Wall Street's tremors to reach Main Street

The biggest impact of Lehman's bankruptcy and other recent turmoil could be tighter credit.

These are desperate times on Wall Street. But what does it mean for Main Street?

In the postwar era, Mom and Pop could usually shrug their shoulders when the pin-striped set worried about financial Armageddon. Perhaps not this time. Turmoil on Wall Street – falling stock prices, megamergers, and bankruptcies – is likely to weaken an already shaky economy. The biggest impact? The availability of credit.

Since March nervous bankers have been making loans as reluctantly as Ebenezer Scrooge. Now, there's concern the mounting losses in the financial sector will make them even more parsimonous. Billions of dollars spent to shore up Wall Street may eventually affect the ability of the local car dealers to finance their inventory and maybe even make it tougher to get a loan to buy a new boat or tack on an extension to the house. At the very least, economists expect even the most optimistic Chamber of Commerce types to tone it down some.

"This is more complicated than a B-rated Shakespeare drama," says Fred Dickson, chief market strategist at D.A. Davidson & Co. in Lake Oswego, Ore. "But one way this is going to translate back into Main Street is that the caution levels are rising."

Rising caution levels means bankers are now moving more deeply into survival mode. Starting this past March, the growth of credit availability has shrunk dramatically. "If we continue like this, we will be in big trouble," says Lyle Gramley, a consulting economist at the Stanford Group in Washington. "To date the recession has been mild, but there is concern it could become an accumulating recession where the unemployment rate begins to rocket up and business cuts back on outlays."

Not all the changes on Wall Street, however, will resonate in Des Moines. For example, Bank of America's takeover of Merrill Lynch may not have an impact on the bank's ability to make loans. "If it's a stock swap that is not resulting in any cash outlays, it should not make any difference in the bank's ability to make loans," says Mr. Gramley.

The bankruptcy of Lehman Brothers Monday may not have an immediate impact on Main Street, either. Lehman Brothers mainly dealt with large financial institutions. Over the weekend, the nation's banks tried to unwind their exposure to Lehman without any major government financial intervention. "If the Fed is right [that] this can be unwound without any major contagion, the effect on Main Street will be nominal," says Gramley, a former Fed governor.

One area of concern that could directly affect consumers is the precarious financial position of Washington Mutual (known as WaMu), one of the nation's largest financial institutions. WaMu's stock has dropped sharply in the wake of the subprime mortgage crisis. In July, the bank reported a second-quarter loss of $3.3 billion. Despite Wall Street's worries, the bank maintains it is in sound financial shape. It has about $200 billion in federally insured deposits.

"They can borrow from the Fed's discount window, so they have a certain amount of time," says Mr. Dickson. "But there is no question their capital base has been impaired."

WaMu is a major supplier of mortgage credit, points out Gramley, which could force the government to step in. "It may fall into the category of too big to allow it to fail," he says.

The financial turmoil has also rocked the insurance industry. AIG, one of the largest insurance companies in the world, is reportedly trying to line up $40 billion. AIG's stock price has also crumbled in recent months. However, the company's problems may not spread widely, says Dickson. "The regulated part of its business should have reserves," he says. "It's a major player in the aircraft-leasing industry but that part of its business might find a buyer."

A prolonged financial market slump could also have an adverse effect on consumer psychology and confidence. "It's not exactly a confidence-booster," says Lynn Franco, director of the Consumer Research Center at the Conference Board in New York. "We will need to see what unfolds over the next several weeks."

The key for consumers, she says, may be whether unemployment picks up. In the last several months, job losses have been running about 80,000 per month. If job losses were to rise to several hundred thousand per month, economists would expect consumers to become even more conservative. "It would be the classic sign of an accumulating recession," says Gramley.

While Wall Street is stumbling, one positive sign for consumers is the falling price of fuel. On Monday, oil prices tumbled another $5 a barrel. On the futures markets, the price of gasoline and home-heating oil fell nearly 17 cents a gallon. "That's very good news," says Ms. Franco. "It has a longer-term impact if prices remain this low since inflation was a key concern that was being voiced."