Tighter lending equals a slower recovery

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Guest Editorial by Bernie Markstein, Chielf Economist, Reed Construction Data

The credit lending standards pendulum continues to swing. In the early 2000s it swung towards less restrictive lending requirements, ultimately reaching standards that were excessively easy. In 2006, as the housing market faltered and problems in subprime mortgage lending began to surface, the pendulum started back towards tighter standards. That trend continued for the rest of the decade, only showing signs of ending and some small movement back towards more reasonable standards in the past year.

Lax lending practices were a key factor in setting the stage for the Great Recession. Now, excessively tight requirements are acting as a drag on the recovery from that recession. A recent report from the American Institute of Architects (AIA), Stalled Construction Projects and Financing Problems, found that the share of projects stalled due to financing problems has almost doubled in the last three years alone. A July 2011 survey referenced in the report revealed, “Over 60% of architecture firms with stalled projects indicated that at least one of their stalled projects was having problems with financing.” This is similar to responses in past surveys by the National Association of Home Builders (NAHB) that showed over 60% of home builder respondents reported losing at least one sale due to financing problems.

Further, the Federal Reserve’s survey of senior loan officers at large national and regional banks has shown continuous tightening of lending standards starting in 2006 until about a year ago for consumer mortgages and commercial real estate loans. Recent surveys have shown only some minor loosening here and there over the past year, primarily by large banks.

So what’s the big deal? Didn’t poor lending standards get us into this mess? Isn’t a swing back to better lending standards desirable?

The answer to the last two questions is yes. However, the pendulum has swung much too far – lending standards have not just moved back to prudent standards, but are now excessively rigorous

The National Association of Realtors® (NAR) reported that contract failures among its member respondents jumped to 33% from 18% in September and from 8% a year earlier, clearly limiting the pace of existing home sales. Not all contract failures were due to financing issues, but financing issues were a major factor.

Among developers and home builders, viable projects are not going forward. And these are not just multi-million dollar projects. The AIA reports that “projects with estimated construction costs of under $5 million account for almost half of all projects stalled due to lack of financing” and that “only 15% of stalled projects have estimated construction costs in excess of $25 million.”

Thus, the answer to the first question is that lending requirements have not just moved back to sensible standards but to excessively tight standards. The result is the cancellation of reasonable (dare we say, prudent?) projects that would have been approved not just in the days when the standard for lending was simply that the borrower could fog a mirror, but for projects that would have been approved back in the 1990s.

Stalled construction projects keep construction workers unemployed and limit building product manufacturers’ sales. This unfortunate scenario results in money that does not go into the economy. Dr. Stephen Fuller of George Mason University has estimated that $1 spending on the construction of buildings results in an additional $1.88 in indirect spending to the national economy.

Excessively tight lending standards are clearly hurting the construction industry and the national economy. Ironically, the reticence to lend to both residential and nonresidential construction is hurting property values in both arenas, making loans to these sectors appear less secure.

We do not want a return to the “wild west” lending practices of just a few years ago, but we DO need to return to reasonable, prudent lending practices of a little over a decade ago. Read More.

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