Banks and other lenders get drunk with enthusiasm of making the big time with increasingly risky loans where they can charge a lot and spread the bounty around. Almost everybody that knew anything about it knew this would come back to bite, but greed is a terrible thing to waste. Well it did come back to bite. Then what do the banks and financial institutes do? Well, of course they overreact, sending the economy further into a tailspin.
I have got to admit that I have neither understood or appreciated this "rational market" theory. There is nothing rational about it. What the banks and mortgage lenders and investment banks did was cause the solicitation of loans that they knew -- they knew -- were not sustainable. They just hoped they could securitize them, bundle them, market them and lay them off on China, the Mideast, Europe and big US investors like insurance companies before anybody caught on. Oh, they will say differently because each person in the chain only paid a small part, but it was motivated by the common factor of greed.
Well, now it has hit the fan. And, what do the banks and financial institutions do? They overreact.
According to CNNMoney, banks have been drastically tightening their lending standards, effectively putting credit out of reach for many consumers in search of mortgages, credit cards or car loans.
According to the Federal Reserve's first-quarter survey of senior loan officers at some of the nation's largest financial institutions, banks were turning away an increasing number of consumers because of credit fears. The Fed is likely to report that this trend continued in the second quarter when it releases its latest senior loan officer survey later this month. Hoping to preserve capital and rid themselves of these troubled loans, financial companies have, as a result, held borrowers to a much higher standard.
Hoping to clear out all the toxic mortgages from their books, banks and other lenders are also raising the bar for potential homebuyers, demanding bigger down payments and additional up-front fees, effectively pricing some shoppers out of the market. By raising the bar, some would-be borrowers have fallen by the wayside.
While the rates on various loans hinge on a variety of factors, such as the 10-year Treasury note and the prime rate, banks tend to have some leeway when it comes to setting lending rates. And some institutions are certainly taking advantage of this fact. Some banks, for example, are boosting rates sharply on loans in order to avoid attracting any new business. Others are upping rates simply to make a few extra bucks.
Banks must also walk a fine line when it comes to credit. For example, some lenders will see the value in turning away new loans in order to preserve capital and to live on for another day. But, it is possible that by making credit standards too difficult, institutions are effectively turning away business and ultimately sacrificing earnings growth. Also, banks and financial institutions run the risk of driving both existing and potential customers into the arms of their competitors - a risky proposition as borrowers can often be a repeat source of business.
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