Are a bunch of monkeys running our financial system?

Great Debates
1

The sub-prime mortgage crisis, and its ever increasing negative effects on the markets and the economy, makes me wonder how this could have possibly happened.

It does not take a rocket scientist to figure out that if you give thousands of loans to people who do not qualify for them, and, especially, if you give them loans with adjustable interest rates that will increase a couple years later, rendering the people borrowers unable to make their mortgage payments, that you are going to have a lot of defaults.

But, not only did they give out such loans, but it seems they “securitized” them (or whatever the term is) and then sold them to lots of institutions who wanted to make high returns. Now of course, everyone is caught with their pants down, and we are facing a crisis, with banks having massive writedowns, on the order of billions of dollars per company ($11 billion for Citigroup and $8 billion for Merrill Lynch )

My question is, how could this have happened?

As I said above, it does not take a rocket scientist to figure out that you don’t give mortgages to people who can’t afford them. The heads of the leading financial institutions are supposedly very smart people with degrees from the top schools. How could they not see this coming?

Here are some hypotheses about how this could have happened.

  1. The heads of the financial system are stupid
  2. They are smart, but could not see this coming, because it was extremely unlikely/unexpected
  3. They are smart, and could see this coming, but don’t care about the resulting losses.
    I don’t buy (1) or (2). It seems that (3) may be the likeliest explanation for now.

As far as I know, when a financial company does well, i.e. makes billions of dollars, people working there get huge bonuses, on the order of millions of dollars. But, when the same company loses billions of dollars a year later, these people don’t give back their bonuses.

At most, they may lose their job, which is not too likely, but even if they do, they have made so many millions of dollars during the boom times, that they can weather out the storm until brighter days are back, and they start the cycle again. For the top guys, like the CEOs, it’s even better, because even if you lose your job due to a bad year, you still get hundreds of millions of dollars in your “severance package”.

Basically, individual employees of a finance company have every incentive to engage in behavior that hugely inflates their company’s profits during some years (to get huge bonuses), while not caring at all whether the behavior that led to those huge profits will lead to huge losses a couple of years later.

So, we have an environment where such huge booms and busts will keep happening (the latest two are the internet boom and then bust in 2000 and the housing boom and then bust in 2007)

Does the above analysis make sense?

If yes, what can be done about the bad mix of finance company employees’ bonus-driven behavior combined with a lack of financial penalty during the bad years? (In an ideal world, there would be reverse-bonuses :slight_smile: )

If not, how do you explain the current situation, given that, in retrospect, all the analyses of the situation make it seem like it was obvious and bound to happen?

2

Seems to this jaundiced eye that, yes, indeed, they knew something like this would happen, I’ve heard people talking about this for months now. They knew it would happen, they just tried to make sure it happened to somebody else. Only way they lose their home is if they forget where it is.

3

I too am stunned and have asked more than once how this could have happened. Mostly I’ve wondered all the same things you did.

And that is bad, but the really weird thing is, they are *still *doing it with cars. I heard an advert not too many weeks ago: If we can’t get you approved for a loan we’ll *give *you a car!

You have to know they are giving bad loans. :confused:

4

The article you linked to gives a pretty good explanation of the complexities involved in how this happened, involving everyone from lenders to borrowers to regulators.

5

Because greed makes people stupid and mean.

6

I have no answer, but isn’t it fascinating how issues like these somehow self-validate every stance along the political spectrum from crypto Marxists to card carrying member of the John Birch Society?

7

The realization of which led Karl Popper to formulate the scientific principle of falsification.

The most characteristic element in this situation seemed to me the incessant stream of confirmations, of observations which “verified” the theories in question; and this point was constantly emphasize by their adherents. A Marxist could not open a newspaper without finding on every page confirming evidence for his interpretation of history; not only in the news, but also in its presentation — which revealed the class bias of the paper — and especially of course what the paper did not say. The Freudian analysts emphasized that their theories were constantly verified by their “clinical observations.” As for Adler, I was much impressed by a personal experience. Once, in 1919, I reported to him a case which to me did not seem particularly Adlerian, but which he found no difficulty in analyzing in terms of his theory of inferiority feelings, Although he had not even seen the child. Slightly shocked, I asked him how he could be so sure. “Because of my thousandfold experience,” he replied; whereupon I could not help saying: “And with this new case, I suppose, your experience has become thousand-and-one-fold.”

8

This is the kind of issue that really confuses me (despite the best past efforts of fellow dopers to shed a glimmer of understanding into my troubled brain!)

Over 15 years ago I was doing collections for S&Ls that would essentially loan several thousand $ to anyone based on nothing more than their signature. And then they acted surprised and indignant when these folk defaulted. That job disappeared with the RTC bailout/takeover.

I often suspect that this type of situation arises largely due to the apparent “short-term” focus on the financial industries - same as much of the rest of industry. There seems to be an overwhelming premium on making the books show immediate profitability, whether or not it can be sustained in the long run.

Added to that, our “service” economy seems to spawn entities that exist primarily for the purpose of dispersing the financial responsibility.

