Borrowers Are Out In the Cold

David Stoyka, a senior account executive at Marx Layne & Co., a public-relations firm in Farmington Hills, Mich., was surprised to receive a letter in January from Countrywide Financial Corp. The mortgage lender had frozen access to his $25,000 home-equity line of credit, on which Stoyka and his wife owe about $16,000. "I had never missed a payment, and have excellent credit," he says. But with housing values declining, wary lenders are turning off the spigots, even to residents of tony Grosse Pointe Farms.

Six hundred miles to the east, a drama is transfixing New York's real-estate community. Harry Macklowe, one of the city's largest landlords, was unable to refinance $7 billion in short-term debt taken out to buy a portfolio of New York office buildings in 2007. He's been feverishly negotiating with lenders to stave off default. Macklowe has put the iconic General Motors Building on the block in an effort to raise cash.

From homeowners in Michigan to Wall Street financiers, Americans at every income level are caught in a full-blown credit crunch. While problems in housing-related credit are now familiar even to casual readers of the financial pages, the rot of bad debt is spreading. "In addition to mortgages, there are also indications that people are straining in credit cards, auto loans and student loans and default rates are starting to rise," says Nouriel Roubini, professor of economics at New York University.

That's bad news for a country that already seems on the brink of recession. If America's $14 trillion economy is a high-powered engine, credit is the motor oil that helps it run smoothly. When the lubricant is in short supply, the economy—like an engine—is more prone to knocks and stalling. "A year ago it was 'no borrower left behind'," says Adam Levin, president of Credit.com, the San Francisco-based consumer-education firm. "Now it's 'no borrower is getting on the train'."

To a degree, today's credit crunch is the inevitable and entirely predictable flipside of the credit binge of the past several years. Banks that have taken 10-figure write-downs and credit losses on subprime mortgages and other soured debt are raising capital from foreign sources, and generally hoarding cash. Finance, like physics, is subject to Newtonian laws. And as Newton's third rule of motion notes, every action inspires an equal and opposite reaction. "The wild euphoria of a year ago devolved into abject pessimism and almost panic in some quarters of the credit market. It has gone from free flowing and cheap to bottled up and increasingly more expensive," says Mark Zandi, chief economist at Moodys/Economy.com.

As in past credit dry spells, high-risk corporations and homeowners with poor credit face the prospect of paying more for debt. But in this, the first debt drought of the 21st century, the impact is evident in unexpected places. Due to the well-documented subprime losses—and to the generally weak housing market—caution has spread to the entire home-lending industry. In the Federal Reserve's January survey, 55 percent of U.S. banks said they had tightened lending standards on prime mortgages in the past three months, while 60 percent had done so for home-equity lines of credit. Lenders are focusing the types of loans they can sell to Fannie Mae, or Freddie Mac, the government-sponsored entities that purchase mortgages meeting strict criteria. According to Inside Mortgage Finance, in the fourth quarter of 2007, 68 percent of all new mortgage debt was so-called agency debt. The upshot? "Anyone who doesn't have a big down payment or equity in their home or good credit may be out of luck when it comes to getting a mortgage," says Guy Cecala, publisher of Inside Mortgage Finance.