Credit crisis poised to spread well beyond U.S. roots

By Emily Kaiser and Brian Love

WASHINGTON/PARIS (Reuters) - The side effects of the year-long global financial market upheaval have hit hardest in the countries that had binged on easy credit -- first and foremost the United States, but also Britain and Spain.

Thanks to steep food and energy prices that are shrinking consumer discretionary spending and hindering central banks from responding to the credit crisis with lower short-term interest rates, the problems look set to spread far and wide.

"Amid convulsing financial markets, we see increasing evidence that the global economy is entering a significant slowdown period, with the weakest readings to come," said Steven Wieting, an economist with Citigroup in New York.

One year after markets seized up on concerns over failing subprime mortgages, banks have incurred some $400 billion in losses and write-downs. That leaves them with less to lend, slowing the flow of credit to the consumers and companies that power the global economy.

U.S. consumers who banked on rising home values to finance their retirements and pad their disposable income are now faced with the prospect of saving the old-fashioned way -- spending less than they earn. That points to a prolonged period of subpar economic growth in the United States, with collateral damage spreading globally.

"In Asia, Europe, and Latin America, while the pace differs, growth is slowing virtually everywhere," said Morgan Stanley economist Richard Berner. "The culprits: spillovers from the U.S. slowdown, higher inflation, reduced energy subsidies, tighter monetary policies and tighter financial conditions."

Deutsche Bank estimates that the cutback in credit will reduce U.S. economic growth by nearly 1.5 percentage points annually through 2010, and a similar decline is likely in the euro zone.

VICIOUS CIRCLE

The direct effects of the credit contraction are most apparent in the United States.

Subprime mortgages, given to borrowers with poor credit histories, have virtually disappeared. Banks are pulling back on the home equity loans that helped finance a five-year consumer spending spree from 2002 through 2006.

Terms have been tightened on a host of loans, including those made to small and large companies, and on financing for commercial construction. Even credit card offers have slowed.

The Federal Reserve, the U.S. central bank, remains concerned about the possibility of a vicious circle, in which slower bank lending constrains economic growth, leading to still slower bank lending.

Already, companies are trimming spending, putting off new store openings or factory investments. Capital spending fell at a 3.4 percent annual rate in the second quarter, according to Merrill Lynch economist David Rosenberg.

The U.S. economy has shed jobs for seven consecutive months, something normally associated with recession. Rosenberg said the pace of job cuts may increase in the coming months because many companies have reduced workers' hours rather than eliminate positions.

With the average workweek down to a record low of 33.6 hours in July, there is not much room left to cut.