US banks tighten as the Fed eases

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The US Fed has dramatically cut interest rates by 1.25% recently. But as it eases, so US banks seem to be tightening their lending criteria for mortgages. Present standards are the tightest recorded

Since 1990, the Fed has asked banks about their lending standards. The chart above (by Merrill Lynch) shows the results. From 1992-2006, banks were relaxing standards most of the time. And even when they tightened, it was only by relatively small amounts, with no more than 20% of the US population being affected.

But over the past year, there has been a major, and unprecedented, change. As the above chart (complied by Merrill Lynch) shows, over 70% of Americans are now finding it harder to get a mortgage. 85% of banks have tightened their standards. And the change is not just affecting the subprime market. Over 50% of banks have tightened their standards for traditional prime mortgages.

The implications of this are enormous. It means that stimulating demand, whether by interest rate cuts or tax rebates, is unlikely to significantly reduce today’s inventory of new and existing US homes, which now stands at 9.6 months. Previous demand relied on lax lending standards – and today’s tighter policies mean that previously qualified buyers cannot now return to the market, even if interest rates go to zero percent.

So in reality, trying to stimulate demand is like pushing on a string. The only way to bring housing supply/demand back into balance is to reduce supply. And as anyone who has ever traded oil products or petchems knows, the only mechanism to achieve this is a sustained period of falling prices.

The banks have clearly recognised this new fact of life, which is why they are rushing (too late, of course) to try and reduce their exposure. Unfortunately, from a chemical industry standpoint, this could help to ensure that sales to the important housing market may take months, if not years, to properly recover.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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