Bailout or Not, Credit Will Be Crunched

THE GOVERNMENT'S SWEEPING FINANCIAL BAILOUT plan may have cheered Wall Street -- but it will take a lot more to lift spirits on Main Street.

The bailout could go a long way in stemming the freefall of financial asset prices, helping to stabilize banks and Wall Street firms. Unfortunately, that won't be enough to truly stoke lending or ease the economic vise that's squeezing American businesses and consumers.

Bank capital will likely remain scarce, businesses will find it tougher to get financing at the same time demand for their wares fades, and consumers are coming under the twin pressures of rising unemployment and falling wages just as their net worths are declining and their ability to borrow is being crimped.

"The risk is increasing for the state of the economy as we move forward because of the substantial stresses," says A. Marshall Acuff Jr., chairman of the investment committee of Richmond, Va.-based Cary Street Partners, and formerly U.S. equity strategist at Smith Barney. "There'll be slow growth in the world; it won't be the end of the world but it will be slow. There'll be no quick fix."

The crumbling of some of the biggest and best known financial institutions in the world in a matter of days is causing jitters throughout American industry. That was clear last week during a conference call arranged by the principals of a $140 billion investment-management firm. One caller, from Boeing, wanted to know how to explain to management what the federal bailout of AIG, once the world's largest insurance company, meant for the giant aerospace company. He was told that Boeing should minimize its own counterparty risk, keep liquidity high and preserve cash flow, especially as the fourth quarter approaches and projections call for record losses at financial institutions.

Another caller, from consulting firm Mercer, wondered about the implications of a long and deep recession. He was told U.S. credit growth could fall as low as 2%, the minimum needed for sustainable economic growth and a level only seen in one decade in the last century: 1930-39.

The current crisis is as much one of confidence as it is of credit. That prompted moves late last week by the U.S. government to restore order, bolster security and alleviate the stresses in the system by announcing a comprehensive plan to safeguard the banking system, instead of waiting to deal with individual cases on the brink of collapse. Meanwhile, the Federal Reserve and major central banks around the world made billions available to ailing commercial financial institutions aiming to free up credit.

All the same, the growth of world economies is slowing sharply. International Strategy and Investment Group in Manhattan is forecasting 1% growth in U.S. gross domestic product through the first quarter of 2010. Germany is on the edge of a severe recession; a wage price spiral is unfolding in Eastern Europe; Asian economies are slowing; and declining commodity prices and deteriorating growth in developed markets are pressuring growth in emerging economies.

Yes, there have been some upbeat signs. The outlook for inflation has improved, the manufacturing sector has picked up, mortgage rates have fallen and energy prices are lower (See story on oil prices). The problem is, it's not enough.

"This is not the end of the credit crunch -- the credit crunch is just beginning," asserts Larry Jeddeloh, publisher of the Market Intelligence Report and founder and chief investment officer of Minneapolis-based TIS Group, an independent research service. "What we have seen thus far are just the first signs of deleveraging at the banks, the consumer level and among corporations. Savings are in. Consumption based on leverage is going out of favor." And he adds: "If you think Wal-Mart and the Dollar Menu at McDonald's rule the roost now, wait a few years... Saving and reducing debt and value shopping are the new trends."