Individual investors are not the only ones who have been affected by the downturn of the U.S. housing market; banks have suffered some serious losses, too. In fact, July 11, IndyMac became the third-largest bank failure in U.S. history, to the tune of $40 billion.
Banks that are still alive and kicking are taking measures to meet a fate such as IndyMac's. One step they are taking is "curtailing loans to American businesses, depriving even healthy companies of money for expansion and hiring," according to an article published Tuesday in the New York Times. "Two vital forms of credit used by companies—commercial and industrial loans from banks, and short-term 'commercial paper' not backed by collateral—collectively dropped almost 3 percent over the last year, to $3.27 trillion from $3.36 trillion, according to Federal Reserve data. That is the largest annual decline since the credit tightening that began with the last recession, in 2001."
The tightening availability of credit comes a time when the economy is already struggling with, in addition to the plummeting housing market, increasing unemployment rates and decreasing consumer spending, as consumers try to grapple with rising prices for gas and food.
Banks have lowered credit allowances in the first half of 2008
The shift in the amount of credit doled out by banks is a sudden shift from even just the beginning of the year. "Earlier this year, credit extended by banks to companies and consumers was still growing at double-digit rates compared with three months earlier, according to an analysis of Federal Reserve data by Goldman Sachs. By mid-June, bank credit was declining at an annualized pace of more than 6 percent," according to the
New York Times. "That is a drop of nearly $150 billion, an amount much larger than the value of the tax rebates the government has sent to households this year in an effort to spur economic activity."
The trouble with this huge drop-off in credit is that, "Access to capital and credit is essential to growth. If that access is restrained or blocked, the economic system takes a hit,” Michael T. Darda, chief economist at the trading firm MKM Partners in Greenwich, Conn., said in the article.
The major banks' crackdown on lending comes as a recalibration of their risk assessment. In the wake of years of easy credit for borrowers, banks have learned the lesson about the importance of stricter lending standards. Lenders' previous lending standards, which often boiled down to available credit for anyone who wanted it, "produced a mortgage crisis whose losses could reach $1 trillion, by many estimates," according to the New York Times.
Now that many banks are suffering from multi-million and even multi-billion dollar losses as a result of losses incurred by real estate loans, they are cautiously concentrating on the borrower's ability to repay. "But if the newfound caution of American banks is prudent in the long run, the immediate impact is amplifying the troubles with the economy. The Federal Reserve has been lowering interest rates aggressively to make money flow more loosely and to spur economic activity," according to the New York Times.
With banks holding tightly onto their money, the cost of borrowing is going up. Not just for mortgages--for corporations, too. Even those corporations that seek loans to expand and add jobs to a floundering economy. And while loans are still attainable for companies with good credit and profitability, rates are higher, and the timeframe to get the loan is longer.
55 percent of U.S. banks tightened lending requirements for commercial and industrial loans to midsize and large companies, according to a survey of senior loan officers conducted by the Fed in April. The previous survey, conducted in January, showed that only 30 percent of banks had tightened lending requirements. In addition, according to the April survey, 70 percent of respondents reported that they had made commercial and industrial loans more expensive.
"Some suggest that the banks, spooked by enormous losses, have replaced a disastrously indiscriminate willingness to hand out money with an equally arbitrary aversion to lend—even on industries that continue to grow," according to the New York Times.
Before the fallout of the mortgage crisis struck, banks were less strict in their lending because they sold the bulk of the loans they made. If one of those loans defaulted, it did not affect the bank. But, thanks to the mortgage crisis, that system is no longer in place, and banks must keep the loans they make. This has made them much more cautious on the whole.
Perhaps realizing that the close-fistedness of banks is coming at a juncture when the economy needs more spending and jobs in order to recover, the Fed "unveiled a barrage of measures yesterday to lend stressed financial institutions more funds, and for longer periods, as it stepped up its drive to limit the fallout from America’s housing slump and the global credit crunch," according to the Times Online (U.K.) "In a signal of concern over the still-fragile state of world financial markets, highlighted only two days ago by the IMF, the Fed expanded its emergency lending scheme for Wall Street investment banks for the fourth time in five months."
Thus, the cheap financing put in place for investment banks, which had been set to expire at the end of September, will now be extended for an additional six months. A program that lends liquid Treasury bonds to investment banks in return for securities will be extended through the end of January.
Commercial banks also received a break from the Fed. "The Fed will make loans under its Term Auction Facility for banks available for up to 84 days, against the present 28-day limit," according to the Times Online (U.K.)
