How we got here

Washington — For most of this decade, buyers of homes and businesses enjoyed "easy" credit, allowing them to get low-interest loans with few questions asked.

Suddenly, credit has become "tight." That means people with spotty credit records are no longer getting mortgages, the largest home borrowers are paying higher interest rates, and some corporate buyouts are in jeopardy.

The changes have spooked financial markets and affected lenders, including Atlanta-based HomeBanc, which has filed for Chapter 11 bankruptcy protection, and Countrywide, the largest U.S. mortgage lender.

But how did credit get so easy in the first place — and what's making it so tight now? And will any of this matter to people who aren't buying a house or a corporation?

Yes, it may well matter, many economists say. They say credit troubles could further depress residential construction, which would push up unemployment. That, in turn, would shake consumer confidence and reduce sales of everything from cars to Christmas presents. Rising loan defaults also could further rattle financial markets. All of this together could trigger a severe recession, perhaps for the entire global economy.

But that worst-case scenario may never play out. Instead, optimists believe the free-market system already is weeding out bad loans and lenders, and calm will soon return.

That's President Bush's outlook. Recently, he told reporters he believes the market "will be able to yield a soft landing."

Patrick Newport, an economist with Global Insight Inc., a forecasting firm, agrees. "We don't think this will lead to a hard landing — a recession," he said.

But Newport added that he is less confident of that outcome than earlier this summer, because the credit tightening has been so severe. "We are a lot more worried than we were a month ago," he said.

Origins in S&L crisis
The story of how the nation got to this precarious point stretches back to the 1980s, when the savings and loan industry collapsed.

In the aftermath of that disaster, regulators began insisting that banks and thrifts with insured deposits start holding more capital to offset risky loans. That spurred the rapid growth of mortgage companies that got their money not from insured depositors, but by selling "securitized" mortgages that were bundled so they could be easily sold like bonds to investors who collected the interest payments.

These companies were regulated less than banks and thrifts, and during the 1990s, many of them started lowering their standards to boost business. For example, instead of requiring borrowers to fully document all income, some started offering no-documentation loans. Initially, such loans would cover no more than 70 percent of the value of the house being bought. But over time, lenders began offering "no-doc" loans for as much as 100 percent of the value.

Also starting in the 1990s, lending got a major boost from falling interest rates that made borrowing much cheaper. First, the 1997 Asian financial crisis drove up demand for safe U.S. Treasury securities, allowing the U.S. government to offer its long-term bonds for low interest rates.

Then, short-term rates took a plunge after the Sept. 11, 2001, terror attacks. The Federal Reserve Board, afraid the U.S. economy would not recover quickly from the assault, started cutting short-term rates and didn't stop until they reached 1 percent in mid-2003.

Buying was a breeze
Between the easy credit standards and low rates, borrowing became a breeze. As buyers snapped up properties, they pushed home prices higher.

Millions of people refinanced their homes or took out home-equity loans. Less affluent people stretched to buy houses before prices rose too far, and by 2006, "subprime" mortgages — the relatively expensive loans used by people with dicey income or credit histories — accounted for a fifth of all home loans The tricky new mortgages helped create some 12 million new homeowners.

On Wall Street, meanwhile, low interest rates helped private-equity firms borrow massive amounts to buy companies.

But eventually the credit party had to end, because the Fed started worrying the economy would overheat and kindle inflation. The Fed began in mid-2004 to steadily push up short-term rates, finally reaching 5.25 percent in mid-2006.

By then, many of the home loans made between 2003 and 2005 were going bad. People who had purchased homes with low "teaser" rates on subprime mortgages suddenly found themselves unable to keep pace as payments moved up.

Meanwhile, investors who had bought securitized mortgages ended up holding a lot of bad loans. The turmoil has caused huge financial headaches for lenders.

Now, with investors no longer eager to pour money into "securitized" mortgages, even the most stable lenders have less access to fresh cash for would-be home buyers. And corporate buyouts that depend on borrowed money are slowing too.

Central banks around the world have been pumping cash into financial markets to calm worries about a growth-choking global credit crunch. A sharp reduction in the availability of credit could trip up everyone from a family trying to get a home equity loan to remodel the kitchen to private-equity investors trying to complete a buyout of Texas utility TXU Corp.

Optimists think the worst is over. They note the European Central Bank said this week that market conditions have started "normalizing." Upbeat economists believe the lending problems will clear up as mortgage companies eliminate their riskiest practices.

But others still see huge risks. If interest rates keep rising, far more Americans may find they can't afford their homes. Then investors holding securitized mortgages would get stuck with more bad loans. The cycle of foreclosures and investment losses could cause home prices to plunge, financial markets to drop and unemployment to rise.

"Consumer spending is the driver of this economy," said Ron Blackwell, chief economist for the AFL-CIO, a labor organization. "If this cascades and turns into a falling housing market, then there is nothing left driving this economy."