Taxes, budget deficits, interest rates, and inadequate spending get most of the attention, but what’s really killing the economy in many areas is lending policies preventing new housing construction. After causing the economic crisis by giving credit too easily, lenders have gone to the other extreme and are denying credit to those with major assets and long track records of success. Since housing construction is the prime force spreading jobs throughout the economy, denying the financing of already approved projects is a monumental jobs and recovery killer. Here’s a sampling of the rules unnecessarily restricting economic revival.
Analyses of the nation’s sluggish recovery rarely mention a prime factor: new lending policies that have virtually halted new housing construction. And while these rules matter little in Florida, California’s Central Valley, Las Vegas and other communities with a housing glut, they are proving economically devastating in San Francisco and other urban centers.
New Deposit and Downpayment Requirements
House or condo buyers expect to make a downpayment and then pay interest for the life of their loan. Imagine if potential buyers were required to make a 30% downpayment and also had to deposit a year’s interest on the loan in advance as a condition of approval, and had to do so for the first two years.
These requirements would kill the home buying industry. Yet many lenders are now imposing these requirements on those seeking construction loans.
Until 2008’s economic crisis, lenders customarily required builders to make downpayments of 15%. This total has now doubled to 30%, with the increased requirement applying equally to potential borrowers with strong past track records of success.
Even more destructive is the lenders’ new deposit requirement. Lenders are requiring a builder of a small twenty-unit project who needs a $10 million loan to come up with $700,000 as a deposit – in addition to the downpayment! – to get the loan.
And the builder has to find another $700,000 for the second year, meaning they would have to give the lender $1.4 million prior to being able to generate any money from the project’s completion.
Not a lot of builders have $1.4 million in cash sitting around to meet this requirement. So projects already approved by local governments are not moving, construction jobs are not being created, and suppliers of carpets, rugs, window coverings, kitchen cabinets, and other necessities for finished units do not get business.
Lenders’ new rules have succeeded in bringing to a halt an industry that directly or indirectly creates 1 in 7 jobs.
And to make the situation even worse, lenders are now required to reduce their portfolios of “high risk” loans to 50% of their total. The term “high risk” applies to all new construction projects regardless of their actual risk, and even lenders that had few are no bad loans are being required to reduce the volume of construction lending.
The rationale for this policy is hard to understand.
It is one thing to prevent lenders with a history of making unsupportable loans from repeating their mistakes; it is quite another to cut the volume of construction loans in half regardless of the lender or borrower’s prior track record.
After using little or no discretion to issue loans to borrowers lacking the capacity to pay, lenders are being prevented from using any discretion to grant construction loans to strong borrowers. So much for the logic of capitalism.
Worsening Credit Crunch
President Obama has repeatedly lamented the nation’s credit crunch, and implored the lenders bailed out by U.S. taxpayers to start making loans to get the economy moving. But based on multiple, unconnected sources with whom I spoke, the credit crunch is actually getting worse.
In addition to making it next to impossible to get construction loans, lenders are now terminating businesses lines of credit. Lines of credit, which allow businesses to regularly access money without submitting loan documents each time, have become virtually essential for many small businesses, who otherwise could not meet payrolls when payments owed to them are delayed (This is particularly true for businesses with government contracts, as reimbursement can occur months after the service is provided).
Recently, a local San Francisco Mission District lumberyard had its line of credit suddenly seized by its lender. This meant that the business had to demand immediate payment from its customers, who then had to pressure those who owed them money.
The net result? New investments by multiple contractors and businesses ground to a halt, with layoffs likely to follow.
To repeat, we are not talking about cases where lenders are refusing to loan to unqualified and/or undercapitalized borrowers. Nobody is suggesting that lenders resume the type of practices that contributed to the nation’s foreclosure crisis and economic meltdown.
The problem here is that businesses that have successful histories, no past defaults, and have come to rely on the availability of credit to carry out their operations, are now being handed a completely different set of rules.
And these rules are completely unworkable, and prevent the nation’s economy from recovering.
Sean Keighran, President of the Residential Builders Association, was among the few willing to speak with me on the record about these destructive lending practices. Keighran recalls joining his father on construction projects in 1979, 1980 and 1981 when interest rates reached 21%, putting a great burden on builders.
Keighran believes that the current credit crunch makes construction much more difficult than in that prior era, despite far lower interest rates today. In fact, every person I spoke with felt the situation had never been worse.
The credit crunch explains why government stimulus spending has become so critical to economic growth. With lenders preventing private construction investment, only government-funded projects can move forward.
Targeting arcane lending rules may never become a mass issue, but unless the rules governing one of our top job creating industries are changed, tough economic times will persist.