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How Will The Credit Crunch Affect Us?

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McClatchy-Tribune

Published: October 7, 2008

Many of us are nervously watching the wild swings on the stock market for signs of a Wall Street collapse, but it's the obscure credit markets that matter most right now to consumers and businesses alike.

The credit markets can be mind-numbing in their complexity, but they are vital to what happens in our everyday lives. They're also the reason President Bush proposed the controversial $700 billion rescue plan. Here are some answers to questions about the credit markets.

Q: What's the credit market?

A: It's not one but several interconnected markets. Some of these markets involve banks lending to each other at overnight rates, and others involve a variety of debt options such as bonds that carry a short lifespan.

Q: How does the Fed's overnight rate affect the credit market?

A: The Federal Reserve establishes a target for the rate that banks charge in overnight lending called the Fed funds rate. But the actual overnight lending rate is set by the banks, which are hoarding cash — and are only willing to part with it for a much higher price. The result: They borrow less, and thus lend less.

Q: How does this translate to problems in my life?

A: Commercial banks take a cue from the Fed funds rate when they set the prime rate, which is the interest they charge on loans to customers with the best credit. The prime rate is usually 3 percentage points higher than the Fed funds rate, but banks set this rate based on conditions on the ground.

Changes in the Fed funds rate affect short-term interest rates, foreign exchange rates and indirectly the price of goods and services and even employment. So when nervous banks charge each other higher overnight rates, it ripples across all kinds of lending in the economy.

Q: How are local communities hit by the credit crunch?
A: Many local governments rely on issuing debt, often in the form of municipal bonds, to fund road projects or other development in their region. They, too, are being squeezed as the cost of credit goes up. Local quality of life will suffer.

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