overall housing demand and make it more
difficult for home sales and prices to stage a recovery," Merrill
Lynch economist David Rosenberg wrote in a report Tuesday.
"The housing market has actually been in a recession for the past
five quarters," he said, "and it's normal to have the credit part of
the cycle react with a lag."
Worst problems in subprime market
The mortgage market woes have been worst among lenders that
specialized in the subprime market. A boom in subprime lending has
had benefits, analysts say, since it has opened the door to
homeownership to many who could not afford it in the past. …