Federal Reserve finds deepening credit crisis

WASHINGTON -- More banks are tightening lending standards on home mortgages and other consumer and business loans as a deepening credit crisis exerts a heavier toll on the economy.

The Federal Reserve said Monday the percentage of banks reporting tighter lending standards rose across various loan types in its July survey. In April, the central bank had found that the percentage of banks reporting tighter lending standards was already near historic highs.

The new survey, conducted in early July, found that about 75 percent of the banks surveyed indicated they had tightened their lending standards for prime mortgages. That was up from about 60 percent of banks who said they were tightening lending standards for prime mortgages in the previous survey.

The Fed's July survey covered 50 banks which hold about 80 percent of the residential mortgages on the books of all commercial banks.

Out of this group of 50 banks, 32 said they were still originating so-called nontraditional home mortgages. Among these 32 banks, about 85 percent said they had tightened their lending standards, up from 75 percent who said they were tightening lending standards for nontraditional mortgages in the April survey.

The Fed defines nontraditional mortgages as adjustable-rate mortgages with multiple payment options, interest-only loans and "Alt-A" mortgages that require limited verification of income.

Few banks unchanged

The Fed survey found that only seven of the 50 banks said they were still participating in subprime mortgages, loans made to borrowers with weak credit histories. Of those seven, six said they had tightened lending standards on subprime loans with only one saying it had left standards basically unchanged for subprime loans.

The survey found that most banks were reporting tighter lending standards across a broad swath of consumer and business loans over the past three months.

For home equity lines of credit, 80 percent of the banks surveyed said they had tightened their lending standards in this area.

For credit cards, the percentage of domestic banks reporting tighter lending standards was about 65 percent, more than double the 30 percent who reported they were tightening lending standards for credit cards three months ago.

Analysts said the big jump in higher standards for credit card debt could represent a serious threat to the already weak economy, given that consumer spending accounts for two-thirds of total economic activity.

Harm Bandholz, an economist with UniCredit Markets, said the tightening in bank standards for credit cards and other types of consumer loans would be "another nail in the coffin of the U.S. consumer, who is already suffering from the weak labor market, high inflation and falling house prices."

David Wyss, chief economist for Standard & Poor's in New York, said the tighter lending standards reflect the huge loan losses that banks have already suffered. Those losses have depleted the capital they need as reserves against future losses and made it more difficult for the banks to sell their mortgages and other loans as asset-backed securities, a process that provides them with money to make new loans.

Waiting for rebound

Wyss said he did not believe bank lending will start to pick up until next spring when he is forecasting that the economy will begin to rebound.

"The country is probably going through the most severe credit crunch since 1991-92," Wyss said, referring to a time when banks and savings and loans came under severe pressure while the economy was in a recession. "I think bank credit is going to remain tight for a while."

The current credit crisis hit with force a year ago with rising defaults in the market for subprime mortgage loans. The credit problems have since spread from subprime loans, mortgages provided to borrowers with weak credit histories, to other types of mortgages and other kinds of loans.

The country's major financial institutions have reported billions of dollars in losses and financial markets remain unsettled with investors concerned about potential losses that have yet to be disclosed.