What gets me, tho, is when such excesses and shortsightedness occurs within the financial industry, which is pretty heavily regulated. If the government did not wish to allow these risky loans, they could easily prevent it. However, I understand that there is a desire to free up money to allow people to buy things - including houses - to help out the building industry, etc.

Similarly, lots of people complain about usurious rates and irresponsible lending by credit card companies, but again, those companies are merely doing what is allowable under law. So the government has decided that there is some benefit to be derived by someone from people borrowing far more than they can realistically ever hope to repay. Either that, or politicians cravenly bow to lobbyists - or a combination of both.

Not understanding much about economics, I emotionally feel that a recession might not be a bad thing. Might force Americans to realize how unsustainable their lifestyles are, focussed as they are on cheap energy consumption and the acquisition of consumer goods. Might take something drastic to refocus people into considering what types of lifestyles and economy will serve us and our grandchildren best in generations to come.

9

Are a bunch of monkeys running our financial system?

Yes, and we’re paying dearly for it.

10

Are a bunch of monkeys running our financial system?

Well, to be pedantically accurate, they aren’t monkeys, but rather apes.

And, of course, each ape was taking the correct action for that ape. The ape that took the mortgage he couldn’t afford got a great house, the ape that wrote the mortgage got a bonus for generating a lot of business, the ape that sold the mortgages down the line got another bonus, and so on.

And we like it that way!

11

There was also some idiot politicians making veiled threats toward people not financing bad credit risks some years back. Apparently some instiutions were so worried about the possibility that they’d have to prove their loans were not based on race that they decided to run some bad credit risks. Probabyl a good bargain for them. :slight_smile:

12

Are a bunch of monkeys running our financial system?

Sadly, no.

Tris

13

You become rich in this country by taking risks. Sometimes those risks pay off, sometimes they don’t. In general, it’s not the cautious person who only takes a risk on a “sure thing” who becomes rich. It’s the person who takes a risk on something that has a greater chance of failure. Look at the career of Donald Trump. He’s a billionaire but he’s also been in situations where he’s owed millions of dollars. It’s people who are willing to do this that make our economy go around. Sometimes these folks end up risking it all on something that, in hindsight, was pretty idiotic. That’s what we are seeing today.

14

Idiocy! It’s what makes America great! And remember, it has electrolytes!

15

The three hypotheses presented are not mutually exclusive. If you insert the word some, you get a more accurate accounting (except for (1); I think “blind” or “unaware” might be better than “stupid” in the applicable cases). After all, the “financial system” is not some monolithic entity with a single world view. Throw in a helping of LonesomePolecat’s greed, Dinsdale’s short time frame, Renob’s risk, and the human tendency to go with the crowd and you have all the makings of the situation as it stands.

Sure, some (stupidly) weren’t aware of the risk. I think it’s safe to say that most thought there wasn’t a decent probability of the crisis actually happening. And yes, I’m sure there were some who saw it coming and simply exploited the situation for their own gain. There were also those who saw it coming and tried to sound the alarm.

Oh, and in answer to your last question: it only seems like it was obvious, as with many/most things looked at with hindsight. Change any of an innumerable set of contributing factors and the whole shebang might have (productively) continued without slipping into crisis status.

16

The scariest part is that while the financial institutions have already acknowledged that the mortgages are worthless, there are still millions of people out there paying on them and living in those homes. Some are hanging on as best they can, some are in foreclosure and some haven’t had their rates readjusted upwards yet ($500B in mortgages will reset to higher rates in the next 12 months). The second shoe drops when these people lose their homes and there is a housing glut.

This first shoe that dropped hit the financial industry and the investor class, the second shoe is going to hit the middle classes who have most of their net worth (for many, all of it) tied up in residential real estate.

I would not want to be a fifty-something suburbanite owning a McMansion right now. What looked like your retirement three years ago now is an albatross.

17

Isn’t there at least a little bit of blame to be placed on consumers who apparently never thought that an interest-only home loan on their modest income was, perhaps, a risky proposition?

The criticism that the financial sector may be run by monkeys is perhaps valid. But why do we seem to accept that consumers need not be any more sophisticated than protozoa?

18

I think everyone in the process probably had a thought in the back of their mind “hey, once this comes crashing down the government will probably bail us out.” Which is exactly what’s going to happen.

And here I am with a reasonable house for a reasonable mortgage and I’m going to be screwed over.

19

Because very few of us really appreciate what your banker understands full well: the enduring miracle of compounded interest. Its like the science fiction movie cliche, where the scientist peers into his microscope and cries aloud “It’s growing! Growing at a fantastic rate!”

For my two bits, drasticly overvalued…seems to me that the crux of it was bundling mortgages into “financial instruments”, which allowed people to package mortgages, make their money and leave nothing but fingerprints, if that. The temptation to squeeze a bit of slightly unethical cash, with no downside, is too much for us monkeys.

20

You’re in trouble? Tough noogies, Invisible Finger of the Free Market. CitiGroup is in trouble? AAaaaroooga! AAAaaarooga! Emergency! Emergency!