Lending Standards Have To Be Fixed and Should Not Be Fixed:
a Contradiction

Y. B. Karasik,
Thoughts Guiding Systems Corp.,
Ottawa, Canada.
e-mail:karasik@sympatico.ca

The Federal Reserve (Fed) unveiled the plan to tighten the lending standards. It says nothing about why they became loose in 2001/2002. But without knowing the causes it is impossible to evaluate the validity of the plan.

In my opinion the standards were relaxed for the following reason. After stock market crash in 2001 people started looking for alternative "more reliable" vehicles of investing. Real estate was a natural first choice. But real estate market was stagnant back then since the early 1990s and did not promise any attractive rates of return (if any at all). In order for market to start growing the hordes of new buyers had to be brought to the market. And the only way to accomplish that was to relax the lending standards.

Now suppose that the lending standards will be tightened up again. This will immediately shrink the pool of potential buyers and throw the real estate market (and home prices) into a tail spin. But not tightening the lending standards up would give rise to the number of not repaid loans ballooning. Hence we have a physical contradiction.

The Fed's plan does not resolve this contradiction and, hence, does not solve the problem.