We have been in an environment of very low interest rates for a number of years. In theory low interest rates should be conducive to greater economic activity, though that hasn’t actually worked out over this time period.
In recent years bank lending has been quite stringent, which tended to limit the access to credit for many borrowers. We are starting to see some evidence of an easing of credit standards, which should give a boost to the economy.
We can think of lending in two ways, one to businesses and the other to consumers. Both are important, though in different ways.
Other than the largest corporations, which can rely on capital markets, most companies are dependent upon bank lending. When credit is more available it is easier for businesses to expand. The most recent survey of senior bank lending officers showed an increase in availability for commercial and industrial loans.
For consumers the largest source of borrowing would be home mortgages. During the previous financial crisis very lax credit standards were one of the principal culprits that caused the recession. Not surprisingly in the aftermath, banks and regulators became very cautious, which helped to prolong the real estate downturn.
What helped the real estate market to recover was a large influx of cash buyers, who were not dependent upon obtaining mortgages. These investors were able to purchase distressed foreclosed properties, and turn them into rentals.
Since real estate prices have recovered, investors are no longer significant purchasers of single-family housing. The future demand for housing will now be coming from individuals who are more dependent upon the mortgage market.
This past week the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac announced a relaxation of credit standards. Currently Fannie Mae and Freddie Mac guarantee approximately 60 percent of new mortgages made. Previously there had been talk about scaling back these agencies role in the mortgage market, but that will no longer be the case.
This move should help demand for homes by first time buyers, where demand has been rather tepid. Many young adults have delayed home buying because of an uncertain job market, as a higher proportion are renting versus the prior generation.
In our area most homes sell for prices above the conventional loan limits, so greater access to these loans will not matter that much. However, for condos and homes in less expensive sections of Los Angeles County these changes should increase demand.
In the short run the effects of easier lending standards should be beneficial to the economy. When businesses can expand, and consumers have easier access for credit to purchase homes economic activity will increase.
In the longer run there is the potential for problems with lower credit standards. We saw what happened when individuals purchased homes they could not realistically afford during the 2005 through 2007 period.
It is doubtful that lending standards will be relaxed to the point we saw during the last cycle. For the time being, would expect the economy to be somewhat stronger. Longer term would hope that the banks and regulators will have learned some of the mistakes they made previously, but we will just have to wait and see.
Allen Wisniewski has been involved in finance for more than two decades. He lives in Culver City with his family.
