Credit Woes Hinting at Consumer Recession

During a conference call following Citigroup's announcement that its chairman and CEO had resigned and that the banking giant would be writing down as much as $11 billion in bad subprime debt, Chief Financial Officer Gary Crittenden was asked if he could assure securities analysts that there wasn't another multibillion-dollar shoe to drop. "Well, no," Crittenden responded. "I obviously can't give you any assurances."

Tighter credit and slowing growth could add up to a challenging holiday season for retailers.

Welcome to America's subprime debacle, a predicament so nasty and unpredictable that few on Wall Street seem to have any idea how bad things might get or how contagious the virus could become. "Unfortunately, the market is so opaque that neither I nor some of the big investment houses have a handle on [this]," says Kim Rupert, a fixed-income analyst at Action Economics.

Citigroup's Charles Prince clearly had no idea of the extent of the company's troubles with hard-to-value, mortgage-backed securities. He's now the former boss of America's biggest bank, replaced as chairman by former U.S. Treasury Secretary Robert Rubin. Prince's exit came shortly after the departure of Merrill Lynch's CEO Stan O'Neal, who also resigned after unveiling surprise losses.

And the hits keep coming. Investment firm Morgan Stanley said it, too, would take a multibillion-dollar subprime write-down in the upcoming quarter. The commercial paper market, where big companies go to borrow, is shrinking again. What's more, when Federal Reserve Chairman Ben Bernanke was asked at a congressional hearing last week whether the Treasury Department's bank-bailout plan would work, he offered a less-than-inspiring answer: "It all depends on the execution."

Consumer crunch. Given the level of uncertainty, observers find it difficult to say when the credit markets will regain their composure. Making things worse is the general slowdown in the economy. Many economists—including Bernanke, whose Fed cut interest rates twice in six weeks—think the economy is throttling down after back-to-back quarters of nearly 4 percent growth. But it's not just big financial institutions dabbling in esoteric debt instruments that are having credit problems. So are consumers and the financial companies they deal with. Shares of Capital One Financial tumbled after the company said higher credit card delinquencies could result in losses next year of more than $5 billion.

The Federal Reserve's recent survey of senior bank loan officers shows that it's growing more difficult for borrowers with even sound credit to get loans. And Morgan Stanley analyst Betsy Graseck expects tough lending standards, along with lower home prices and increased subprime delinquencies, to metastasize into a consumer credit recession. "We believe there will be contagion from subprime housing to prime housing to auto to card loans," she argues. More evidence of consumer problems: Retailers reported their weakest October sales since 1995. With both corporate America and the American consumer getting squeezed, it's little wonder that spooked investors sent stocks tumbling some 4 percent for the week.

Consumers may eventually become a more troublesome aspect of the credit crisis at this point than big banks' problems. Take Citigroup, for instance. Sure, it has big challenges, not the least of which is its $55 billion of direct subprime exposure. But Citi also has a lot going for it. With total assets of roughly $2.4 trillion, Citigroup is a financial monster. The company could absorb a pretax loss of $18.7 billion in the period and still break even for the year. "There is way too much gloom and doom about Citigroup," says banking consultant Bert Ely. If only the same could be said about the holiday shopping season.