Here’s a scenario for you:
A stranger comes up to you and asks to borrow some money. You have the ability to make the $5,000 loan being requested. The stranger can’t provide you with much information. They are vague about what their job is, how much money they make and how they will be able to repay the loan. They don’t have any assets to speak of. But they “promise” that they are going to repay the loan.
Does it sound like a good idea to make this loan?
If you said “yes,” then congratulations, you have what it takes to be a modern day finance company.
Now, you get to CLAIM YOUR PRIZE: Billions of dollars of losses!!!!
It used to be the job of banks and finance companies to ferret out the bad borrowers - you know, doing their best to solve the old adverse selection/moral hazard problem. From the huge mess we have in our financial markets right now, it seems as though all the computer algorithms that they had drawn up to make lending decisions did way worse than a monkey could have done in releasing funds to borrowers who were never going to make a payment.
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Finance giant and investment bank Morgan Stanley has just announced that they will “freeze” all of their clients’ home equity lines of credit (HELOCs). While the company isn’t releasing much information about this as of yet, one can speculate that the main reason for this is that the values of homes have dropped so much over the past 12 months that the equity being borrowed against is no longer there.
Hmmmm…
Knowing what we know about how many Average Joe’s and Jane’s use their homes like ATM machines, taking out equity to buy everything from new cars to vacations and plasma T.V.’s, it isn’t hard to see how further changes like this in the lending markets are going to make for a very lean Christmas this year in many homes.
This is likely troubling for consumer spending, since much of it relies on the “2 C’s:” confidence and credit. The mortgage and finance companies, who used to woo Average Joe with tantalizing offers of cheap and easy credit, are now gunning for him. It seems every dollar of red ink is stained with the blood of Average Joe’s and Jane’s across America.
If I could rub an old lamp and give orders to my genie, I would wish for ‘normal’ lending standards to return to the market - you know, like it used to be before things got absolutely nuts and ghosts started getting financing for leaving some residue on the wall.
