The recent turmoil on Wall Street has frozen lending among banks, sending rates soaring and prompting financial institutions to hoard cash. The situation grew so dire that central banks in the United States, Europe and Japan were forced to inject tens of billions into the system in hopes of greasing the lending wheels.
Even if consumers have no direct dealings with the now-bankrupt Lehman Brothers or the now-bailed out American International Group, they may very well feel the ripple effects. The most evident impacts are rising mortgage rates and instability in once-safe money market funds. But the tensions on Wall Street will make it even harder for people - even those with good credit - to get a loan.
Consumers won't be the only ones hurt. Businesses will also find it tough to get financing.
"The price of money has increased and the availability of financing has been impacted," said Keith Gumbinger, vice president of HSH Associates, which tracks mortgage rates. "It's pure volatility right now. There's no way to know on any given day what's going to happen in any given market."
Mortgage rates soarMortgage rates jumped sharply on Wednesday, after falling more than a half-point after the federal government took over Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) on Sept. 7. Rates spiked to 6.11% Wednesday, up from 5.87% the day before, Gumbinger said.
In the wake of the government's $85 billion rescue of crumbling insurer AIG, investors fled to the safety of Treasurys, freezing out mortgage-backed securities and sending rates soaring.
While rates remain below their summer highs, the spike is troubling. The economy needs low mortgage rates to stabilize the housing market, Gumbinger said. Higher rates make it harder for people to buy a home or to refinance into more affordable mortgages.
Money market funds shakyThe demise of Lehman Brothers and troubles at AIG (AIG, Fortune 500) have put stress on many money market funds, which invest in short-term debt issued by the federal government or by companies.
Putting money in these funds was thought to be as safe as money in the bank, and many people stash their extra cash in them.
But unlike money in the bank, these funds can lose value. Traditionally, financial institutions make sure that money market funds maintain their $1 per share value, but with this week's turmoil, fund companies found themselves scrambling. Investors withdrew nearly $80 billion from money market funds on Wednesday alone, according to Peter Crane, founder of Crane Data, which tracks money market funds.
The Reserve Fund announced Tuesday that it had to cut the price of shares in its primary fund to 97 cents and investors who wanted to withdraw money would have to wait a week for the proceeds. Under siege from redemptions, Putnam Investments said Thursday it would close its institutional prime money market fund and return all proceeds to investors at $1 a share.
Meanwhile, other fund companies - including Wachovia's Evergreen Investments and Frank Russell Funds - announced Wednesday that their parent companies would have to inject money into the accounts to maintain their $1-a-share value.
Most money market fund investors, particularly those whose holdings are at larger institutions, will not suffer losses, said Christine Benz, director of personal finance at Morningstar. Companies will step in to prop up the funds.
"Many firms that offer money market funds would face huge reputational risk if they allow them to break a buck," she said.
While financial institutions are stepping in to prop up their funds now, they can't do this indefinitely. Also, they may have to think twice about acting if the funds' values fall too steeply.
Some people think they have money market funds, when they actually hold short-term bond funds. The value of these investments can fluctuate since they put their money in riskier assets.
But even true money market funds vary in their investments. Those that invest in safer Treasurys offer lower rates, while those in short-term corporate commercial paper have higher yields but are more likely to stumble, said Hildy Richelson, co-author of "Bonds: The Unbeaten Path to Secure Investment Growth."
"If your money market fund is yielding more than others, then they are reaching in some way," Richelson said.
Paulson readies the ‘bazooka’
