Home > Government & Politics > Lending Lesson Not Yet Learned

Lending Lesson Not Yet Learned

On June 14, 2010, the Wall Street Journal printed an op-ed piece about the politicizing of the Federal Reserve System, which has functioned for 97 years with minimal political meddling.  There are provisions in both the House and Senate Financial Services Reform bills which have the potential to introduce a lot of politics into the U.S. monetary policy.

One thing mentioned in the article is the creation of a high-ranking position at each of the 12 regional federal banks.  This Presidential appointment would be responsible to “ensure equal employment opportunity and the racial, ethnic and gender diversity” and “increase the participation of minority-owned and women-owned businesses in the programs and contracts.”  Seems rather benign until you consider the backdrop of the mortgage meltdown over the past couple of years.

One of the factors that contributed to the present financial crisis and economic recession was issuing home mortgages to people who had a dubious ability to repay.  The Federal government’s goal for more than 20 years of increasing home ownership resulted in a gradual change of lending standards (e.g., subprime loans, 100% financing and option ARM’s). 

Twenty years ago virtually every banker would have considered it insane to lend on any of these terms, yet they did.  Why? Because they were able to off-load these loans to Fannie Mae, Freddie Mac and other investors.  The government was willing to back the loans because it furthered their goal of increased home ownership.

Like a pendulum, the lending standards over the past two years have swung dramatically in the other direction.  Clients who purchased or refinanced their home have experienced difficulty getting approved, even though they had a securities portfolio multiples times the value of the loan they were seeking.  In less than 12 months lenders went from giving loans to people who couldn’t repay to virtually refusing loans to those who don’t need to borrow.

A loan is different from a gift… the money is supposed to be repaid.   If you have ever lent money to someone, even $5, you know the greatest risk is that you won’t get repaid. Common sense would dictate that a borrower’s ability to repay is the most important criteria when making a loan. 

In Martin Luther King Jr.’s famous I Have a Dream speech, he said he dreamed that “my four little children will one day live in a nation where they will not be judged by the color of their skin, but by the content of their character.” I’m sure that banking practices were not on his mind the day he delivered his speech, but the principle applies. No one should be denied a loan based upon their race or gender, but you also should not get a loan, or preferential terms because of it either. The concern with these political appointees is that they will exert pressure on the banks to lend based upon gender or race, rather than strictly on the merits of the loan. 

There are many lessons to be learned from the financial crisis of 2008.  One of those lessons is to deny loans to people who can’t reasonably repay, even if it’s for a good cause.  Politicians should not pressure banks to lend to people who can’t repay.  If they do, it’s a lending lesson they have not yet learned.

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