US credit woes ripple across globe

It's a good thing that the world economy had a head of steam going into this summer, because it now faces financial headwinds made in the USA.

On Monday, shares of the German industrial bank IKB plummeted as the bank announced its earnings would be hit hard by the rising default rate of American subprime home loans.

The news served as a reminder: Politics may be local or national, but the realm of banking and finance is international.

In fact, when concerns about a tighter flow of credit sent stocks tumbling in the United States last week, the phenomenon was really global. Borrowing is becoming more difficult and more expensive worldwide. And stock markets fell as much last week in Europe and developing nations as in the US.

The good news is that these financial tremors come at a time of robust growth in most nations. For American workers that means a healthy demand for exported goods, which helps offset the impact of a deep housing slump.

"The likelihood is that the global economy will move through this OK," says Michael Cosgrove, publisher of the Econoclast, a market newsletter in Dallas. Although credit markets are global, many nations' economies are "not nearly as linked to the US as they once were."

Still, the process of unwinding after years of easy credit is fraught with risks.

In recent years, relatively cheap money has been available worldwide, fueling a surge of corporate buyouts backed by borrowing. Now, investors worldwide are rethinking this leverage, and repricing the debt.

"This is not just a US phenomenon," says Jay Bryson, a global economist at Wachovia Corp., a large bank based in Charlotte, N.C. "As investors become a bit more risk-averse in the United States, they're clearly going to become more risk-averse abroad as well."

In just past six weeks, he notes, investors have begun demanding sharply higher interest on higher-risk debts. In both Germany and the US, the gap between the interest rate on 10-year government bonds and the rate for B-rated corporate bonds has widened by about one full percentage point.

This adjustment may be a healthy one, many analysts say.

Last Friday, US Treasury Secretary Henry Paulson said that a global market swoon the day before represented simply a "repricing" of risk. "We have a strong economy, a strong economy globally. So I take real comfort in that," he said.

So far, credit isn't drying up. But it is becoming more expensive, and banks are having a harder time reselling loans to other investors.

• In the US, this has meant a bumpier pavement for the private equity firm Cerberus as it presses forward with its buyout of Chrysler.

• In Russia, natural gas giant Gazprom postponed pricing a bond offering last week, according to media reports.

• Also in Europe, banks faced a hiccup in their financing for Kohlberg Kravis Roberts, which is buying the drugstore chain Alliance Boots. The banks had to delay selling some of the debt.

All this looks like a manageable adjustment.

But historically, the shifting of a so-called credit cycle often involves a swing from one extreme to another. The big risk, some economists say, would be if a major investment firm faced a crisis, sending shock waves of worry that hobbled the global finance system.

That's what happened, for a time, in 1998 after a large hedge fund Long Term Capital Management collapsed. Central banks rushed to reassure global markets, but it served as a warning of what can happen.

"I don't think any of us imagined the chain of events" that led to that debacle, says Mr. Bryson. Today, financial markets are by most accounts stronger than they were then. But they have also grown more complex.

"We just don't know who's holding all the risk," Bryson says.

The shift in the credit climate stems in part from Federal Reserve policy. The US central bank moved to stimulate the economy after the recession of 2001, but began to shift back into neutral gear beginning in 2004.

Rising mortgage rates, and record home prices, spelled the end of a housing boom. Now, as mortgage-loan woes surface with drumbeat regularity, a wider global repricing of debt is well under way.

Whether the process remains orderly will depend on how wisely investment banks and other big investors have managed their operations.

But in any case, the path ahead is made easier by solid economic growth.

Worldwide, output of goods and services appears poised to advance at a 4 percent or higher pace for the fifth consecutive year, as tracked by the International Monetary Fund on an inflation-adjusted basis. That puts the rest of the world on a faster track than the US.

This doesn't mean that the world wouldn't be hurt if a recession hit the world's biggest consumer market, the US.

But for now, growth overseas is providing a cushion to financial shocks, and helping the US to weather its housing downturn.

Companies such as Caterpillar, the maker of heavy machinery, are seeing their export sales surge even as the US market is in slow gear.

Moreover, although the Fed has tightened its monetary policy into the neutral zone, other central banks worldwide haven't tightened as much, says Nariman Behravesh, chief economist at Global Insight, a forecasting firm in Lexington, Mass.

"It means exports are really one of the engines of growth" during an otherwise slow stretch, he says.