The Clenching Of U.S. Credit Markets

Here are some scary facts. The Federal Deposit Insurance Corp. recently warned that bad real estate loans could hurt the banking industry. A growing number of banks, including Bank of America and First Union Corp., are talking about problem loans. Bank liquidity has fallen to its lowest level since the end of 1989. The growth in bank lending has dropped sharply, to a 1.7% annual rate of increase. The trend is worrisome.

And it's getting worse. The bank syndication market, which packages and sells loans, is cratering. Investors in these loans, mostly insurance companies and other banks, are dialing back fast. Indeed, it appears that a slow-motion financing crunch is under way in the U.S., moving its way up the corporate ladder. First the market for initial public offerings dried up. Then the high-yield junk-bond market weakened considerably. The stock market started to swoon. Now, the banks are tightening. For many companies, each and every avenue for credit is beginning to close down. At the least, the cost of borrowing, when it is available, is going up sharply.

Add it all up, and a nascent credit crunch is increasing the chances of a hard landing for the economy. The Federal Reserve said in its latest Open Market Committee statement that it is ready to let the economy "expand for a time at a pace below its potential." That potential is probably in the range of 3% to 4% annual growth. With a credit squeeze already putting strong downward pressure on the economy, the Fed must take care not to go too far. It takes 6 to 12 months for changes in monetary policy to affect the economy. If the Federal Reserve waits too long to reverse its current tight-money course, the momentum for a hard landing could become unstoppable.

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