Fed: Banks Toughened Lending Requirements Amid Slump

The Federal Reserve said more banks made it harder to borrow money as defaults and delinquencies on home loans soared and the economy faltered.

Most "domestic institutions reported having tightened their lending standards and terms on all major loan categories over the previous three months," the Fed said yesterday in its quarterly Senior Loan Officer Survey.

Funds were scarcer for homebuyers and small businesses, credit card loans became tougher to get, and even banks' best customers were subject to greater scrutiny. Tighter credit may delay any recovery in economic growth, which economists forecast will slow well into next year.

"The credit crunch is intensifying," a senior economist at UBS Securities LLC in Stamford, Conn., James O'Sullivan, said. "It reinforces the view that the economy will be weak in the next several months and there will be renewed pressure on the Fed to start easing again."

The survey, conducted last month, covers 52 domestic banks with combined assets of $6.1 trillion, along with 21 foreign institutions. About 75% of American banks indicated they tightened standards on prime mortgage loans, up from 60% in the previous survey, the central bank said.

Bank stocks pared gains after the report. The Standard & Poor's Financials Index gained 5.49 points to 299.57 in New York. The index climbed as high as 305.23 before the survey was published.

The Fed has reduced its main rate 3.25 percentage points over the past 11 months to 2%. Still, rates on a 30-year mortgage stood at 6.52% August 7, nearly unchanged from 6.59% a year ago, according to data from Freddie Mac.

"When the Fed started to cut rates, mortgage rates and other rates were actually lower than they are today," a former president of the San Francisco Fed Bank, Robert Parry, said before the report. "To say that things are easier in many areas of credit would be mistaken."

Banks may be reluctant to lend against housing collateral that is falling in value. Home prices in 20 American metropolitan areas dropped 15.8 percent in May, the biggest decline since record keeping began in 2001, according to the S&P Case-Shiller Home-Price Index.

"There is a bandwagon effect," the president of ClearView Economics LLC in Pepper Pike, Ohio, Ken Mayland, said. "When times are tough, the herd starts running in the other direction, with tougher standards pretty much across the board."

About 30% of American banks said they had sold mortgages of as much as $729,750 to Fannie Mae or Freddie Mac during the prior three months, or had the two companies package the loans together as mortgage bonds, the Fed said.

The economy is also faltering. The unemployment rate has moved up 1 percentage point during the past 12 months to 5.7%, while delinquencies on home loans to borrowers with weak or limited credit histories rose to 18.8% in the first quarter from 13.85 a year earlier.

"Large majorities of domestic respondents reported having tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the previous three months," the Fed said.

Of the 32 banks that originate non-traditional mortgage loans, about 85% reported tighter lending standards, up from 75% in the prior survey, the Fed said.