As one who recently exited the banking field after 30 years, I am following the media closely as it relates to our financial crisis. One of the issues receiving prominent coverage is that of bank lending. More specifically, there seems to be significant belief among the experts that banks must lend more money before the economy can begin to recover. Much of the dismay surrounding the TARP fund/bank bailout has been on this very subject; apparently financial institutions "banked" their TARP funds instead of shoveling it out the door, as Congress and the media expected.
First, let me go on record as saying that I disliked the way TARP was handled, especially in late 2008. I thought the funds would have been put to better use in purchasing bad loans versus direct investment into the recipient banks. Restrictions should have been placed on the use of funds, especially if those funds were used to fund acquisition of competitors. And, senior executives in situations where their banks were in dire need of capital infusions should not be entitled to any bonuses or excessive salaries in any form.
All of that said, I still have massive reservations in expecting banks to suddenly open the floodgates by making loans. In fact, I believe it is a "chicken and egg" scenario; banks will resume lending when demand returns, and will do so under more conservative policies than exercised previously.
Imagine, if you will, that you are a credit manager for a mortgage lender. For the last year, the media, Congress, and the new President have chastised the industry for making risky loans to unqualified customers. In fact, it is safe to postulate that the entire housing boom, and therefore, the growth in the U.S. economy over the 2000-2007 time period was propped up by one single fact--a housing boom created a construction boom, which in turned fueled the entire economy, and all of it was based upon the fact that millions of Americans were able to buy houses they shouldn't have been able to purchase!
With all of the criticism directed at lenders for making "poor" loans, why would any credit manager want to jump back into that particular fire? The media, as is often its wont, has no idea what its talking about. On the one hand, they've run hundreds of articles on risky lending practices. On the other, they are now running stories about businesses unable to obtain loans, and lenders sitting on their TARP money instead of making loans in the midst of one of the most serious recessions this country has experienced.
Now that the mortgage market has self-destructed, those left standing have done what the critics have been suggesting; instituting tighter lending standards. These tighter standards have reduced demand, since not as many borrowers qualify. Once the meltdown spread to the general economy, demand has dropped further, as people delay large financial commitments while they feel their jobs are at risk. In short, tighter standards and home buyer reluctance are the primary reasons banks are not lending mortgage funds; the demand simply isn't there.
Once we all realized that real estate and construction were propping up the entire U.S. economy, its failure in turn triggered a national recession that has now spread to all economic sectors. Then, demand for other types of loans, such as commercial loans, decreased as businesses have hunkered down. In addition, it makes sense that during a recession, banks would look at new commercial loan requests carefully, even if they are from long-term clients. With virtually all businesses experiencing declines in revenues, almost any loan is fraught with risk. Historical performance does not guarantee future success when recession is in play. Given that your corner bank is loaning your money, one might hope that bankers take a more cautious approach for the time being.
The final reason your bank is loaning less money is their uncertainty over the state of their current loan portfolio.
Unsound mortgage lending practices triggered the current crisis. It also propped up what has turned out to be unreliable demand for housing. But major projects take one or more years to get off the ground. As a result, many banks lent builders speculative loans for everything from single houses to entire subdivisions. When those loans were approved, business was brisk, demand was high, and pre-sales of homes and lots in proposed projects were in place. By the time the projects were approved by local authorities, road and infrastructure built, lots cleared, and model homes erected, the economy had tanked. Right now, many banks and other lenders are stuck with stalled projects. Until their current loan "inventory" corrects itself, they are going to be unwilling to lend new funds on large projects. In fact, they may need to shepherd funds in case their current loans fail, and the bank is forced to sell their collateral at a loss. With property values dropping 20-40% nationally, very few lenders are comfortable with the value of real estate supporting their loan portfolio.
The housing industry collapsed in 2007 (much earlier locally, around mid-2005). By mid-2008 the entire economy was in decline. Look around your own neighborhood. Are as many people eating out in restaurants? Are the jewelry or clothing stores packed? Real estate has a domino effect on the economy. The logger in Washington state, the carpet maker in Dalton, GA, the guy driving the trucks full of Maytag washers and dryers; all of them are significantly reliant upon the housing industry. Those who believe that developers and mortgage lenders were the only beneficiaries of the housing boom are way off base. And, any stimulus package or bank bailout that does not address the demand for housing is likely to fail.
The bottom line is that your local bank is likely being affected even if they never got involved in real estate lending. Insurance companies, typical lenders for big projects such as shopping malls and office buildings are now seeing vacancies at record levels in their projects, and potential defaults. A small loan made to a business for a vehicle, inventory, or equipment may be in danger as the recession deepens and spreads to the general economy. In fact, a bank that was already being conservative is likely to be moreso today, given the uncertainty surrounding the depth and duration of the current recession.
If one excludes the crazy mortgage loans that were offered during the real estate bubble, the rest of the problems banks are now wrestling with were largely unforeseen. Forcing banks to loan money now, especially making it a quid pro quo of any bailout program is likely to make things worse. The vast majority of banks are well-run and aware of their communities. They may not have foreseen the tsunami that was caused by the mortgage industry, but they are keenly aware of their local circumstances right now. They are in the business to make money, and the only way they can do that is to loan money. When the time is right, they will.
Until that time comes, the government would be better served by finding a way to return demand in the mortgage industry. As we know "easy" mortgage loans are not the proper course, the government should look at other incentives; tax breaks for new home purchases, tax breaks for green builders and buyers, buying toxic assets from banks that could benefit. But don't pick on your local lender for being conservative in the present environment. It is possible they are merely being prudent.
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