Are a bunch of monkeys running our financial system?

[JohnT]

@Ravenman

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?

Yes. And I don’t know. Just because one doesn’t like to do math isn’t an excuse not to do math.

Not that pushy salesmen, Greenspan, etc, can’t share some of the blame, but the ultimate responsibility for saying “No” falls upon the people signing the agreement.

When my wife and I moved up here to Knoxville back in 1999, we were shopping for houses and our first real estate agent kept on showing us houses in the $300-$450k range, even after being told our combined incomes were about $65,000, with the wife losing hers for a few years as we gave birth to our first (bringing us down to ~$50k). She kept on assuring us that financing wouldn’t be a problem, that she was confident we could “grow” into our payments ( :rolleyes: ), etc. We ditched the agent, told her that she had a damn hard time paying attention, and got another one who actually did listen to us. We told him we didn’t even want to go for the traditional “3X your income” rule and eventually bought a house for $92k, about 1.4X our combined income.

OTOH…

My parents bought a $2 million spread about 3 miles from our house - $500k for the house and 2 acres, $1.5m for an additional 18 acres. All this is supported by an interest-only loan, one with a balloon payment to come due in 2010 (or 2015, I can’t remember which). This house was bought near the height of the bubble, late summer 2005, and my stepmother has been furiously “improving” it 'cause she’s worried that the house has lost value since the purchase. Even though their income implies that they’re “rich”, I, too, wouldn’t be surprised if they are going to be caught up in this subprime mess before all is said and done with it.

Sorry… “she”. My father passed away this October, so it’s no longer his worry. But, you know… they didn’t say “No”. They figured that everything was, somehow, going to be all right, they didn’t bother to run the numbers, and if they did, they blithely assumed that they would find a solution to paying off a house that was 7X their annual income before the chickens come home to roost.

Which they will.

So, people can talk about “preying upon the financially unsophisticated” all they want, but financial sophistication is only a small part of the equation: the ability to live within ones means, and to recognize what those means are and will be, is even more important. The ability to say “no” to sales pitches that sound too good to be true is far more crucial than the ability to create financial projections in Excel.

[Voyager]

@JohnT

Yes. And I don’t know. Just because one doesn’t like to do math isn’t an excuse not to do math.

Not that pushy salesmen, Greenspan, etc, can’t share some of the blame, but the ultimate responsibility for saying “No” falls upon the people signing the agreement.

Have you read Jonathan Chance’s link? The company talked about there was specifically targeting people with bad credit, the people who never said no. Plus, they were not giving these people good information about their options. Plus the lender colluded with appraisers and banks to give credit to people who should have been rejected.

Your theory seems to be that banks shouldn’t even bother to run credit checks, because no one should try to get a loan who won’t be able to repay it. Plus, the company in the linked article cold called people with bad credit. Sure there is blame to go around, but most of it goes to those who violated proper procedure and possibly the law to press bad loans onto people.

The person in the link mentions that when a W2 was sent by mistake to a bank, the response was that the W2 showed that the person didn’t qualify, and that the lender should be more careful and not send embarrassing W2s any more. Now tell me that the borrower is more culpable than the lender there.

[John_Mace]

Maybe it’s just me, but I make sure I can afford my mortgage payments and don’t rely on some other institution to do that for me. Was the rate increase on these loans so buried in the small print that a reasonable due diligence by the borrower could easily miss it?

[Measure_for_Measure]

@John Mace

Maybe it’s just me, but I make sure I can afford my mortgage payments and don’t rely on some other institution to do that for me. Was the rate increase on these loans so buried in the small print that a reasonable due diligence by the borrower could easily miss it?

I trust that the dishonesty of the lenders varies.

While John’s question is certainly worth looking into, it is not the most relevant one. The key issue now is not being nice to borrowers, it’s making sure that this monstrous stack of cards doesn’t collapse, along with the remainder of the economy.

Initial indications are that the latest plan involves triage among:

1. Those not in default and default not imminent
2. Those not in default and default reasonably foreseeable
3. Those in default or default imminent.

Group 1 are encouraged to refinance if necessary. Group 2 are put on a fast track and may have their teaser rates frozen – lucky for them! Group 3 are SOL.

Golly isn’t that mean to the banks? Not really: they’re better off cutting group 2 a deal than facing the expense of foreclosure. Golly doesn’t that mean that some sharp home buyers might make off well? Sure does. But the case-by-case approach isn’t working too well – the caseload is too overwhelming.
Some loans never should have been made – they were nonviable from the beginning. Others were plausible -provided housing prices kept rising. Still other borrowers became “Subprime” due to illness etc, so that stretching out payments became necessary/wise for the lender. As Tanta of http://calculatedrisk.blogspot.com likes to say, “We are all subprime.”

[Polerius]

@Ravenman

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?

@JohnT

Yes. And I don’t know. Just because one doesn’t like to do math isn’t an excuse not to do math.

