Banks continue to tighten loans, slowing recovery

As banks maintain a tight rein on loan standards and consumers hold back on taking new debt, the economic recovery looks like it will be a slow one. Economists don't have a clear picture of what's next for the economy. Some believe that the downturn has been so severe, we'll see a strong recovery. Others think that, as businesses and consumers pay down debt or hold back on purchases, the recovery will be weak. Another group of economists say that there will be a quick, short rebound, followed by another recession.

The government decided to try to push the odds for at least a weak, longer-term recovery by extending the Term Asset-Backed Securities Lending Facility (TALF) through March 31, 2010. Under this program, the Fed makes low-interest loans to investors and offers them loss protection so they can then buy securities backed by consumer and business loans. It was supposed to end in December.
So far, TALF has not been very successful. The Fed has funded about $30 billion of the $1 trillion set aside for the program'slending. It has faced two big problems: finding investors who want to participate and finding loans to buy. Banks either don't want to sell into TALF at reduced rates or are making so few loans that they don't need to sell off the ones they have.

Another big factor probably stems from the fact that the stiff loan standards now in place make it impossible for many borrowers to qualify for new consumer or business credit loans. In fact, 30 percent of banks said that they were tightening standards for both consumer and business loans even further. Even among those who aren't tightening standards, most said that they had no intention of easing them until the second half of 2010. In other words, the banks say, we'll wait for a recovery before we start making it easier for consumers and businesses to borrow. In a report released yesterday, the Fed predicted that lending standards across all loan categories would remain tighter than their average levels over the past decade.

Demands for loans also continue to remain weak in every sector but residential mortgages. Most mortgages being made are refinances, and even they have slowed as interest rates continue to creep up. Banks say that the drop in commercial lending has happened primarily because of low consumer demand, but another key factor is that banks are finding fewer borrowers who have good credit.

The Fed indicated that consumers are continuing to pay down debt and reduce spending. Businesses continue to downsize, cut costs and reduce inventories. Until there is a change in this pattern, we won't see increased demand for lending, nor will we see any significant signs of a recovery. In fact, some economists believe we are in a severe credit contraction whose effects will be felt for years.

Clearly without some good news in the job market, consumers won't be spending money any time soon. Even if one has a job, the fear factor that the job could be lost is very high. However, consumer spending has been the key factor that has gotten us out of most recessions.

The "cash for clunkers" program showed that there is pent up consumer demand out there as long as consumers can get their hands on money. Maybe it's time for the government to find more ways to give consumer incentives, even if it means bypassing the banks and their tightened loan standards.

Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Improving Your Credit Score.
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