The Importance of Setting Lending Limits

Executive Summary

• In the US there used to be limits of income that a bank could loan.
• This helped keep the debt load or overhead to a manageable level.

Introduction

The previous lending limits that were common and mandated are described in the following quotation.

“What he’s suggesting, of rules for bank lending against real estate, is exactly what existed in the United States from 1945 for the next 20 years. Anyone could go into a bank and ask for a mortgage. The banks were limited … and the amount of money they could lend for real estate – it was limited. Debt service could not absorb more than 25% of your income. And that 25% of income would be in the form of a self-amortizing 30 year mortgage. So what that did was limit the amount of real estate lending throughout the country to the amount that anybody could afford, and housing prices were low. Well, the banks fought against this, they lobbied against it and now instead of being the limit of 25% of your income, the government Federal Housing Authority guarantees mortgages – government guarantee the mortgages – up to 43% of your income, and the banks can fiddle by saying, ‘OK we won’t have to pay any amortization so you won’t own your house in 30 years. You won’t have repaid any of your debt at all. You’ll just be paying the … it’s an interest only loan and you don’t have to make any down payment’. After World War 2 you had to make 20 or 30 percent of the price of the down payment so the banks have added, they’ve leveraged the whole market because banks don’t ever want the loans to be repaid. They want the loans to grow and grow and that’s what makes, ultimately, the debts impossible to be repaid. So the banks and financial system have lobbied for a system that must mathematically collapse. That’s what Steve and I are talking about. It’s the way it’s set up.” – Michael Hudson

Source: Michael Hudson https://michael-hudson.com/2020/12/jubillee-perspectives-with-steve-keen/

This is further elaborated upon in this quotation. 

“My idea was to say, let’s limit the amount that banks can lend to some multiple of the income earning capacity of the property being purchased and we have imputed rented series throughout the world. People actually calculate what rent would be earned by an owner occupied property if it was on the rental market rather than owner occupied, so we already have the stats to say what this could be and my rule of thumb is to say, let’s limit the amount of lending to 10 times the annual income of the property being purchased, so in that case like if you look at a property, which is like where I used to live in London, the income earning potential of that place was 12 times my rent, which is £180,000 total, £15,000 times 12. I would limit it to 10 times that rental income with £15,000 that would be £180, 000, that’s all you could borrow to buy the place. Now at the moment if you and I were competing over that property to buy it, the one of us that got the bigger loan would win. But if you said … neither of us could borrow more than £180,000, and that would be stated on the contract of sale and on all the advertisements, then the one of us [that] would win the contest […] would be the one that had saved more money. So rather than having a [negative] positive amplifying feedback between house prices and leverage, you’d have a dampening effect, and that’s to tame the property market.”