Lights are on, but banks increasingly closed: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

LONDON (Reuters) - The second half of 2008 looks like it will put the "self-reinforcing" into "self-reinforcing credit spiral."

Banks in the U.S. are cutting back savagely on credit to individuals, making mortgages and consumer loans tougher to get and more expensive.

Borrowers in turn are missing more payments, prompting more writedowns and leaving the banks still less to lend.

Securitization, once celebrated as the shadow banking system where lenders could pass on repackaged debt to eager investors, is little more than a memory with the exception of the government-supported Fannie Mae and Freddie Mac markets.

All of these factors are magnifying one another.

And the banks themselves say it is going to get worse.

The Federal Reserve's July Senior Loan Officer survey, one of the best indicators of on-the-ground conditions, showed broad and deep tightening across a range on consumer and housing loans, even in the face of slackening demand.

About 75 percent of domestic lenders tightened their standards for housebuyers, even the best borrowers, in the second quarter. That's a huge majority and up from 60 percent of lenders in the April survey.

And if you want a home equity loan: forget it. About 80 percent of domestic banks have raised their hurdles for making loans.

But the most striking tightening was in consumer lending, where about 65 percent of domestic banks made it tougher to get credit card loans, more than double April's 30 percent.

Many banks said they would continue to tighten for the rest of this year and into 2009.

"It looks both worse and more broad-based than the crunch in the early 1990s," said Peter Possing Andersen, senior analyst at Danske Bank in Copenhagen. "You are seeing a second round now where credit tightening is showing up strongly in consumer and business loans."

And of course this will make it worse for consumers and for banks, and demonstrates that the Federal Reserve's unprecedented measures to try and break the cycle have yet to work.

The Fed has cut rates, it has orchestrated bailouts and it has provided huge amounts of liquidity through new lending programs. But liquidity and capital are two different things, and what banks lack, and can see dwindling further, is capital.

Meanwhile recent news from financial companies show that, even putting their constrained capital positions aside, banks are absolutely right to be making credit more scarce and expensive.

NO GOOD DEBTORS ANY MORE

Consumers are struggling to pay interest on their debts as well as high food and energy prices, house prices are still falling and borrowers thought to be better bets than subprime are going bad at alarming rates.

JPMorgan Chase & Co (JPM.N) said it had lost $1.5 billion thus far this quarter on mortgage-linked assets, as credit markets deteriorated. JPMorgan also said that it sees further credit deterioration in its consumer portfolio, during the rest of 2008, which will mean they must take more reserves against losses.

It also said charge-offs on home equity loans could keep rising this year, while prime and subprime mortgage charge-offs were likely to rise "significantly." The bank was aggressive in buying market share in 2007, when many competitors were forced to draw back, a gambit that clearly did not work out and has been noted by other lenders.

Fannie Mae (FNM.N), which last month needed government assistance, said last week it would wind down its Alt-A business that makes loans to borrowers just above subprime in creditworthiness. The lender, which recorded a $2.3 billion loss in the second quarter, said it was being hit hard by increasing defaults and by the increasing costs of those defaults, as falling property prices, especially in bubble markets like California, leave them less to recover through foreclosure sales.

Fannie said its Alt-A foreclosures have doubled in southern California, while almost two percent of the loans in its Florida book are now referred for foreclosure.

Not an economy most banks would like to lend into, at least not until housing shows signs of bottoming.

It is just about possible at this point to construct an argument that says that most of the losses have been concentrated among either foolish overstretched borrowers or ones unlucky enough to get involved in housing markets that were hugely inflated.

But credit is not just tightening for the foolish or the Floridians, it's tightening for everyone, and into a weakening economy in which it's harder to keep a job.

"If you compare households now and the early 1990s ... this time you have the same type of problems but much worse: a bigger increase in energy prices, a bigger housing downturn and a bigger financing crisis," said Andersen at Danske Bank.

It won't last forever, but the worst part of the crunch is still to come.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email: saft@thomsonreuters.com --

(Editing by Ruth Pitchford)