America's lenders have slammed on the brakes, and the economy's gone through the windshield.
Eventually, of course, the credit crisis will ease, regulators will sweep up the debris, and the economy will heal -- but it's likely to have a limp. The days of easy credit won't return anytime soon.
"There is a real rethinking in what's going on in consumer banking," banking expert Kathleen Khirallah of research company TowerGroup told clients in a recent conference call. "I think we can expect a return to conservative banking practices and business models."
If you think you'll be in the market for a loan soon -- a mortgage, a car loan, even a credit card -- you should know what might be ahead.
To get a glimpse, though, you have to look to the past: specifically, to the 1970s, when lenders were a lot pickier about who got money.
To understand how different the lending world was then, consider that in 1975:
- Less than 40% of U.S. households had even one credit card, compared with 75% today. Total outstanding revolving debt was $55 billion, compared with nearly $1 trillion now. In 1975, 63% of households with a credit card paid their monthly balances in full; today, that figure is 45%. In 1975, most lenders required borrowers to repay 5% of their outstanding balances each month. By that standard, the minimum payment on the average credit card borrower's $2,200 debt would be $110 rather than the $44, or 2%, that many lenders require today.
- Car loans were typically for two to three years, four years at the most, and usually required a down payment of 20% or more. Leasing existed, but not in a form that was attractive to most consumers (most customers had to buy the cars at the end of the leases). Today, four out of five car loans last longer than four years; some stretch as long as nine years. And until recently, leases made up as much as 20% of the auto finance business. An average 2008 new car cost about $27,000. At 1975 standards, you'd need to put down $5,400 (plus taxes and fees), then make 36 payments of nearly $700 a month.
- Adjustable-rate mortgages hadn't been invented yet, at least not for the masses. Home loans were at a fixed rate, usually for 30 years, and generally required a 20% down payment. A family making the median income of $13,719 spent about 2.5 times its income to buy the median-priced house. At that 1975 standard, the 2006 median family income of $45,000 would have bought a house priced at $112,500 -- less than half of what a typical house cost that year.
Those were the days before loan securitization had been invented. Lenders hung on to the loans they made, rather than selling them in chunks to investors. If borrowers defaulted, the lenders bore the consequences, which made them cautious.
Credit scoring existed, but in a very different form. Each major lender tended to use its own system, based on its experience with borrowers, and no scoring formula was considered so reliable that it would be used without considering other factors, such as the borrower's down payment, income and employment stability.
Contrast that with the last days of the credit boom, when FICO scores were all that mattered to some lenders."All the (auto lending) decisions were credit-score-driven," Jesse Toprak, the executive director of industry analysis for auto research site Edmunds.com. "Some didn't even ask how much people made."
Similar thinking drove the mortgage and credit card industries. By fall 2006, many lenders were approving home loans to people with poor credit scores without demanding proof of income or assets. Down payments were optional, and some lenders financed more than the cost of the home.Meanwhile, credit card issuers sent out billions of direct-mail offers a year. Zero percent balance-transfer offers abounded, and some companies built thriving businesses by extending credit to people with lousy credit scores -- including some who had just filed for bankruptcy.