The Credit Chokehold

Breaking the vicious cycle of tightening will take time, but how much?

And now the five-day financial forecast: Rain. Rain. Rain. Rain. Rain. What makes this soggy future depressingly predictable is that credit contractions persist by feeding on themselves, like a snake swallowing its tail. In the boom years, Wall Street and banks made tons of foolish loans, especially in real estate. Now losses on those loans are forcing them to shrink lending as rapidly as they once expanded it. This week's Cover Story explains how each dollar of loan loss can force commercial and investment banks to reduce lending by $15 or more. By one estimate, mortgage-related losses alone could cause a trillion dollars in credit to vaporize. The banks' pullback will open the door for new players, like hedge funds and private equity firms, to dispense capital to companies away from the prying eyes of regulators.

Fannie Mae (FNM) and Freddie Mac (FRE), the two mortgage-finance giants, are supposed to stand tall at times like this. But at the moment they're most needed, they have lost investors' confidence. What's keeping them going is the now-explicit support of the federal government, raising the question of why they're structured as private companies at all.

How long will the tight credit last? Our Cover Story sees years of pain ahead. But in a commentary, Chief Economist Michael Mandel predicts that the next President will push through a rescue plan that will get credit flowing. "By this time next year," he writes, "we could see a reinvigoration of the financial markets."

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