Our Ass-Backwards Banking System

Sunday, April 13, 2008 | 08:19 AM

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).


You Thought You Had an Equity Line
Gretchen Morgenson
NYT, April 13, 2008

Sunday, April 13, 2008 | 08:19 AM | Permalink | Comments (72) | TrackBack (0)
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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.


Posted by: Scott Frew | Apr 13, 2008 8:51:14 AM

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