NEW YORK - Washington's financial bailout plan is now law. So the credit spigot will start flowing again, banks will resume lending, and an economic recovery can begin, right? Wrong.
Experts say the most important thing that needs to happen before the $700 billion bailout even has a chance of working: Home prices must stop falling. That would send a signal to banks that the worst has passed and it's safe to start doling out money again.
The problem is the lending freeze has made getting a mortgage loan tough for everyone except those with sterling credit. That means it will take several months or longer to pare down the glut of houses built when times were good - and those that have come on the market because of soaring foreclosures - before home prices start appreciating.
Housing is a critical component to the U.S. economy and by extension the availability of credit. Roughly one in eight U.S. jobs depends on housing directly or indirectly - from construction workers to bank loan officers to big brokers on Wall Street.
A turnaround in housing prices would boost confidence in the wider economy and, experts hope, goad banks into lending again. "Housing traditionally does lead the economy through a recovery. I think it's going to be critical for a sustained recovery in this cycle, too," said Gary Thayer, senior economist at Wachovia Securities.
In the meantime, people like Alicia Elliott are adjusting to a new American reality: Life without credit. The 21-year old Morgantown, W. Va., resident just bought a used mobile home, borrowing $4,000 from friends and family because she couldn't get a bank loan.
"I tried to. Couldn't do it. It's just hard to get a loan," said Elliott, who works as a cashier at a Lowe's Cos. store. She used to get bombarded with offers for credit cards. Now she can't even get one. "I get denied one after another after another. It doesn't matter if you have a co-signer or not," she said.
Trey Simmons, a 31-year-old barber at a Dallas hair salon, said he worries tighter lending standard will squash his goal of buying a home next year. "Credit is a privilege everybody can't get," Simmons said. "I had credit at a young age and messed up."
He now operates on a strictly cash basis. "If I don't have it," he said, referring to cash, "I don't spend it." The dilemma boils down to a matter of trust. "Credit, by definition, means trust and faith, and for many reasons trust and faith have been damaged," said Sung Won Sohn, an economics professor at California State University, Channel Islands.
Sohn said the near certainty of a recession makes it too risky for the thousands of small and medium-sized banks across the country to lend to people like Elliot. "Banks know the economy is getting worse, so ... they will keep being cautious," said Sohn, a former banking executive.
Still, the government hopes that by scooping up billions of dollars in bad mortgage debt and other toxic assets, banks eventually can clean up their shaky balance sheets, crack open the vaults and send money washing through the system again.
The rescue plan also raises the federally insured deposit limit from $100,000 to $250,000, a move that could boost banks' reserves and further grease the lending wheels.
Rep. Barney Frank, D-Mass., the Financial Services Committee chairman and a key negotiator over the past weeks, said the measure was just the beginning of a much larger task Congress will tackle next year: overhauling housing policy and financial regulation in a legislative effort comparable to the New Deal.
In the meantime, the Treasury Department is moving swiftly to get the plan started. Treasury Secretary Henry Paulson said Friday he did not wait for final approval of the measure to begin preparation.
He has been lining up outside advisers as his staff works out details on a multitude of complex issues. But several hurdles could trip up the plan. For starters, even when the Treasury starts buying bad assets, some banks may hoard the cash they receive in return until they see how the plan pans out.
That has the potential to make the lending logjam worse, said Vincent R. Reinhart, former director of the Federal Reserve's monetary affairs division. "They may sit on the sidelines and wait to see (the bailout) get some traction.
The problem is if everybody sits on the sidelines, nobody gets in the game. It's a risk," he said. It also creates a vicious cycle: No trust means no lending; tight credit means it's harder to buy a home; the more difficult it is to buy or sell a home, the further home prices will fall; and the further prices drop, the more foreclosures there will be. U.S. home prices - down 20 percent from their peak in July 2006 - still have further to fall, and must hit bottom before demand picks up.
The long-awaited bottom in prices could be a year or more away. But Jim Gillespie, chief executive of Coldwell Banker Real Estate, said he hopes that lower prices, combined with the government's actions will jump-start stagnant demand.
The federal bailout plan, he said, "will give people reassurance that mortgage money is available." Jobs are another big concern. The stranglehold on credit has choked companies big and small that depend on regular inflows of borrowed money to pay employees and stay afloat.
The Labor Department said Friday that employers cut 159,000 jobs in September, the fastest pace of losses in more than five years. Experts say that number will grow as the effects of the credit gridlock course through the economy in coming days and weeks.
The nation's unemployment rate is now 6.1 percent, up from 4.7 percent a year ago. Over the last year, the number of unemployed people has risen by 2.2 million to 9.5 million. The unemployment rate could rise to as high as 7.5 percent by late 2009, economists predict.
If that happens, it would mark the highest since after the 1990-91 recession. Boosting employment is critical to kick-starting lending because "if jobs are growing, then incomes are a growing, and if incomes are growing then people are consuming," Reinhart said.
Consumers and businesses have retrenched so much that some analysts fear the economy stalled or shrank in the third quarter that ended last week. The Labor Department report Friday showed wage growth for workers is slowing, meaning they'll be more hard-pressed to spend, especially for something as expensive as a home.
Many economists predict the economy will contract in the final quarter of 2008 and the first quarter of next year. That would meet the classic definition of a recession - two consecutive quarters of a shrinking economy. One bright spot: optimism hasn't been totally squashed yet.
Morgan Cavanaugh, proprietor of Moriarty's Pub in downtown Cleveland, has been trying to sell another bar he owns to ease his workload, but the prospective buyer hasn't been able to raise the money.
Now that the bailout legislation has the green light, he's hopeful he'll get a deal done. "It passed. Let's work something out," Cavanaugh told the man over a cell phone Friday just after the House approved the plan.
He flipped the phone shut and smiled from behind the weathered mahogany bar of his 75-year-old Irish pub. "He's going to put the loan request in again. It's looking up," Cavanaugh said.