I am not sure if there is a GQ answer for this, but please do your best. Is it a matter of banks being extra cautious? Have reserve requirements increased recently? (I asked this question a while back and was told the answer is no.)
I understand that this is putting the brakes on the economy right now.
Thanks,
Rob
Risk models have been re-done. To reduce risk, down payments must be higher; credit scores must be higher and proof of income is more demanding.
Banks are getting money essentially free from the Fed (0% interest) and lending it back to the the Treasury at a higher rate by purchasing T-bills. Not sure where I found this, but I’ve seen it mentioned in many places.
Philster, I was speaking more about commercial lending, and cdsilv, are you saying that there is plenty of lending, it is just all to the gov’t?
It’s kinda complicated. But for several years there, ‘creative’ mortgaging methods meant that it was far too easy to get a loan. Lots and lots of people bought expensive houses they couldn’t afford with mortgages that had adjustable interest rates, or were interest-only, or various other tricks. Other folks bought several houses at a time with these mortgages–they’d hold on to them for a few months as prices rose quickly, sell them off, and pocket the equity. People who already owned homes took out home equity loads when their houses rose in value.
Eventually the hot housing market started to go down–it couldn’t go up forever like that. A whole lot of people defaulted on the mortgages they couldn’t pay for. As the housing market went down, people who hadn’t invested in their houses with large down payments walked away from their mortgages which were now ‘upside-down’ --the houses were no longer worth anything near what was owed. There were a lot of foreclosures, banks found themselves overextended, and they had to stop all that easy lending. Now we’re pretty much back to the model where you have to actually qualify for a loan and show that you’ll be able to pay it back. (For the moment, that’s not easy to do, but as time goes on it will normalize more.)
It was something of a vicious cycle. The government pressured banks to give out high-risk mortgages in order to promote “affordable housing” (which isn’t affordable at all when the reality of your ARM suddenly kicks in and you find yourself bankrupt). Banks discovered they could sell lots of bad mortgages in bundles and make lots of money. People were willing to take on huge amounts of debt in various ways and assumed that it wouldn’t ever come back to hurt them.
There’s way more to it than that. I am not an expert and this is just a rough sketch. But essentially, a whole lot of people --gov’t, banks, and home buyers–made bad decisions while assuming that the cost would be pushed on to someone else, or that it would all work out just fine. Money, however, is like gravity–you can’t just change the rules and it hurts when reality shows up.
Again, I was referring to commercial lending. Apparently, businesses can’t get the lines of credit they need to expand which is hampering the economy.
Thanks,
Rob
>The government pressured banks to give out high-risk mortgages in order to promote “affordable housing”
What law forced this and when was it passed? I believe this is a debunked right-wing talking point (blame government for all woes, never capitalism or corporatism).
Okay.
Last school year, I co-signed a student loan for my nephew.
This school year, he applied for a second loan, for his second year, and was turned down. The same lender would not even take my co-signer application. He went to another lender, which did take my co-signer application, and we were still denied the student loan.
My credit score, debt-to-income ratio, income, and asset value has not changed considerably. If anything, my home and investments have increased in value since one year ago.
Yes, of course, I will be calling the lender and Equifax to try to find out what’s up, but… mortgages aren’t the only form of loan, so what gives?
As Philster has noted, the risk models have changed. Presumably there are regulations about how much risk a bank can have on its books. If banks have a lot more risk on their books, the credit risk that was acceptable last year might be too high for them to make a new loan to this year.
I was a commercial lender in the past, and I currently work on the other side soliciting commercial loans. There is plenty of money available from banks for customers that qualify. I have dozens of large banks, domestic and foreign, that are basically begging to lend money.
Further, over the past several years, many of the largest banks essentially tied doing commercial loans to investment banking business. I mean by this that they would really only be interested in providing the loan if they could also get capital markets business like equity and bond underwritings, hedging business, and the like. That is becoming less the case right now. Banks are lending solely for the purpose of earning interest income now.
The biggest problem is that many customers just can’t qualify for a loan. The reasons should be obvious. In general the financial condition at many companies is much poorer now than it was a few years ago. Banks don’t just loan money without any kind of defined ability to get paid back.
Most normal secured commercial loans have a primary source of repayment and a secondary source of repayment. Cash flow is the most common source of repayment. A bank needs to be able to model that under conservative assumptions, the company can pay back the loan with cash flow. A liquidation of collateral might be a secondary source of repayment. This could mean that the loan to collateral value ratio is no greater than a certain percentage. Another source of repayment (particularly for commercial real estate) is refinancing the loan. For example, a bank might make a three year construction loan for an office building. They expect the primary source of repayment to be someone else refinancing this loan with a long term loan. Insurance companies were big in the long term commercial real estate business. That market has dried up.
Commercial real estate lending is out there, but its finding good borrowers and good assets that is tough. Commercial borrowers in a lot of cases still think this is the good ole days where you can get big loan proceeds on easy terms. Forget it. A lot of lenders are applying tougher valuations and more stringent cash flow requirements. You may have to be willing to take on recourse.
Few are willing to underwrite a loan based on possible improvement in cash flow, they are going to underwrite what you have in place today. And then they will haircut it just for an extra measure of safety.
It is worth noting that this is exactly what happened after the 1929 stock market crash. Hoover gave a lot of money to the banks and encouraged them to lend. After all, how can banks make money without lending? The banks kept the $ that time too and tightened lending just like now.