One aspect of the subprime crisis that Wall Street "experts" failed to grasp was that the real concern was not bad loans to high-risk borrowers.
Rather, it was that a change in lenders' attitudes towards one group of borrowers could easily spread to other parts of the system and trigger a severe and widespread reduction in the availability of credit -- a crunch, in other words.
In an overleveraged economy such as ours, such a development could spur the rapid deflation of a bubble that has sustained spending and investment for far longer than warranted by many traditional fundamentals, leading to significant economic contraction.
Well, it seems that what the highly-paid prognosticators should have been worrying about is actually unfolding. In "Lenders to Home Buyers Tighten Further," the Wall Street Journal details the unwelcome news.
Stricter Rules Hit Borrowers With Good or Bad Credit; Higher Costs for Businesses
More banks are tightening lending standards for home buyers -- even those with good credit -- and raising borrowing costs for larger businesses, according to the Federal Reserve's latest survey of banks' senior loan officers.
The survey, conducted in the first half of October, involved 52 domestic banks and 20 foreign institutions. It was the Fed's first poll of loan officers since the summer credit crisis. The Fed received the results by Oct. 18, ahead of last week's policy meeting at which it cut its benchmark interest rate by a quarter percentage point to 4.5%.
Speaking in New York yesterday, Fed Governor Frederic Mishkin signaled little interest in additional interest-rate cuts. He said he hadn't seen evidence of "serious spillovers" through the broader economy from the sharp downturn in the housing market and the tightening of credit.
He said the risks to the economy would have been greater if the Fed hadn't made its latest rate cut.
"In circumstances when the risk of particularly bad economic outcomes is very real, a central bank may want to buy some insurance and, so to speak, 'get ahead of the curve,' " he said.
The Fed survey showed lenders' growing scrutiny of real-estate loans and increasing caution about other types of lending.
About 40% of banks said they tightened terms for prime mortgages in the prior three months for people with the best credit records. That was up from about 15% in the previous survey in July.
About 60% of banks said they tightened standards on home mortgages classified as "nontraditional," up from 40% in the previous survey.
Five of the nine banks that originated subprime mortgages -- for people with the weakest credit records -- reported stricter terms. That was the same as in the July survey.
The Fed survey found that about a quarter of domestic banks tightened their standards for loans other than credit cards in the prior three months, up from about 10% in the July survey.
Lending standards on credit cards changed little, though some banks increased the difference between the rates they charge their customers and the cost of their funds. The Fed figures showed demand for consumer loans dropping as standards tightened, following the historical trend.
Responding to a special question in the latest survey, about 45% of banks said their volume of "jumbo-loan" originations -- those above the $417,000 threshold set by regulators -- had declined during the prior three months.
For business customers, about one-fifth of domestic banks said they tightened standards involving loans to large- and medium-size firms -- up from about one in 10 in the July survey. About a third raised the spreads for their loan rates.
The banks that tightened terms "pointed to a less favorable or more uncertain economic outlook as a reason for having done so," the Fed said. Many of the banks "also cited decreased liquidity in the secondary market and reduced tolerance for risk as reasons for a move toward more stringent lending policies."
I think the Citi disclosures today say a lot. I also think there is a lot they don't say, but that's another matter. The bank needs to rebuild its capital base and that should reduce its appetite for new loans. I also read an article today at calculated risk about a couple of credit unions going under in CA.
I have several questions from the 10Q Citi filed. I think there are still some open questions. They have a note about total exposure (including “notional amount”) to off-balance sheet entities that increased from $109 billion in June to $141 billion at the end of October. This is a very large increase given the trend in this number over the past year. I posted a piece today about it at www.polecolaw.blogspot.com and welcome any insight.
Posted by: Mark Palermo | November 06, 2007 at 02:20 AM