The Financial CrisisEngulfs the U.S. Economy

The chaos on Wall Street has now hit the people on Main Street. Thousands of Americans are unemployed, and worse may be on the way.

It’s all over for Bill Heard. The aging gentleman had been America’s largest Chevrolet dealer up until a few weeks ago when he ended his family’s business and its 89-year history. In front of a Decatur, Alabama judge, Heard, known as “Mr. Big Volume” because of the successful dealership he had built, filed for bankruptcy protection and laid off most of his 3500 employees. A few were kept on to assist in winding everything down.

“The conditions needed to keep the company going just weren’t there,” said Heard, tersely. By that, he meant mainly the mother company of Chevrolet, General Motors, whose products he put into the public’s hands for many years.

Weeks prior to Heard’s difficulties, GMAC, the financial arm of General Motors, had stiffened the financial requirements for dealers to get the loans necessary to finance their purchase of vehicles for the showroom floor.

Average Americans are now feeling the effects of the credit crisis every day. Getting credit is becoming increasingly difficult even for solvent bank customers who would normally not have any problem getting a loan.

”Banks are inventing new excuses,” complains Mike Jackson, CEO of America’s largest automobile dealership, AutoNation. “People aren’t getting the loans they need to buy cars.”

Hundreds of thousands have already lost their jobs and the number of unemployed is at its highest level in five years. On Wednesday, Wal-Mart, the world’s largest retail chain, announced declining sales during September and warned of weak October figures as well. Owners of stores selling high-end items like wines and expensive cosmetics have begun targeting less affluent customers by offering less expensive goods.

What began as a bubble in the mortgage market has now poisoned the global financial world and threatens to plunge the entire economy into severe recession. That nasty word “depression” is also making the rounds – even President George W. Bush warned of the possibility.

How could the dream of becoming a homeowner, something many Americans were able to do, end in such a global disaster?

The roots of the actual problem come from the real estate market. At first, it was just a case of borrowers with bad credit ratings who couldn’t keep up with their payment obligations. They purchased houses in the hope that real estate values would continue their double-digit increases.

Instead, the tsunami of payment defaults and repossessions pulled the entire market into the crisis. Because banks began to make it harder to get credit, capital markets began drying up and they had to be more careful to whom they were willing to lend. They restricted their loans to a minimum, but now the real estate market can’t restart despite lower house prices: potential buyers can’t get loans. Sellers have to accept losses, if they’re able to sell at all.

The result: entire neighborhoods stand empty. The sharp decline in home values in the United States means that one in six homeowners now owes more in mortgage payments than the house is worth.

How greatly Wall Street’s problems have bitten into the general economy is shown by the paralysis in the commercial paper market. By this, we’re talking about extremely short-term loans, often overnight, with which mainly businesses get cash in order to pay salaries and wages, pay suppliers, or allow for accounts receivable.

This market is regarded as the oil in the engine of commerce. During the Wall Street boom, more and more institutions got involved in this market. In order to create adequate supplies of tradable paper, banks began creating a new type of commercial paper. Instead of this new paper being issued by a credit-worthy institution, it was backed by bundled credit card bills, automobile loans, and also by mortgages.

The commercial paper market was therefore infected by the mortgage crisis. Then the financial institutions themselves began to teeter. The fatal result was that investors pulled back.

For weeks, these bundled debts have failed to attract any buyers, a fact that has caused deep distress to companies like General Motors, America’s largest automobile manufacturer, and the diversified company General Electric.

“The commercial paper market is in extreme distress because money market funds and investors are holding back on buying. Financial institutions issued a majority of the paper. Their problems now make it difficult for them to perform their usual role as lenders to businesses and individuals,” according to the Federal Reserve in a statement issued earlier this week.

With that, Ben Bernanke’s Fed took the final step: The Federal Reserve now buys up the commercial paper and supplies liquidity in the market. The Federal Reserve Bank has thus indirectly become a house bank for big business, an extremely unusual measure.

Wall Street condemns the measure as the “General Electric Bailout Package.” No one knows whether it will help or not. None of the measures has ever been tried before – none has really worked, not even the government’s $700 billion bailout package.

A dismal scenario? Everything could get much worse. If fear overcomes the American consumer’s desire to spend, that could ensure that the downward spiral worsens and accelerates.

“We’re faced with a feedback effect, where credit and the financial crisis vie with one another,” says Kenneth Thomas of the Wharton School of Business, University of Pennsylvania. The feedback happens in many ways. “Those who want to buy houses now while prices are low are unable to get financing. That further weakens the housing market and therefore the banks’ mortgage-based securities.” The financial institutions and companies holding this bad paper take a beating – and that further limits their financial maneuvering room.

Another downward spiral will be caused by unemployment; people lose their incomes and therefore can’t make their mortgage and credit card payments.

Bank of America, the largest bank in the nation when measured by the amount on deposit, has already begun to feel that effect. When Bank of America published its quarterly figures at the beginning of the week, they alerted investors to rising loan defaults on all fronts – from mortgages, to consumer loans to credit card payments.

Chairman of the Federal Reserve, Ben Bernanke, was forced to admit that the road out of this crisis would be long and difficult. “The prognosis for economic growth has gotten worse and the risks for a reversal of that growth have increased,” he stated. That admission by the most important reserve banker unleashed a new wave of panic on New York markets.

It will also have great consequences for Bill Heard.