Tightened Lending Standards: Reading Between the Lines

Here is a graphic from the WSJ depicting the percentage of loan officers who are increasing their lending standards:

 

Graphic courtesy of the WSJ

 

Now the obvious conclusion that many people are going to draw from looking at this data is that banks are tightening too much, it's going to be really hard to get a loan, etc, etc. However we need to put things into the proper perspective. The data just indicates the percentage of banks that have higher standards compared to a period when standards were too low, not an indication of how tight standards are per se. If the ideal standard could be quantified by some number "X," and 90% of all banks originating subprime loans were using a standard that could be quantified as 0.75X,  then 75% of banks raising their subprime lending standard to "X" in the wake of the housing crisis is actually a good thing.

Credit Customers (Corporate & regular Consumers) got so used to the weak lending standards of old that any increase in standards sounds the proverbial alarm, when in truth the banks may just be raising standards to a more common sense level. When interpreting the change in credit standards we really need to be comparing present standards to the standards of the late 90s into (maybe) mid to late '01, not comparing today's credit standards to the standards of 2005.

Still, without knowing what the standards are, all this graphic does is tell you how many banks are tightening to any degree, rather than the actual degree of increase.

However one inference you can make from the graphic is that more banks are increasing standards for prime loans then they are for exotic and subprime loans, which is a bit of a strange thing since the default rates for prime fixed rate loans are barely above historical norms (see below). While the data doesn't differentiate between prime fixed rate mortgages and prime HELOCs and ARMs (products that are showing higher default rates), it does make one wonder if the banks are punishing their best customers the most.

 

Graphic Courtesy of the WSJ

 

Either way, it goes without saying that massive losses from poor lending standards coupled with fear are driving a lot of bank lending decisions right now.Let's hope they get to a happy medium (reach the proverbial "X") sooner rather than later.

WSJ article

Comments

[johnthebear:]

It is not to hard to figure out when you think about it...

What happened to the traditional loan with a 75% to 85% L/V ratio with decent a credit report?

If you don't have a down payment, you should not be buying a house.... period.

2008 Aug 12 06:02 PM

[Markham Lee_:]

It's amazing too me how fast the thinking on mortgages changed...

...when I finished college in '98 my classmates and I were thinking in terms of how to save as much money as possible for a down payment.

Fast forward to '05 and I had co-workers touting the stupidity of "wasting money" on a downpayment: "if you want to build wealth you have to buy a house with no money down"

-M

2008 Aug 15 04:40 PM