[R-G] "Ever-growing Majorities of Banks Intending to Tighten Their Credit Standards across the Board and to Charge a Bigger 'Spread'"

[Yoshie Furuhashi]

<http://www.federalreserve.gov/boarddocs/snloansurvey/200808/>
July 2008
The July 2008 Senior Loan Officer Opinion Survey
on Bank Lending Practices

<http://www.ft.com/cms/s/0/f0aa9396-6ba9-11dd-bf1a-0000779fd18c.html>
Long View: This train crash's final impact is still awaited

By John Authers, Investment Editor

Published: August 16 2008 16:55 | Last updated: August 16 2008 16:55

It was Jeremy Grantham, one of the most respected sages in the world
of fund management, who first described the problems gripping the
credit market as a "slow-motion train wreck".

Since he said that more than a year ago, the metaphor has
metastasized. It has become one of the most popular descriptions of
the market's upheaval last year.

There is good reason for this. The risks of the inflated bubbles in
housing and credit markets were obvious even before those bubbles
burst. The consequences we have suffered so far were all predictable a
year ago.

But markets and economies work at a much slower pace than a train,
even if the laws that bind them are almost as strong as the laws of
physics.

If we were to watch a train wreck in slow motion, there would be an
initial attempt to slow down, as the drivers desperately tried to
regain control. Then would come the moment of impact. Then one coach
after another would crash into the coach in front of it.

In markets and the economy, a sudden contraction in credit will lead
to acute difficulties for banks and it will choke off economic
activity. It will take a huge bite out of companies' earnings.

However, it will not have these effects immediately. It takes time for
bankers or consumers to understand what has hit them and then to
adjust their behaviour. When they do, it is like the impact of a coach
crashing into the coach in front. But, while waiting for the next
impact, markets can convince themselves that everything will be all
right.

This explains the pattern equities have been following in the past
year. They have moved from crisis to crisis, with rallies in between,
as participants persuade themselves the worst is over. And most people
have an interest in seeing the market rise rather than fall, so
bullish theories make the rounds. Then the impact of the latest
collision becomes undeniable and prices dive once more.

A perfect example is the Federal Reserve's quarterly survey of senior
lending officers of US banks. Over time, these surveys have been
almost perfect leading indicators. If credit for consumers is
tightened, then employment will fall, generally with a lag of about a
year; tightening standards for real estate loans lead to lower
investment in real estate, again with a lag of about a year; and so
on.

The latest lending survey, for the third quarter, appeared on Monday
and showed ever-growing majorities of banks intending to tighten their
credit standards across the board and to charge a bigger "spread".
This terrible news had barely any impact on the rally in stocks.

Much the same is happening in the housing market. If house prices
fall, then people are less rich and spend less; they are more likely
to abandon their houses to foreclosure. That will then affect the
value of securities backed by their mortgages and inflict pain on
whoever is holding them.

But, again, this process has a long lag. It takes time for homeowners
to realise what is happening and stop paying and, after that, the
process of foreclosure takes months. Further lags are created by the
phenomenon of variable rate mortgages, relatively new in the US.
Borrowers who took a low "teaser" rate can see a rise in their rate
coming. But it is not until the rate rises that they change their
behaviour.

So the recent evidence that many borrowers will have critical
difficulties repaying option-arms (adjustable-rate mortgages) once
rates are adjusted higher over the next year has had little impact. A
regulatory filing for Countrywide, the huge US mortgage lender that
first ran into problems a year ago, makes startling reading. For the
borrowers of $25.4bn in option-arms, their mortgage now typically
accounts for 95 per cent of the value of their home, compared with 76
per cent when the loan was made.

At the international level, problems for the UK have been inevitable.
With an even more inflated housing market than the US, and greatly
dependent on the stricken financial services industry, it was clear
that Britain stood to suffer more than the rest of the world.

But until the last few days, sterling remained at historically high
levels against the dollar. Even this month, it nearly reached $2, a
level that was obviously far out of whack with the relative purchasing
power of the two currencies.

Now we have seen the moment of impact for the British currency. Once
the long-term trend for a strong pound had been broken, as happened at
the end of last week, it collapsed against the dollar.

Maybe commodity prices – now apparently in free fall from gold to oil
to grains – are following the same rule of physics. They gained as
traders worked on the theory that they would benefit from inflation –
now they are falling as the sentiment takes hold that the world
economy will stagnate.

Whatever happens, this train wreck is playing out in very slow motion.
We may have much longer to wait until the final impact has juddered
through the train.

john.authers at ft.com