Not that pushy salesmen, Greenspan, etc, can’t share some of the blame, but the ultimate responsibility for saying “No” falls upon the people signing the agreement.

…
So, people can talk about “preying upon the financially unsophisticated” all they want, but financial sophistication is only a small part of the equation: the ability to live within ones means, and to recognize what those means are and will be, is even more important. The ability to say “no” to sales pitches that sound too good to be true is far more crucial than the ability to create financial projections in Excel.

The topic of this thread was not to assign blame for all the housing defaults, it was meant to understand why the “smart” people in the financial industry got into a situation that allowed these bad loans to cost their companies billions of dollars, and cause a huge crisis in the market and the economy.

A prudent Citibank/Merril Lynch trader/employee/CEO would think “You know, maybe I shouldn’t buy all these securities that are based on loans to people who can’t afford them. Once they start defaulting en masse, which anyone with half a brain can see that they will, this will cost the company a lot of money”

No, instead, they went ahead and invested so much money that when the shit hit the fan, they lost billions and billions of dollars.

Why did they invest this way? This is not about why the loans were given in the first place, although that question does apply to the institutions that gave the loans.

Regarding the lending institutions, why did they make the loans if it was pretty clear that people who can’t afford their mortgage would default sooner or later?

• Is it because they spread the risk and made money by “securitizing” the loans?
• Is it because they thought that, with continually rising house prices, even if the people defaulted, the banks could get their money back? (If this is the case, they were idiots to assume house prices would continue to rise at the same pace as in the past few years)
• Or is it because, the individual loan officers did not care about the long term health of their company, as long as they made boatloads of money before the crash?

[Polerius]

I wanted to note that every time some crisis happens, the experts come in with their “reasons” why it happened.

But, this is a bit like if you have a friend who is a drunk, and who gets wasted every few days.

Every time he gets wasted, he will say something like “well, I just happened to visit Bob, and it was his birthday, and we decided to celebrate, and one thing led to another and I drank too much”, and the next time he will say “you see, I just happened to be at the company party and we were having such a good time that I drank too much”

Every time he will find “reasons” why he did what he did, but the underlying reason that he gets wasted every few days is that he is a drunk. He has a problem.

The same with the financial system. Every time, it’s this or that reason: “it’s the Asian crisis of 1997”, “it’s the overvalued internet stocks”, “it’s the subprime loans”, etc

Every time, there is a good “reason” why that particular crisis happened, but the underlying reason that this happens every few years must be that the system has fundamental problems.

One such problem is the one pointed out in the OP, namely, that individual financial company employees don’t care if their company loses billions a few years later, as long as they themselves can make millions of dollars when the times are good, and don’t face financial penalties due to the losses they cause later.

And since this is something that is clear to anyone working there, they have every incentive to keep coming up with new investment vehicles that enable huge gains in the short term (thus ensuring millions of dollars in bonuses), while totally disregarding the long term potential disaster.

Even the CEO benefits from this setup, so there is no incentive for him to put the kibosh on using these new investment vehicles (especially if the other banks are using them and making money in the short term, thus making his company lag by comparison if he doesn’t use them, and if things collapse in the future, well all the companies will lose, and so his company can blame it on the “crisis”)

[elucidator]

Too much regulation, governmenet interference, that’s the problem, gotta trust the Invisible Finger of the Free Market. And tax cuts. Definitely, tax cuts.

[RedFury]

@Renob

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.

America, Land of 371 Billionaires and 3.5 Million Homeless

No further comment needed.

[jshore]

@Polerius

Regarding the lending institutions, why did they make the loans if it was pretty clear that people who can’t afford their mortgage would default sooner or later?

• Is it because they spread the risk and made money by “securitizing” the loans?
• Is it because they thought that, with continually rising house prices, even if the people defaulted, the banks could get their money back? (If this is the case, they were idiots to assume house prices would continue to rise at the same pace as in the past few years)
• Or is it because, the individual loan officers did not care about the long term health of their company, as long as they made boatloads of money before the crash?

I know this is a cop-out but I would say it is some combination of this. In particular, I think that it is human nature (at least among those folks who do not have a strong disposition to worrying, as I do) to discount dangers off in the future when there are immediate short-term gains. And then the longer things continue to be okay, the more confidence people feel that there really won’t be a problem. In particular, amongst those who are predicting eventually problems, there will always be those who predict them to occur to soon. Then when they don’t materialize, the perpetual optimists will say, “See…These doomsayers were predicting the end of the world and it didn’t happen! They were wrong again.”

The same thing happened with the tech bubble in the late 90s. And, you see the same thing with environmental issues such as global warming and various resource issues with overpopulation such as the depletion of aquifers (see this thread, especially the excellent post #16 by Stranger On a Train).

So, I think this is a lot of the problem. However, your last point also weighs into things. It is certainly easier to justify this sort of behavior to yourself when your incentives are structured such that the disaster will probably not really affect you too badly. (I don’t think there are that many people who are callous enough to know a disaster is going to happen but to simply not worry about it because it won’t hurt them [although maybe I am too optimistic about human nature]…but I think this makes it easier for them to rationalize in the ways that I am discussing here.)

