The Fed May Need A Crowbar For This Credit Crunch

Interest rates are falling. The stock market is rising. And peace is breaking out in the Middle East. At last, things seem to be coming together for the economy. But there's one big problem: Consumers, the driving force in the economic expansion of the 1980s, may not provide the wellspring of spending that has rescued the country from previous recessions. And that could put a serious damper on the recovery.

While much has been said about the credit crunch affecting business, consumers are involved in a huge credit crunch of their own. The crunch has both supply and demand facets. Burdened by debt and with their incomes falling, consumers are less interested in making purchases. Just ask Norman Rosenstein. In previous recessions, the general manager of Joseph F. Stein Inc., a tiny Cadillac dealership in Asbury Park, N. J., always managed to sell a fair number of cars. But the weekend crowds that once browsed through his showroom have vanished, and sales have been cut in half. Says Rosenstein: "I've been in the business for 46 years, and this is the worst I've seen it."

LONG CURE. Consumers who want to buy but need credit are facing chary bankers who are tightening loan standards considerably. In an extreme case, FirstChicago Corp. has begun reducing credit lines and canceling the credit cards of New England consumers who have had trouble servicing their debt. Even the strongest banks, where loan volume continues to rise, are cautious. "There's a lot of money available," says John B. McCoy, chairman of Banc One Columbus, Ohio. "It's just findingthe creditworthy borrower you want to lend to."

That means the Federal Reserve Board's usual curative measures to pump up the economy may take longer to work this time. True, there is always a lag between lower market rates and cuts in bank-lending rates, as there is between Fed easing and the economy's rebound. And peace in the gulf should buoy consumer confidence. Still, "the Fed will have to do more than has often been the case to get life back into the economy," says Allen Sinai, chief economist at Boston Co.

So far, the crunch has been most apparent among businesses. Many companies that took on heavy debt loads during the `80s are trying to reduce their burden, not increase it. And companies that want to borrow are encountering very skeptical lending officers. In the Fed's most recent survey of senior bank-lending officers, a third of U. S.-based banks--and 89% of foreign banks in the U. S.--reported raising their standards for commercial loans.

To help ease the crunch and spur the economy, the Fed has relied heavily on lower interest rates. The central bank has cut the discount rate twice in less than two months. The latest reduction came on Feb. 1, when it lowered the rate by another half-percentage point, to 6%. The federal funds rate--the rate banks charge each other for overnight loans--is down to 6.25% from an average of 7.31% last December.

'STILL TIGHT.' The Fed also has tried to end the drought in bank lending by reducing the reserves banks and thrifts have to hold against certain deposits. That freed up $13.6 billion for new loans. Still, even Fed Chairman Alan Greenspan concedes the credit crunch facing business has proved tough to crack. "It's still there. It's still tight," he told the Senate Banking Committee on Feb. 20. "The crunch continues to require unrelenting effort until it's resolved."

But it is the crunch on consumers that poses the worst threat to the economy's recovery. Some consumer-credit rates have been slow to come down. And some rates may never change. Credit-card companies have learned that consumers are almost oblivious to the interest rates they pay. Notes M. Douglas Crisp, a senior vice-president of consumer lending at First Union National Bank in North Carolina: "There are still lenders out there issuing cards at 19.8%, and people are still paying it."

Other lenders contend that, because consumer debt is so high and buyers so skittish, lower rates won't help. This is most apparent in the auto industry. Though Chrysler Financial Corp. lowered its rate on a three-year car loan to 7.9% in early February, vehicle sales remain slow.

Many banks may keep rates high because they are more worried about consumers' ability to pay their debts and want to compensate for default risk. For instance, about 4% of credit-card receivables were 90 days past due at the end of the third quarter. At the same time, bankers are under pressure from regulators to boost their capital. And that means bankers need higher profits--much higher. "There are a lot of bankers out there trying to rethink whether the historical spreads are right in this environment," says John W. Westman, chief financial officer at Banc One. "Most bankers are saying: `I'm not sure what I should be making, except what I made before isn't enough.' "

Banks are also boosting consumer credit standards. Consider Shawmut National Corp. The Boston-based bank has cut back on no-downpayment loans for cars. Some borrowers now have to put up as much as 20% of the purchase price. Shawmut has also reduced the average term of a new-car loan to 53 months from 60 months. What's more, loan officers are paying closer attention to applicants' credit histories and job stability, too.

Even where rates have fallen steadily, such as those on home mortgages, the economic kick has been slow in coming. Home sales remain sluggish, and housing starts are plummeting. In the week ended Feb. 15, about a third of applications were for refinancing existing loans, according to the Mortgage Bankers Assn. Mortgage refinancings help burnish household balance sheets during a recession, but the sad state of the housing market suggests a slow pickup at best.

MORE BANKRUPTCIES. Even if the banking system regains its health and starts putting out the welcome mat for borrowers, in other words, there's no guarantee that consumers will return to their spendthrift ways. More individuals are having trouble coping with their existing debt payments. Nonbusiness bankruptcies rose 15% in 1990, to some 710,000 filings, or more than 1 million individuals, according to Regional Financial Associates Inc. The economic consulting firm says bankruptcy filings could hit 800,000 this year. Even more telling, a recent survey by Brittain Associates Inc., an Atlanta consultant, found that one in five U. S. households has stopped or will stop using at least one of their credit cards.

To crack the credit crunch nut, some economists believe the Fed will have to get a lot more aggressive. Despite a two-percentage-point drop in the federal-funds rate since July, the M2 money supply grew at a bare 1% annual rate from Mctober through January--well below the Fed's target range of 3% to 7%. Only in February did M2 rise to a 3.3% growth rate.

Eventually, loose money and low rates will work. But rates may have to go much lower to cajole debt-weary consumers into spending again. Only when that happens will the economy break out of the doldrums.