How hard will tight credit hit?

The Dow tumbled 585 points last week, the largest weekly point loss in five years.

Publication: Christian Science Monitor
July 30, 2007
By Ron Scherer

The era of easy money is drying up—hitting Wall Street and its deal-makers first.

Last week, the prospect of fewer mergers and acquisitions caused the stock market’s sharp drop. The Dow Jones Industrial Average fell 585 points for the week, the largest weekly point loss in five years. Even a positive report on the gross domestic product in the second quarter—up at a 3.4 percent pace—failed to stem the stock sell-off.

Now, economists are watching credit markets carefully to see if tighter lending standards for wheeler-dealers will spread to Main Street, where credit is still readily available. According to the Federal Reserve, consumer credit grew by 6.4 percent in May.

So far, credit is available for companies with strong balance sheets. It’s private-equity groups, used to virtually restriction-free lending, that are finding it more difficult to obtain loans. By one estimate, buyers are in the market for about $200 billion to provide long-term financing for acquisitions.

“Maybe they can’t get the big Wall Street deals done at the cheap interest rates they used to get,” says Michael Swanson, chief economist at Wells Fargo Banks in Minneapolis.

The reduction in merger activity could eventually have an effect on the economy, says John Silvia, chief economist at Wachovia Corp. in Charlotte, N.C. “The main impact on Main Street will be a decreased ability to finance economic growth,” he says. “At the margin, there will be less investment in equipment and software and less ability to fund home mortgages and commercial activity.”

The actual impact on the GDP may be only 0.1 or 0.2 percent in 2008, estimates Mr. Silvia. But it may also mean that the softness in the housing market continues longer than anticipated. “Economists are going to start to downshift their economic expectations for next year,” he says.

However, it may be too early to start reducing GDP estimates, Mr. Swanson believes. “If you tie equity performance to GDP, you’re putting the cart before the horse,” he says, adding, “If the economy does well, the earnings and dividends will follow, and the market will follow that.”

Even though the economy rebounded in the second quarter from a weak first quarter, economists were not that impressed. Combining the numbers for the first half of the year results in an average GDP of 2 percent. “That’s relatively lackluster,” says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla.

In addition, consumer spending slowed from a 3.7 percent pace in the first quarter to a 1.3 percent rate in the second quarter. Much of this slowdown may be the result of a second-quarter drop of 0.8 percent in disposable income, after a rise of 5.9 percent in the first quarter. “We had a huge increase in gasoline prices, and wage growth was stronger in the first quarter,” says Mr. Brown.

However, some elements of the economy have remained strong. For example, tourism in some parts of the economy is booming as foreign travelers, particularly Europeans, come to the United States.

“There has been a huge boom for travel from the UK to the US and [especially] New York,” says Elon Kenchington, chief operating officer of Gansevoort Hotel Group in New York. “Visitors from the UK have now grown to about 10 percent of our business.”

One advantage of more leisure travelers is that the occupancy for the Gansevoort is now running between 93 and 95 percent full. With such high occupancy, the hotel has been able to increase its room rates by 15 percent. “With all the foreign travelers, it gives a unique feel to the hotel,” Mr. Kenchington adds.

In Kennebunkport, Maine, the Breakwater Inn & Spa is enjoying a good summer as more Americans opt for vacations that don’t require air travel. “We’re benefiting from the constant delays and the overcrowded flights,” says Terri Kenny, the innkeeper. “We’re running between 82 and 87 percent occupancy, and we’ve had lousy weather,” she says.

Parts of the high-tech industry are also bright spots for the economy. Take Serveron in Hillsboro, Ore., whose revenue has been growing at a 40 to 50 percent rate since 2004. The company provides equipment that measures the condition of electric transformers. “The average age of an electric transformer is 42 years,” explains Bart Tichelman, the CEO. “The design life is 50 to 60 years, and there is a waiting list of about two years for a new transformer, so you can see the problem.”

This coming Friday, economists will get a more up-to-date view of the economy when the Labor Department releases the July employment numbers. Part of the high-tech industry are expected to provide a boost to the numbers. Two years ago, Watchfire Digital Outdoor in Danville, Ill., had 60 employees. Today the manufacturer of digital billboards has 175. The company’s technology allows advertisers to change their message instantly, alerting consumers to sales or closeouts. The firm is adding 35 percent to its factory space. “We have a dynamic business, so our problems are growth problems. So they’re good problems,” says David Wood, the president.

In Orem, Utah, AtTask Inc. is also on a fast track. The company, which provides on-demand project-management software that helps companies get work done on time, grew 200 percent last year. This year, it’s on track for a 350 to 400 percent increase in revenue.

“We’re ramping up our teams—we’ve doubled our team size in the last few months—and building our infrastructure,” says Scott Johnson, the CEO. “The reason we’re flourishing is that business needs to be more efficient,” says Mr. Johnson, who says clients include companies such as Apple, General Electric, and Walt Disney.

This entry was posted in Clients in the News. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *