Easy credit tied to low rates, new lenders

August 18, 2007|By Marilyn Geewax | Marilyn Geewax,Cox News Service

WASHINGTON -- For most of this decade, buyers of homes and businesses enjoyed "easy" credit, allowing them to get low-interest loans with few questions asked.

Suddenly, credit has become "tight." That means people with spotty credit records are no longer getting mortgages, the largest home borrowers are paying higher interest rates, and some corporate buyouts are in jeopardy. The changes have spooked financial markets, sending the benchmark Dow Jones industrial average last week more than 1,000 points below the record 14,121.04 it reached July 19.

But how did credit get so easy in the first place - and what's making it so tight now? Will any of this matter to people who aren't buying a house or a corporation?

Yes, it may well matter, many economists say. They say credit troubles could further depress residential construction, which would push up unemployment. That, in turn, would shake consumer confidence and reduce sales of everything from cars to Christmas presents.

Rising loan defaults also could further rattle financial markets. All of this together could trigger a severe recession, perhaps for the entire global economy.

But that worst-case scenario may never play out. Instead, optimists believe the free-market system already is weeding out bad loans and lenders, and calm will return soon.

That's President Bush's outlook. Recently, he told reporters he believes the market "will be able to yield a soft landing."

Patrick Newport, an economist with Global Insight Inc., a forecasting firm, agrees. "We don't think this will lead to a hard landing - a recession," he said.

But Newport added that he is less confident of that outcome than earlier this summer, because the credit tightening has been so severe. "We are a lot more worried than we were a month ago," he said.

The story of how the nation got to this precarious point stretches back to the 1980s, when the savings and loan industry collapsed.

In the aftermath of that disaster, regulators began insisting that banks and thrifts with insured deposits start holding more capital to offset risky loans.

That spurred the rapid growth of mortgage companies that got their money not from insured depositors, but by selling securitized mortgages that were bundled so they could be easily sold like bonds to investors who collected the interest payments.

These companies were regulated less than banks and thrifts, and during the 1990s, many of them started lowering their lending standards to boost business.

Also, starting in the 1990s, lending got a major boost from falling interest rates that made borrowing much cheaper.

Between the easy credit standards and low rates, borrowing became a breeze. As buyers snapped up properties, they pushed home prices higher.

Millions of people refinanced their homes or took out home-equity loans. Less affluent people stretched to buy houses before prices rose too far, and by 2006, subprime mortgages - the relatively expensive loans used by people with dicey income or credit histories - accounted for a fifth of all home loans. The tricky new mortgages helped create some 12 million new homeowners.

On Wall Street, meanwhile, low interest rates helped private equity firms borrow huge sums to buy companies.

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