Our Ass-Backwards Banking System
As the credit crunch metastasizes its way through the financial system, its worth recalling its simple origins: The lending of money to people who could not afford to pay it back. That error was then compounded, by failing to maintain security for loans by traditional metrics, i.e., insufficient loan-to-value (LTV) measures.
The banking sector's solution to this problem? Cancel loans to the most credit worthy borrowers, including those whose loan-to-value exceeds traditional historical requirements.
Such was today's shocker, as examined in Gretchen Morgenson's column in the Sunday Times:
"The latest example of this is in the mass freezing of home equity lines of credit going on across the country. Reeling from losses on their wretched loan decisions of recent years, lenders are preventing borrowers with pristine credit and significant equity in their homes from tapping into credit lines that they paid dearly to secure.
In the last 30 days, lenders have sent several hundred thousand letters advising borrowers that their home equity lines of credit are frozen, estimated Michael A. Kratzer, president of FeeDisclosure.com, a Web site intended to help consumers reduce fees on home loans.
Major lenders — including Washington Mutual, IndyMac Bank and the Greenpoint Mortgage Unit of Capital One — say that declining property values are prompting the decisions to cut off credit."
While it certainly is in the interest of lending institutions to be cautious with loans where home prices are falling and the LTV no longer protects them against additional loss exposure.
What of regions of the country where property values are rising?
"But these actions are being taken even in areas where property prices are rising, Mr. Kratzer said. What’s worse, the letters provide no explanation for how the lenders determined that the property values underlying the equity lines had fallen.
Frozen home equity lines will surely intensify the consumer spending downturn and put added pressure on an already weak economy. Indeed, on Friday, consumer confidence as measured by the University of Michigan plummeted to its lowest level since 1982. The drop was attributed mostly to higher fuel and food costs, but consumers’ views on their current and expected personal financial situations dropped to their lowest readings since November 1982 and April 1980, respectively."
The timing is perfect: cutting back lending to people who can repay loans just as the economy slips below the waterline.
I should pitch that business idea as a start up to my VC friends: Getting fees from clients for providing no products or services. "And, as you can see in slide 12, this model has an excellent profit margin..."
Here's the sickest part of the entire affair: Borrowers with an
excellent credit rating will see their FICO score dinged when their home
equity line is frozen. Why? When a lender suddenly caps a $50,000 line
at $25,000, it appears that the borrower tapped out the entire amount
of the loan. This reduces their score.
The lawyers are -- rightfully -- gonna have a field day with this one!
>
UPDATE: April 13, 2008 1:31pm
Calculated Risk has a very different read on this: HELOC Nonsense (I'm not sure which offends Tanta more -- the journalistic or banking aspects of this story).
>
Source:
You Thought You Had an Equity Line
Gretchen Morgenson
NYT, April 13, 2008
http://www.nytimes.com/2008/04/13/business/13gret.html
Sunday, April 13, 2008 | 08:19 AM | Permalink
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Barry:
Far be it from me to defend the banks; they can reliably be counted on to lend to excess into every hot market,and then assiduously nail shut the barn door after all the horses have left. But I'm not sure GM's article is quite the indictment she intends, or you interpret it, to be. First, the citing of Yakima, Appleton, and Raleigh-Cary's rising Q4 property values aside, I think it's fair to say, as fair as a blanket statement can be, that property values are rising virtually nowhere in the United States at the moment. And secondly, GM cites the many small business owners who use their HELOCs to fund their business ventures. Isn't that what business lines of credit are for? And if these businesses don't show the cash flow or profitability to justify lending to them directly, then aren't banks correct to take a cautious stance with regard to loans to those businesses? This is, after all, how a credit crunch builds: individual businesses making decisions which are, at ground level, rational and correct in the assessment of self-interest involved (Why lend to a small business into the teeth of an economic slowdown, if that business' prospects are expected to turn down as well?), but which are collectively deleterious to the national economy-- animal spirits in retreat.
