Subprime mortgage failure hurts overall economy

Nonmortgage consumer debt has doubled in the
past 10 years.


DETROIT — 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.

“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, Mich.

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.

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 GI 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 nonmortgage 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 percent 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 percent of disposable income, up from under 14 percent 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, Mich., 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.

In theory, bankers make loans only to credit-worthy borrowers.

“We used to say, the best way to train a loan officer is to make him collect his bad loans,” Moran said.

But through the years, lenders occasionally relaxed standards to such a degree that billions of dollars were risked on shaky loans, triggering an eventual collapse. The savings and loan debacle of the late 1980s proved one such episode, which devastated commercial real estate markets.

This time around, the slack standards allowed millions of high-risk borrowers to get easy home mortgages. When this so-called subprime market collapsed beginning about a year ago, ordinary working people bore the brunt.

By some estimates, nearly 2 million U.S. residents will lose their homes to foreclosure this year, with more foreclosures coming in 2008 as low-rate adjustable mortgages reset to higher and less affordable rates.

But the damage from the credit crunch, while concentrated in the subprime mortgage market, has spread far beyond it. Already, borrowers with good credit ratings are paying higher fees and having to put more money down to get a standard mortgage.

Linda Ross, a veteran real estate agent with Hall & Hunter in Birmingham, said that just a few years ago bankers would lend homebuyers whatever amount they wanted. Recently, though, she had a client who, even with a secure job and a salary in the range of $60,000 a year, couldn’t get a mortgage without having a parent co-sign the loan.

“They’ve really tightened up because they’ve gotten stuck with all those houses,” Ross said of lenders.

There’s no question that the economic outlook is worsening. Moody’s Investors Service reported in December that it had given negative outlooks or reviews for possible downgrade to over 90 percent of homebuilders, 32 percent of restaurant companies and 33 percent of building material companies.

The real threat is that this lending squeeze will so choke off new investment and consumer spending that the nation’s economy tips into a recession. If that happens, the easy credit of the past few years could morph into something a whole lot more painful.