When the Credit Markets Thaw

Today we will hear about the government’s plan to buy up the toxic assets from various banks. The idea is that this will allow banks to begin lending again. Examples being reported in the media are small business loans, capital loans, mortgage loans, and education loans. I still don’t have answers to my over-riding question.

What credit standards and qualifications will be used to lend money going forward? Will the sale of these “toxic assets” really mean that people can borrow money again for houses, cars, credit cards, student loans? I’m not convinced.

Don’t get me wrong, I think getting these toxic assets off the books is a good idea – we did it before during the S&L crisis in the late 80’s; we experienced it here in New Hampshire in the early 90’s when the FDIC came in and took over many of the well-established banks and liquidated their toxic assets. The process over time, works.

No, I’m talking about two things – reserve for loan losses and credit standards. When banks sell their loans to the secondary market (like mortgage loans), there isn’t a need to set aside money for loan losses because they don’t own the loan (the investment banks like a Lehman Bros or Merrill Lynch owned then – hence their demise). They do however; many times own the loan portfolios for their equity loans, consumer loans (auto & personal) and credit cards. The delinquencies on these portfolios are also rising and will most likely be the next shoe to drop. To protect themselves, banks have to set aside enough cash to account for their projected losses on these portfolios (called loan loss reserves). This in essence, reduces the amount of available money to lend for new loans.

As far as credit standards are concerned, we live in such a credit-scored world, it’s fair to assume that credit scores are universally declining due to the unemployment rate, higher delinquencies and foreclosures / repossessions. Will these folks be locked out from borrowing new money? Will lending institutions be forced to reduce lending standards to accommodate this growing set of borrowers? If not, will increased lending to only those borrowers who meet a higher standard be enough to lift the economy from its present state?

Curious questions from a former lender….