Rgds.
Posted by: Scott Frew | Apr 13, 2008 8:51:14 AM
Hmm, interesting. While it SUCKS royally that high quality borrowers with tons of equity and great credit scores are being screwd by the reduced lines.
However, it is not surprising that banks are doing this. They are crunched. They need to raise capital, not give out more. And clearly they went overboard in a number of areas. This is simply a side effect, a metastasized tumor as you say, and HELOC lines have been getting frozen and reduced for months now.
Its a new world...I hope people are able adapt to a world where money isn't just thrown away anymore.
Posted by: UrbanDigs | Apr 13, 2008 8:51:36 AM
forget about home loans, i have first hand experience that the banks have changed their view on personal loans. i know of a situation in which a borrower who has been a regularly borrowed money and paid it back and not in default of any loans was turned down for a bridge loan because of a LACK OF LIQUIDITY. This individual has in which as a net worth of about $10 million and annual earnings for the last 6 years in excess of $2.5 million(some years much higher). BTW the source of repayment for the bridge loan was identified and was a recurring distribution for the last 3 years(from a non-wall street business).
WHAT ARE BANKS NEW LENDING CRITERIA? I GUESS THEY WILL LEND YOU MONEY IF YOU CAN PROVIDE COLLATERAL IN CASH!!!
Posted by: Ron | Apr 13, 2008 8:54:41 AM
How can banks gave a profit if they hoard their money?
Posted by: Mel | Apr 13, 2008 9:02:49 AM
UrbanDigs raises a good point. A bank has less required capital against a $25k line than against a $50k line. Reducing the unused lines of credit is probably a way of hoarding capital. I'd bet that in those appreciating areas a phone call to the bank stating that you want to actually use that line would get it increased. Regulators might eventually catch on that $25k lines are really $50k lines, because they'll be increased with one phone call, but that could take quite awhile.
Posted by: mort_fin | Apr 13, 2008 9:14:26 AM
I wrote of this possibility three years ago. It isn't so difficult to comprehend that banks would create their own demise. They've done it so often it's almost as easy to predict as the sun coming up tomorrow. Bankers aren't exactly the salt of the earth and neither are they rocket scientists as we are finding out. (even though they hired rocket scientists, quants, to create this mess.)
It is not accurate to assume those that appear credit worthy today are going to be credit worthy tomorrow. And, the riskiest markets today are the ones where property values have yet to start falling.... ...because there simply is not enough money available to pay back all of the loans made. There never was. So, bankruptcies are going to rise. It's a fact based on the amount of money available. Something that bankers knew yet it didn't stop them. Well, at least they should have known. Given the cumulative IQ of Wall Street is as a herd, I might believe they actually didn't understand this. But, it's also one reason why the dollar will eventually rise. Supply and demand trumps speculators trying to kill the dollar for profit. Another special game the bankers are playing. Isn't it wonderful that people from the U.S. are actually trying to kill the dollar for profit? We live in a great society where truth and morals on Wall Street have helped to create the Great Society........
In other words, everyone is now a major credit risk regardless of backward looking credit history. This is no different than those saying housing prices were going up so those markets were a good credit risk. Only to find out a year later they the hottest markets were the worst risk. In other words, in this cycle, historical correlations of all types will be broken.
This cycle will turn most everything people believe to be true on its head. In the end, that's a very good thing. But, it's going to create alot of pain in the process.
Posted by: bdg123 | Apr 13, 2008 9:26:24 AM
We run a mid-sized landscape design/install business. During our insane spring season, aside from retained earnings, we invariably dip into our home equity line of credit. Wrote a check last Tuesday from our E-trade account. Check was returned on Friday, same day we received a letter from E-trade explaining the policy. Thanks!!!! Oops. Already wrote checks against it!!!
Our equity in the home and property is at least 3 times our mortgage.
Monday will be a mad scramble for funds. Hopefully, our local bank will extend our business line of credit.
