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Why Should I Care?: Credit Crunch

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Like shooting finance in a barrel.

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The prospective clients you've been liquoring up are starting to crack. Lubricated but lucid, you suggest migrating to someplace more intimate. After all, the right ambiance is central to closing the deal. They shrug, agree, figure you're good for at least two or three more rounds at the next destination.

A signed contract in your manicured hands will be sweet vindication after weeks of ass-kissing: Endless emails; too-frequent phone calls; you even endured an entire Little League season's worth of stories from a vice president living vicariously through his 9-year-old daughter.

Across the dance floor you go to close out what will no doubt be an aggressive tab - the cost of doing business, you assure yourself.

The bartender, oblivious to the magnitude of the situation and its implications for next quarter's sales numbers, returns from the register with a dour face.

"Have another card?" she yells over the pounding base and general din.

"Uh, sure."

You weren't ready for this. The contents of your purse are emptied on the bar as you dig for a backup. You swear there was plenty of room on that card and, anyway, American Express (AXP) should cover overages. What kind of low-rent advertising agency do you work for that it doesn't even pay its bills on time?

Did the company set spending limits on expense accounts? Why weren't you told? Ever the dutiful employee, there's a reason you took these gin-sipping executives to this bar and not the Four Seasons for top-shelf martinis.

Your mind spinning with doomsday scenarios, you hand over another card. Your personal card.

The U.S. economy is finance-based, which is just a fancy way of saying it can't function without debt. Easy access to credit is what enables America to open for business each morning. And the addiction starts at the top.

Depending on which subversive website you consult, the U.S. government's debt is over $9 trillion. To avoid raising taxes to levels certain to incite civil unrest, Congress asks the Treasury Department to issue even more debt to finance everything from the war in Iraq to stocking Air Force One with tasty snacks.

Investment banks, foreign governments and individuals line up to buy Treasury securities (government bonds) of varying duration, risk and reward. And although American debt is seen as the least risky in the world, the government still has to pay for the pleasure of playing with somebody else's money. Granted, the interest rate is a smidge lower than for the University of Massachusetts senior working 3 jobs to make rent and the minimum payment on his credit card, but the cash isn't free.

The supply of this credit by banks and lenders -- and the demand for it by businesses and consumers -- expands and contracts with the natural ebb and flow of business.

Good times encourage risk-taking: Business owners can sweet talk banks into funding a new plant or another batch of sales recruits with greater ease.

Bad times, however, cause lenders to become risk averse and demand higher interest rates to cover their bet in the event they don't get paid back.

Economic activity slows down as lenders lick their wounds. More expensive loans make it tougher for businesses to translate ideas into projects and projects into profits. Consumers cut back too, as credit card offers stop filling the mailbox.

Normally, this purging process takes a few years, but soon enough banks are ready to lend again and the economy begins to grow anew.

But under extreme circumstances, the amount of bad debt in the system can overwhelm this natural cleansing. If one group of borrowers begins defaulting en masse -- holders of subprime mortgages, for example -- lenders start to fear that loans of all types may soon go sour. They slam on the breaks and limit lending to the most credit-worthy of borrowers.

A credit crunch, for all its complexities, is exactly as it sounds. Aversion to risk spreads throughout the lending world, which noticeably decreases the availability of credit. Borrowers (businesses and consumers), hit with higher interest rates and increased restrictions, get by with less, postponing purchases that require more cash than they have on hand.

The bartender returns.

"Sorry, this one didn't go through either."

Sheepishly now, confidence rattled, over the bar goes the trusty Discover Card (DFS). You barely use this one; the account only stays open for emergencies.

As plastic slides through scanner, you can almost hear the electrons racing, searching at light speed for a simple "yay" or "nay" that could determine your professional future.

The barmaid turns and, without so much as a word, drops your credit card on the bar - along with a receipt. That was close. You take a beat to regain your composure.

It's time to go close that deal.
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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