Problems in Lending

Lending Agencies are facing serious issues or are actually going out of business. I find this to be a symptom of our larger problem and the contagin that causes the current crisis.

I will deal with the contagin part first and then will begin to deal with the larger problem.

Yes problems in the lending field are a part of what is causing our current economic crisis. So lets look at some reasons for that.
1. Making bad loans: Bad loans are bad for the person recieving the loan and the company lending. Because the person recieving the loan going to eventually fail in a purchase or even worse a business venture. This sets him back further than he was to start with. Often times when you take on a loan you are in what appears to be a good financial situation but when you forclose you are in a poor financial situation.
The Lender faces a different set of problems. Since most loans default during the first few years they have taken little profit and that is lost because they dont forclose immediately they wait to see if the loan can be worked out. Their payments arent happening and they have a large portion of money tied up that should be making them money elsewhere. Also during the current crisis their other end(the collateral or the assest that is borrowed against) has been decreasing in value instead of improving in value. An example that might hit home is: If you were renting out a house for 1 year and had made a rather large investment in it. You would be depending on not just this years payments but future payments. If instead of having these payments you had only the couple of months payed and then stopped receiving payments. You would be set back a good bit, but you could recover fairly well when you evicted the renter after two months delinquency and got another renter. So you evict them which isnt fun, but are shocked to find that your house has been torn to pieces and requires another loss. Thats what banks are facing. The loans are going bad and the assets are losing value also. Both problems by nature is a crisis.

2. Declining asset value: I have covered this to a degree in the previous section. I will point out a few other angles. Banks are backed by a large amount of assets and are required to keep a certain amount of liquid assets to cover any potential withdrawals or requirements for collateral. You can see that if the overall assets are declining in value this will put a squeeze on the banks value and shrink the pool of liquid money. This is why local banks in areas unaffected by the economic crisis are not facing many problems. Also the banks are sometimes tied to each other with regular loaning between each other that allows them to take higher investment risk. This is just not going to happen now. The interbank loaning for short term needs is down to a minimum.

Now If they dont want to loan money as a result of declining asset values and small cash pools. Normally they raise interest rates and only lend to proven creditable sources. This makes sense because the higher interest rates slows the rate of loans because people want to take fewer loans for higher interest rates. Also the lending to proven creditable sources makes sense because those people or companies who pay their bills do not present nearly as many problems during the periods where their assets are losing value. Why? Because people that pay their bills continue to pay their bills and the assets doesn't have to be sold.

Finally they will require more strict downpayments. Why? because if you payed $20,000 earnest or downpayment you will almost certainly pay the final $80,000 for your loan because even if you couldnt. You could almost always sell the asset for more than $80,000 even if there was an issue. Making declining asset values much less of a concern.

My next blog will deal with this issue further.