Easy Credit Turning into Hard Times?

0 Comments | Insight on the News, Nov 8, 1999 | by Patrice Hill

Analysts worry that banks are too quick to give credit where credit isn't due ... and will pay the price during the next recession.

The easy flow of credit during the 1990s has helped to fuel a nationwide housing boom and spending spree that has kept the economy humming. But analysts say banks have lowered their lending standards, particularly to tap into the fast-growing minority markets, and have been under strong political pressure to do so despite studies showing minorities are more likely to default than whites. The result of this largess may be soaring levels of bankruptcy and default during the next recession.

"We have created a tremendous amount of risk," says Cynthia Latta, economist with DRI/McGraw-Hill in Boston. "At some point, the economy is going to turn down. There will be large numbers of defaults that will trigger a lot of political heat."

Politicians have pushed for the lower standards out of a legitimate desire to spread today's prosperity to groups that previously were on the margin, says Latta. "Banks are under a great deal of pressure to lend in these communities," she says. "It is very political. But I still have reservations about whether you're really doing anyone a favor by letting them borrow 100 percent of the cost of a home. It makes it so easy for them to get in over their heads." If the economy turns sour and unemployment rises, minorities will be the first laid off -- paving the way for a wave of defaults.

Federal laws on fair lending and community reinvestment require bankers to reach out to minorities, notes David Lereah, chief economist with the Mortgage Bankers Association. The record rates of homeownership among minorities as well as the rest of the population shows that these reach-out programs are working.

Nevertheless, Lereah agrees that banks and the economy will pay a price in the next recession. "If the economy goes into a tailspin and experiences recession, then I do worry about some of the low down-payment loans," he says. "The borrowers don't have that much at stake, don't have that much equity in the homes. If they lose their jobs, they could walk away from the homes."

A recent study by Freddie Mac, the federally chartered Federal Home Loan Mortgage Corp. that buys mortgages from banks to resell to investors, documents the shaky financial standing of minorities. The study found that nearly half of black borrowers and a third of Hispanics have "bad" credit records -- that is, they have a record of delinquent loans or bankruptcy -- compared with a quarter of whites. Moreover, income does not explain the disparity, according to the study. Among people with incomes of $65,000 to $75,000, 34 percent of blacks have bad credit, compared with 20 percent of whites.

In light of the study, Freddie Mac has established an education program with five black colleges to teach students to better understand credit and the importance of maintaining a good record. One reason minorities may have worse credit records is they are much less likely to grow up in family-owned homes than whites, says Latta. She adds that most Americans are ignorant about credit and money issues, and political leaders should consider requiring courses in high school about money management to address the nation's growing problems with credit abuse, bankruptcy and abysmally low savings rates.

"The real danger in this is we're talking about an economy that has really been supercharged by the wealth effect from the stock market and the tremendous job market," says David A. Levy of the Jerome Levy Economics Institute. "A lot can happen when the stock-market bubble bursts, and that will happen sooner or later." Already, personal bankruptcies and household debt are at record highs -- "a time bomb" waiting to explode when the economy takes a downturn.