Financial markets continue to inch back toward normal. Rate premiums for less than prime borrowers have declined substantially since last fall but remain high, even for a recession period. Both bank lending and commercial paper are now expanding slowly. Note that commercial banks provide only about one-third of the credit in the economy.

Compared to 2004-07, a much larger share of loan applicants are being denied credit at any interest rate. But the number of consumer and business loan applicants who can not get credit during a recession is only slightly higher than during past recessions. Bad credit ratings and/or bad financial status or prospects are now the main reason for denying credit. Banks have accumulated nearly a $T of surplus reserves on deposit with the Federal Reserve Board. Some of this is being kept as insurance against further depreciation in their troubled mortgage and other assets. But some is available for lending but is not being lent because of a scarcity of acceptable loan opportunities.

However, the part of the financial market most important to construction is still essentially non-functional with no signs of imminent improvement. Almost no collateralized mortgage bonds, both residential and commercial, are now being issued. These are still toxic. No investment manager wants to admit buying new one when he still has much depreciated old ones. This market may not ever revive.

Fannie Mae, Freddie Mac and FHA, financed by the Federal Reserve Board, are providing the small amount of new residential mortgage capital needed. This source of capital will not be enough to support a much larger new home market beyond 2010. Private capital has to be somehow brought back to residential finance. It is not yet clear how this will happen.

Obtaining a new commercial mortgage still remains very difficult, even for borrowers with solid financial statements. This funding is now coming directly from the previous buyers of commercial mortgage bonds and is expected to expand when commercial construction begins to expand in 2010.

There is no final resolution for the credit problem yet in place. Banks and other lenders need a $T of added capital. Congress refuses to appropriate it. Private non-bank investment managers are still reluctant to supply it because they fear that the Obama policies weak weaken banks further and depreciate any investment that they make now. The stimulus plan about to be enacted, the revisions announced to the TARP by the Treasury Department, pending housing legislation and the current policies of Freddie Mac, Fannie Mae, FHA, FDIC (which seizes the assets of bankrupt banks and disposes of them) are all draining cash out of banks by banning foreclosures, forcing banks to accept lower mortgage payments and forcing banks to make more bad mortgage loans.

U.S. Construction Finance Environment — January 2009