by Eric Englund
Inflation is an immoral tax that leads to immoral values
~ Anonymous South American banker
Having been in the credit profession for the past 23 years, I have observed several cycles involving the loosening and then the inevitable tightening of credit-underwriting standards. Of course, the Federal Reserve stands at the epicenter of such cycles. While money and credit are flowing like beer at an Irish pub on St. Patrick’s Day, everyone ends up looking like an attractive credit risk. When it appeared that the U.S. economy was heading into a recession, after the collapse of the dot.com and telecom bubbles, the Federal Reserve opened up the taps and encouraged one and all to imbibe its tasty, low-cost credit – with the most popular “flavor” being the mortgage loan. At this point, mortgage lenders merely became bartenders serving anyone who walked in the door. To reach this nadir in mortgage-lending standards, it is inescapable that the “Five Cs” of credit were ignored regardless if a mortgage loan was deemed prime, Alt-A, or subprime. This is exactly why the home-mortgage meltdown has just begun.
One aspect of my job entails analyzing personal financial statements. Twenty years ago, without a doubt, households had much healthier financial conditions. Back then, in proportion to household net worth, savings were much higher and debt levels (especially automobile, credit card, and mortgage debts) were dramatically lower. It is alarmingly common, today, to see households with well under ten thousand dollars in savings yet half-a-million dollars in mortgage debt – not to mention thousands of dollars in credit card debt and tens-of-thousands of dollars in automobile debt. Such households are literally one or two missed paychecks away from being destitute. Yet, amazingly, the heads of such households are considered to be prime-level borrowers (as long as there is adequate income to cover monthly debt service and expenses). What has happened, in the sphere of personal-credit underwriting, is that risk parameters have been redefined with the word “prime” having been defined downwards.