By Emily Kaiser - Analysis
WASHINGTON (Reuters) - From subprime borrowers to lumberyards to corporate giants, tighter lending standards are starting to pinch consumer and business spending, threatening to slow already tepid U.S. economic growth.
While Treasury Secretary Henry Paulson insists credit problems stemming from a housing downturn are “largely contained,” banks are increasingly leery of backing all sorts of risky loans, not just subprime mortgages for borrowers with shaky credit.
“All the hoopla about subprime has created a sense among creditors and lenders that maybe they should rethink their easy terms,” said Milton Ezrati, senior economist at Lord Abbett & Co. “It means that we have what is equivalent to a Fed (interest rate) tightening going on.”
Reduced spending stemming from the tighter credit terms could shave one-third of a percentage point off the U.S. economic growth rate in the short term, Ezrati estimated, though he added that more sensible lending standards would be good for the economy in the long run.
The first credit problems emerged in the home mortgage market, where lenders clamped down following a spike in subprime defaults and foreclosures. More recently there have been signs that terms are getting tougher for businesses, too.
Some smaller lumberyards have effectively had their vendor credit cut off and are now left paying cash on delivery to suppliers, Credit Suisse retail analyst Gary Balter wrote in a note to clients.
Merger and acquisition activity has cooled from a torrid pace as private equity firms find less appetite for leveraged buyouts. Corporate stock repurchase activity has slowed.
The Standard & Poor's 500 index .SPX of major companies is down about 6 percent from an all-time high notched on July 16 as credit concerns mount, with Tuesday's news of trouble at American Home Mortgage Investment Corp. AHM.N jangling already frayed nerves.
Much of the concern on Wall Street has centered on the health of the U.S. consumer as household spending takes a hit from the double whammy of a weak housing market and rising gasoline prices.
However, the biggest blow may come from Corporate America.
Business investment was a key factor behind the stronger-than-expected second-quarter gross domestic product figure issued last week.
While consumer spending advanced at a slim 1.3 percent annual rate in the second quarter, business investment rose at an 8.1 percent pace.
If companies pull back just as consumer spending is tapering off, it would hamstring the U.S. economy.
Tighter credit is already stinging some smaller retail trade companies that supply goods to stores, said Richard Hastings, senior retail analyst with Bernard Sands, which advises retail vendors on credit risks.
“We are seeing the beginning of some significant credit tightening, especially in the default market for trade credit risk,” Hastings said.
If terms stay tight through the critical holiday shopping season and into next year, suppliers will have little choice but to cut back on shipments, he said.
Not all companies are cutting back on spending, however. Diversified manufacturer Eaton Corp. (ETN.N), which has made seven acquisitions this year, told Reuters on Wednesday that it expects to keep up the pace in the coming year.
Another subtle side effect of tightening credit is the decline in corporate share repurchases. As borrowing costs rise, companies have less incentive to ramp up debt to fund major stock buybacks, which typically push up share prices.
Paul Kasriel, director of economic research at Northern Trust in Chicago, said U.S. households have been net sellers of stock recently, so they were able to cash in when companies launched big buybacks.
That, along with home equity loan withdrawals, helped finance the consumer spending that has supported the U.S. economy through the recent boom.
“The mortgage tributary has been dammed,” he said. “Households will have to depend more on the buyback tributary. If we start to take that away, that will be another blow to consumer spending.”
Additional reporting by Nick Zieminski in New York