Also on Monday, we switch all of our retirement accounts from E-trade to someone, anyone, else.
The money we'll be withdrawing is actually more than our credit line. Hope in some small way it hurts them.
Also, in recent years, most local banks have refused to issue small business loans. Everytime I asked, they'd ask "Hey, how much equity do you have in your home?"
Small businesses have had no choice but to turn to home HELOCs recently.
Posted by: Joe | Apr 13, 2008 9:50:11 AM
Barry,
The entire tone of your article sounds as if some HELOC is a God-given entitlement to home owners, and not something that is contingent upon the voluntary agreement of 2 parties to a transaction.
Far be it from me to come to the defense of the bank-sters. But as a few other posters alluded to--because the banks were stupid for lending out to people who couldn't pay it back, they are hungry for capital. They simply CAN'T expand their balance sheets if they have any hope of surviving the credit crisis. That means some borrowers who wouldn't have any problem in prior times getting a loan are denied this time around.
Banks have to get liquid. I mean, there are depositors (like me) who would like THEIR money when they choose to make a withdrawl. I think MY DEPOSIT--cash already provided, is more important than the whim of some borrower to expand their debt ratios, regardless of how good their credit may be.
As the idea of credit scores being good predictors of repayment: wasn't that already tried with ALT-A mortages, and found, in current cicrumstances--to be flat out wrong?
You can't have it both ways--you can't say the banks are stupid, and need more govt. oversight, and then say they are being unfair by restricting their lending to people who YOU think are good risks.
If you think these high FICO borrowers are good risks, why don't YOU fork over the cash, and give them a HELOC out of your own pocket?
~~~
BR: I didn't say it was unfair -- I said it was Ass-Backwards.
P.S.: I do not make HELOCs. Thats part of a long list of activities I do not engage in. These include painless dentistry, road paving, raising honeybees, cosmetic surgery and domestication of wild animals. I prefer to stick to the sweet spot of my competencies (as soon as I figure out what they are, I'll let you know)
However, if I WERE in the business of lending money to people, I would prefer it were to people who could pay it back, had good credit, and plenty of security. But hey, that's just me.
Posted by: double R | Apr 13, 2008 9:54:41 AM
It is somewhat sad to hear complaints about loss of HELOC access as if it were an inalienable right. A sypmtom of swallowing the wrong pill and believing the "big lie" that wealth creation is the result of spending, not saving, that financing home equitity growth made more sense than putting cash savings in the bank.
To mix a metaphor, when the tide goes out, you find out there is no free lunch - and you can't borrow a swimsuit from the bank, either.
I'm somewhat surprised by the surprise - what in hell did people think a credit crunch would do to loan availability?
Banks are not in "money making" mode - they are in "survival" mode. Better get used to it for the next few years.
Posted by: Winston Munn | Apr 13, 2008 10:09:54 AM
BR writes "....The lending of money to people who could not afford to pay it back...."
all that activity kept America working and cashing in
on the holding back $$'s ... imo its a grand game of Risk (Parker Bro.)
http://en.wikipedia.org/wiki/Risk_%28game%29
Posted by: Greg0658 | Apr 13, 2008 10:10:53 AM
I'd characterize the origins of the crisis differently: artificially low rates created an asset bubble against which dodgy lenders were able to justify making absurd loans to risky credits. The subprime slime is just the top layer floating on a sea excessive leverage. [BTW, Mish Shedlock covered this HELOC business a few weeks ago.]
Posted by: John F. | Apr 13, 2008 10:20:32 AM
Barry wrote, "The lending of money to people who could not afford to pay it back. That error was then compounded, by failing to maintain security for loans by traditional metrics, i.e., insufficient loan-to-value (LTV) measures."
Actually, Barry, I believe you have this stated backwards. The rise in housing prices forced the change in LTV measures in order to provide the leverage to maintain the prices, which then led to lending to non-qualified borrowers in order to sustain an artificial growth. Subprime loans maxed out in 2004-2006, so it was not the 2001-2003 start of the party that caused the losses.
