The Credit Vise Tightens

Consumers and businessmen feel the 20% pinch

Is there economic life after a 20% prime rate? That was the question in the nation's business and financial community last week, as banks hiked their best corporate interest rate to 20%, the ninth increase in the prime since the first of the year. The latest rise pushed the country's basic price for business borrowing money to its highest level in 141 years. The alltime record holder: 36% interest in 1839 during the Martin Van Buren Administration, when overextended land speculators and merchants set off financial panic, one-quarter of the young nation's banks failed, and a deep depression helped kill Van Buren's hope for a second term.

This time around, nobody is in a panic, but the anxiety index is rising. Some economists are beginning to wonder whether Federal Reserve-imposed credit controls and prohibitive interest rates may lead to an economic freeze rather than simply the desired cooling shower for business. Almost as soon as interest rates hit the numbing 20%, several bankers were predicting that they would keep marching toward 22% or more and cause a serious economic decline. Yet the high cost of money seemed unavoidable, if inflation is to be controlled. Said Economist Alan Greenspan: "The only safe policy at this stage is to risk overtightening. If we consciously try to avoid that, we are going to reopen the spigots of inflation."

There were some signs that the cooling of the economy is taking hold. Last week the Commerce Department announced that its Index of Leading Economic Indicators had declined for the fifth straight month, dropping 0.2% in February. Normally, three consecutive drops in the index is considered evidence of an upcoming recession. Unemployment last month also edged up to 6.2% from February's 6%, while inflation continued to roar ahead. Prices paid to producers increased 1.4% in March, a stunning annual rise of 18.2%. The auto industry is certainly slowing down. Car sales slumped 18% last month from the same period a year ago, and automakers this week will lay off more than 60,000 workers, bringing industry unemployment to 223,000.

Americans are now staggering under an installment and mortgage debt load of more than $1 trillion. Yet even credit crunches create opportunities, and some canny consumers have found profits in the vortex of soaring interest rates. A Detroit magazine editor, for example, now sends his savings across the border to invest in the Canadian Bank of Nova Scotia, where six-month certificates yield 17.5% and up, or 2% more than is available Stateside. Two daughters of an affluent Birmingham, Mich., physician used $14,000 in low-interest Government student loans (see box) to invest in real estate and bank certificates. One of the most popular gambits in the new scramble for cheap loans is borrowing on the cash value of whole life insurance policies. People can often get the money at 8.5% interest and then put it into money market funds yielding at present about 14%.

The investment ploys are only part of the profound changes occurring in the nation's financial system, as it tries to adapt to the new world of persistent high inflation. The Federal Home Loan Bank Board has revealed that during the second half of last year, 266 of the nation's 4,100 savings and loans and other thrift institutions lost money. Wall Street analysts say that at least 20% of them are now operating in the red. Amid this disarray, the Government is quickly changing the nation's banking statutes. President Carter last week signed a new law phasing out interest ceilings on passbook accounts (now 5 1/4% for banks and 5 1/2% for thrift institutions) and permitting banks everywhere to pay interest on checking accounts, a practice already pioneered in a few states. This will make banks and other savings and loans more competitive with high-flying money market funds that pay higher interest and offer check-writing facilities. The Home Loan Bank Board also adopted new regulations that will allow savings and loan associations to raise or lower rates on new mortgages every three to five years. This could cause the rate of an individual family's 30-year mortgage to fluctuate by as much as 5% up or down, following market conditions, and may mean the end of traditional long-term fixed interest home loans. Lenders have complained that they are losing money because they still carry loans made in those halcyon days of 6% mortgages at a time when they are being forced to pay as much as 16% interest to attract new deposits.

Businesses are having slightly better success than consumers in the search for credit funds. Says Gary Wenglowski, chief economist of Goldman Sachs: "Money is still available for the major companies, although it is very costly." One way companies have kept flush with cash is by borrowing money abroad where interest rates are lower. IBM recently obtained $227 million worth of West German marks and Swiss francs at up to 14% less than it would have paid for the money domestically.

Even struggling Chrysler Corp. managed to wrest some good tidings from the generally dismal news by reaching preliminary agreement with 175 of its major domestic and foreign lenders on a $650 million aid package needed to qualify for federal loan guarantees.

But not all businesses are faring as well. Many rural banks are cash short, and U.S. Farmers Home Administration loans in some areas have begun drying up. In Iowa, 23 needy farmers were refused credit when $37.2 million in available 11% Government money ran out. "Everyone out here is scared," says John Phelps, 29. "Farmers aren't scared of a national collapse. They're watching one in their living rooms."

Corporations are also seeing the first shriveling credit lines. The Industrial National Bank of Rhode Island is limiting the use of its $1.3 billion corporate loan portfolio by curbing lending for so-called nonproductive purposes, such as a company buying back its own stock or shopping for acquisitions. One Georgia bank takes an even tougher line. Says Willy Alexander, vice president of Atlanta's Citizens and Southern National Bank: "We have absolutely discouraged borrowing for bricks and mortar, heavy machinery or inventory buildup." Already hard hit by the housing slump, the forest products giant Georgia-Pacific announced a 25% reduction in capital expenditures rather than attempt to float another expensive bond issue.

Smaller businesses are having the worst difficulties. Because they are less creditworthy, they usually have to pay 2% to 3% above the prime rate. But some banks have inaugurated "two tier" pricing, knocking a point or two off the customary rate for good but smaller customers. Says Michigan National Corporation Banks Vice President Phil Essig: "We're not really in a position to carry these people, but what can you do?" More and more banks and savings and loan institutions will be asking that painful question, as credit-hungry consumers and businesses increase in numbers and need during the coming months.

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