One of the contributing factors of the 2008 financial crisis was the fact that lenders loaned money to borrowers with sub-par credit histories. This was particularly the case in the mortgage market, where loans to subprime borrowers were then securitized, obscuring the weakness of the underlying loans and leading to the failure of firms such as Bear Stearns and Lehman Brothers. Now that growing evidence shows a return to more lax borrowing standards, could this help precipitate another financial crisis?
Stricter Banking Regulation After the Crisis
Nearly a decade of ultra-loose monetary policy has resulted in trillions of dollars of new money flooding the financial system. Its effects were more muted than one might expect, for two reasons.
First, significant portions of the new money are still being held by banks as reserves at central banks. That has limited the amount of money that is flowing into markets to be loaned out.
Second, bank regulators in the aftermath of the financial crisis took a hard line against loose credit standards. In many instances they tried to be as strict with banks as possible, ensuring that only the most creditworthy borrowers could get new loans. Recent data indicates, though, that underwriting standards have now started to loosen.
Credit Card Debt Increasing
Data from credit card companies shows that many companies have begun to relax their underwriting standards and extend credit cards to subprime borrowers. Credit card debt has now risen to levels that haven’t been seen since the financial crisis, with the average amount of credit card debt per household increasing 6% last year.
It’s not surprising to see credit card debt increasing, as lenders who could no longer lend to homebuyers sought to make loans where they could. Credit card debt isn’t the only type of debt that is increasing, as auto loans and student loan debt have also been on the rise.
Most troubling, however, is that credit card charge-offs are increasing too. Charge-offs are credit card debt that is so delinquent that credit card companies give up on trying to collect it. That’s a troubling indicator of the financial health, or lack thereof, of American households.
Zero-Down Mortgages Return
Another example of a return to the days of the last housing bubble is the return of zero down payment mortgages. Traditionally, a 20% down payment was expected of homebuyers to ensure that they had an incentive to stick to the mortgage. As the housing bubble heated up, down payments grew smaller and smaller, with down payments eventually reaching zero.
The problem with a zero-down mortgage is that the homebuyer has no equity in the house to begin with, no “skin in the game.” If house prices start to fall and the house’s price drops below the value of the mortgage, the homebuyer could just hand over the keys and walk out, leaving the lender holding the bag.
That’s what many underwater homebuyers did during the financial crisis. Since they hadn’t forked over any money up front, they had no incentive to keep the house. Paying 10% or 20% up front would have meant walking away from tens or hundreds of thousands of dollars that had been paid in the down payment, making the borrower far less likely to walk away.
And while the lenders offering these newest zero-down mortgages claim that they are being far more selective with whom they lend to, the reality is that over time the pool of eligible borrowers will be increased and lending standards decreased, in order to bring in more potential profit for the lender.
While these data don’t necessarily indicate the cause of the next financial crisis, they do show a troubling return to some of the bad lending behavior that made the last financial crisis worse. Taken together with other indicators, they’re worth keeping an eye on. They could be leading indicators that another crash is just around the corner.