As in all pyramid or Ponzi schemes, the ones who got in early did quite well - those late to the party - well, oh, well.
Posted by: Winston Munn | Apr 13, 2008 10:28:33 AM
What do you expect from a bunch of inbred SOB's.
I've never had a HELOC because I bank at a 'country' bank. My banker knows me and has my tax returns and balance sheet/net worth statements.
Small businesses need to find a small bank and offer to move your accounts there. These national Bank in a box on every corner have no lending authority except what the mother bank allows.
Get a real banker and quit whinning. Your home is not an ATM machine.
Posted by: Ross | Apr 13, 2008 10:32:38 AM
The indomitable Tanta does a much better job with this piece at Calculated Risk...I suggest reading it in conjunction with BR's comments..
Posted by: Jay Weinstein | Apr 13, 2008 10:47:52 AM
Ross,
How right you are. The flip side of too-big-to-fail banking is one-size-fits-all management.
Posted by: Winston Munn | Apr 13, 2008 10:51:26 AM
For another take on this see:
http://calculatedrisk.blogspot.com/2008/04/heloc-nonsense.html
rt
Posted by: rtalcott | Apr 13, 2008 11:06:02 AM
whats the big deal ??
Lender lends money, takes losses,
stops lending money. So what ??
Bernanke should keep his nose out of the
"Free Markets".
Posted by: rickrude | Apr 13, 2008 11:13:01 AM
Insolvency (bad debt related) is the huge "burning TOXIC HOT POTATO" that everybody is tossing around. NOBODY wants it, the FED is attempting to cut it into TOXIC FRENCH FRIES, Thinking this might aid the system in digesting this BAD DEBT.
Posted by: mw | Apr 13, 2008 11:13:24 AM
The banks are not cutting off "credit." They are reducing their capital requirements and seeking to minimize lending at sometimes very low rates. First, these are HELOCs, emphasis on the equity part. It is their fiduciary responsibility to cap these loans if the LTV is actually breached. I agree that there is probably a lot of excess in their zeal but not all of this is some unfair or unwise practice.
I'm sure WaMu regrets their loaning me 6 digits at prime minus but for now they are still honoring the deal. If they try to renege in my case (30% CLTV) then they are going to hear about it. And that is the crux, until I hear specific examples where the therms of the HELOC are arbitrarily breached it is a nothingburger.
Posted by: Rob Dawg | Apr 13, 2008 11:13:47 AM
BR wrote:
"That error was then compounded, by failing to maintain security for loans by traditional metrics, i.e., insufficient loan-to-value (LTV) measures."
The crux of the biscuit.
Nothing has anywhere near the value we thought it had (or worse, nothing has a value that can be accurately determined). Credit ratings are ratings, after all. Look where the ratings agencies took us. As house (or car or hamburger) is only worth what you can sell it for today. Future projections are prognostication.
From BR's post:
"...preventing borrowers with pristine credit and significant equity in their homes from tapping into credit lines that they paid dearly to secure..."
"...paid dearly to secure?"
There is no security in a line of credit. There is no security in the "securities" derived from overleveraged lines of credit.
Credit, as we have come to know it, is down for the count.
We will learn, the hard way, what generations before us already knew: credit is a tool best used sparingly - it cannot drive the financial system.
That way lies serfdom.
Posted by: Marcus Aurelius | Apr 13, 2008 11:22:31 AM
In my previous comment I should say that insolvency is directly related with bad debt. Of course insolvency is NOT bad debt.
Posted by: mw | Apr 13, 2008 11:29:15 AM
Barry,
You would do a great service to dig in on this a little more. Calculated Risk does a great job with respect to your above comments and the original source. Regardless of the "right or wrong" on this, the impact will be huge. For three reasons:
1. Upon hearing about this trend of withdrawing lines, many people, including some I know, are draining their HELOC lines and putting the money in low rate savings accounts, etc. Impact: these loans will perform, consumers will lose money paying interest on the lines, consumer confidence will be shaken, etc...
