Lender Mismanagement?

An industry magazine called Inside Mortgage Finance conducted a poll among 1700 mortgage brokers and found that 1 in 3 mortgage loan applications failed to close in August. Lenders rejected nearly half of potential borrowers who want to refinance their ARMs, according to the survey. It seems that even while banks tighten up their standards due to default, they are increasing their potential inventory of REOs. Are they shooting themselves in the foot? Is there a better way to handle this?