How the failure of subprime mortgages hurts the overall economy

The entire article is at freep.com Consumer debt is obviously increasing at an alarming rate. However, if credit starts to dry up so does consumption and production causing a depression. Already some economists are claiming that there is a depression in the US.


A shaky house of cards

How the failure of subprime mortgages hurts the overall economy
January 6, 2008

By JOHN GALLAGHER

FREE PRESS BUSINESS WRITER

Given the huge piles of consumer and business debt out there, many U.S. residents seem to think easy credit is their birthright. That cozy feeling that a loan is always within reach is getting rudely shaken. An international credit crunch is upon us. The subprime mortgage crisis spawned it, but everything from home-equity loans to business lines of credit may be touched before it's over.

Sectors as disparate as auto-parts suppliers and developers of riverfront condos in Detroit are feeling the pinch of tighter credit, battering an already weak Michigan economy. "The unwinding of debt is all encompassing. It's from the little homeowner out there to the big corporation," said Larry Moss, senior vice president for the Raymond James investment firm in Birmingham.




The credit crunch overlaps with other negative trends, most noticeably the poor housing market and weakening consumer spending. The fear is that tighter credit and weaker spending will reinforce and amplify each other, creating a downward spiral leading to a recession.

"Once you get in that cycle, then it becomes really, really scary," said Amiyatosh Purnanandam, a professor of finance at the Ross School of Business at the University of Michigan who has studied tight-credit periods.

Key to survival

Credit -- the ability to get a loan -- will determine much of the course of economic activity in 2008. Among much else, credit or the lack of it will determine whether several auto suppliers survive a trip to bankruptcy court, whether condominium projects along Detroit's east riverfront get built, and whether millions of consumers take a vacation, buy a car or purchase a house.

For Ray Parker, a Detroit commercial real estate broker, the weakening economy has meant some personal tightening up. Parker recently refinanced his Southfield condominium with a new mortgage. He got a shock when the home appraisal came in $20,000 below what he had paid for his condo because of a real estate market battered by the subprime crisis.

"I'm trying to pay my credit cards off in case things don't get much better in the real estate business. They have not been great," he said.

Easy credit is a distinctly modern phenomenon. In the tight-money era of the 19th Century and early years of the 20th, farmers, tradespeople and ordinary working folks found credit hard to come by. An old joke defined a banker as a man who would lend money only to those wealthy enough not to need it.

After World War II, however, the G.I. Bill helped millions of U.S. families buy houses with government-backed mortgages. Banks eager to grow began to look for new customers and new ways to lend money.

The advent of computers opened new possibilities in mass marketing of credit cards in the 1980s and '90s. Niche marketing -- creating a loan product or line of credit for every conceivable borrower -- became the norm.

Today, it's the rare U.S. adult who doesn't carry at least some debt: a mortgage, a car loan, a student loan, a home-equity line of credit or credit card debt. And the amount of that debt is rising rapidly.

Ten years ago, consumer debt in the United States, excluding home mortgages, totaled $1.24 trillion. Today, Americans have roughly doubled the amount of non-mortgage debt they carry, to $2.5 trillion, or $8,300 for every man, woman and child in the country.

This easy credit helped make consumers the drivers of the U.S. economy, with consumer spending accounting for an estimated 70% of economic activity in the nation.

But at a price: A typical homeowner's debt burden including mortgages and other types of credit now stands at about 18% of disposable income, up from under 14% in 1980, according to the Federal Reserve Board.

For businesses, too, credit is lifeblood. Lines of credit and, for larger corporations, commercial paper, bonds and other forms of borrowing are as essential as any raw materials.

"I don't think businesses ever got to the point where credit was thrown at them the way consumers did," said Justin Moran, a Grosse Pointe banking consultant, "but certainly the so called middle market, small business credit, is a growing phenomenon."

That's why the current credit crisis has so jarred the U.S., and global, financial system. In an economy greased by relatively easy credit, the inability to lend or borrow on the usual terms threatens not just consumers, but industry after industry.