2. Many who have no clue about this consider their HELOC "personal wealth" and continue to spend and make decisions based on the availablility of their line. This spending does indeed fall in to BOTH business and consumer categories. The HELOC is financing for many, many small businesses.
In fact a friend is considering some equipment purchase for his business and plans to use his line for it. This will impact business spending.
I have a seasonal business and my HELOC which is actually in first position is mentally anyway my 'back up line' for my business. If that were to disappear it would impact my business decisions.
3. This will force more homes on to the market and drive prices down. Face it, many pay their living expenses with their HELOC and when it is drained OR CANCELLED they will have to sell. In fact, dealing with that right now with a close family member.
There ya go. This is a BIG DEAL and the consequences are only now being felt.
Posted by: Rich Shinnick | Apr 13, 2008 11:58:14 AM
This is why I always tell people debt should be a necessary evil not a necessary component of their financial lives. People usually laugh about it but if you are a debt slave and your 'benefactor' gets into trouble no one is required to bail your out or fund your enterprise though many corrupt politicians think they have the right to by taking my money to do it.
The sooner people get to the point of funding themselves the less the bankers will control the economy. If you are not a worthwhile investment to yourself then why should you be to a banker?
I don't think google worries about a call from the bankers but the airlines sure do
I know this argument flies in the face of current financial philosophy but times like this shows why it is right from where I stand.
What the Bible said thousands of years ago is still true today. The borrower is servant to the lender
Posted by: DavidB | Apr 13, 2008 12:05:16 PM
So, people would rather lose their homes than a potential line of credit? If you get in trouble and can't pay, then you lose the house. And just because someone has good credit doesn't mean they won't get sick or lose a job.
As I keep explaining to my kids, and wish our financial market understood, "The rules are there for your protection". Ignorting them, or not revising them when situations are changing, is rather foolish.
My credit union hasn't made stupid loans, and are more than happy to extend us a HELOC and not cancel it.
But it's not at 95% LTV, either.
Posted by: donna | Apr 13, 2008 12:40:11 PM
This is happening with many banks- seems to come and go.
Maybe some of the banks, noticed they need cash more than customers.
High quality borrowers getting frozen, Bank probably hadn’t even examined the loan file yet . And that may be a reason banks are suspending credit.-Find potential losses before occur. Like seeing if and who owns the first mortgage to buy it to protect, the second they own. Also check possibility of borrower will walk bc upside on mortgage, or short sale,- and all the while spending all the cash from the HE.
Maybe if home prices drop so far that so many home owners owe more than worth, more will walk. Seeing others do it , everyone follows- a herd - almost like looting stores- “If every one else is getting a new TV, then why be the one getting nothing- can’t catch us all.” No one wants be only one left in neighborhood, and paying on 600k for house worth half of that.
Lenders, Govt, legal system - etc.. must be careful not to give borrowers the perception of: not really accountable for bad decision, Talk of bail outs/relief - That impression alone, could cause some owners o believe they can stick the loss back on the bank, and that they’re the victims here. On the other hand, if lenders/government are too insensitive and appear unwilling to help at all, then borrowers could get really pissed and quit paying just for spite.
Bad situation when some many mortgages never had equity to start with, add falling home prices, and even some also having 2nd & 3rd liens from piggyback/HE- even borrowers not having problems with payments walk out/pull short sale- Home Equity lender screwed.
I bet we are seeing “rolling freezes” where lenders turn credit off, and then turn it back on. I mean, banks have to keep lending, and HE is $$$ interest. They have to generate income somewhere. Banks are cracks heads, they can’t resist for to too long, they always give in and come back for.
Posted by: TM | Apr 13, 2008 12:49:56 PM