[TLDRIDKJKLOLFTW]

It’s almost like their prioritized their own short-term gain with no consideration for the long-term or for society at large!

[elucidator]

OK, look, I’m a mathtard. I know diddly-squat about the intricacies of financial instruments, except that those instruments usually end up thrust up some poor dumb shmuck, when you start in talking about amortizing the long range fiduciary argle-bargle, my eyes glaze over and I slip closer and closer to a coma.

Just one thing I want somebody to tell me: where did all the money go? I mean, its gone, right? But it didn’t just evaporate, did it? Go “poof” - gone? So, somebody’s got it, right? Can we make them hock it up, like a hairball of Benjamins? Can we ship them off to Club Fed, where the chef can’t make a decent white sauce?

Thing is, I sense a somewhat bizzare morality at play here. If the fuckees weren’t smart enough, that’s too bad for them, should have paid more attention in school, or some such. Why is it that a man who wouldn’t dream of robbing a blind man or a cripple has no problems screwing someone who isn’t as smart? Mathtards like me are fair game?

Rob somebody with a gun, go to jail. Rob them with a nice clean spreadsheet, fart through silk undies and order frappuccino. Wrong. Just plain wrong.

[John_Mace]

The problem is, these loans have be packaged, and repackaged and jumbled into “financial instruments” all over the globe. One reason this is as bad as it is, is that it’s so hard to know exactly where they are. You might own some of this paper, 'luc, and you wouldn’t even know it.

[elucidator]

@John Mace

… You might own some of this paper, 'luc, and you wouldn’t even know it.

Not a chance. Zero, zip, nada damn thing.

[John_Mace]

@elucidator

Not a chance. Zero, zip, nada damn thing.

You don’t own any mutual funds? No investments whatsoever?

Please tell me that isn’t so…

[ColonelDax]

@John Mace

You might own some of this paper, 'luc, and you wouldn’t even know it.

Indeed, many people who had invested in supposedly ultra-safe money-market funds thought they didn’t own any subprime debt. Turns out that it ain’t necessarily so.

[Voyager]

I heard something disturbing on Marketplace yesterday (or it might have been the KQED California Report.) 61% of people with subprime loans would have qualified for regular loans. (I’m not sure if this is nationwide or California only.) The lenders got additional commission from putting people into the loans. I’d suspect that this worked by not giving normal fixed rate loans as an option. Since qualification criteria are no doubt proprietary, how would the average person know that he had a better option?

As for those who bought these loans, I wonder how many were tagged as having been done with no documentation? None that were AAA rated, I’d hope.

[LonesomePolecat]

@elucidator

Not a chance. Zero, zip, nada damn thing.

You don’t have a pension plan at work? A 401k? A CD? Life insurance? A savings account? Nothing, no kind of savings or investment vehicle at all? That would be very odd. The only way to be sure you don’t have any money invested in this mess would be not to have any kind of savings or investment of any kind. Of course, maybe you’re one of those folks who keeps it all in a mattress at home, but somehow I doubt it.

[John_Mace]

@Voyager

I heard something disturbing on Marketplace yesterday (or it might have been the KQED California Report.) 61% of people with subprime loans would have qualified for regular loans. (I’m not sure if this is nationwide or California only.)

I heard something similar. The person said 50%, but I’m sure that was rounded off, and it was a national number. I think it was on the New Hour with Jim Leher.

The lenders got additional commission from putting people into the loans. I’d suspect that this worked by not giving normal fixed rate loans as an option. Since qualification criteria are no doubt proprietary, how would the average person know that he had a better option?

By shopping around, like the average person does for pretty much everything. If you don’t shop around for the most expensive item you’ll ever purchase, you need some serious educumation.

[msmith537]

@Voyager

I heard something disturbing on Marketplace yesterday (or it might have been the KQED California Report.) 61% of people with subprime loans would have qualified for regular loans. (I’m not sure if this is nationwide or California only.) The lenders got additional commission from putting people into the loans. I’d suspect that this worked by not giving normal fixed rate loans as an option. Since qualification criteria are no doubt proprietary, how would the average person know that he had a better option?

Don’t confuse subprime loans with ARMS and fixed-rate mortgages. A sub-prime loan and an adjustable rate mortgage (ARM) both have a fluctuating interest rate. The difference is that with sub-primes, the lenders take on an aditional risk, which they offset with higher interest rates and additional fees.

But, you are correct. It is predatory if the borrowers have good credit and the lenders are steering them into higher interest rate sub-primes.

[mks57]

@elucidator

Just one thing I want somebody to tell me: where did all the money go? I mean, its gone, right? But it didn’t just evaporate, did it? Go “poof” - gone? So, somebody’s got it, right? Can we make them hock it up, like a hairball of Benjamins? Can we ship them off to Club Fed, where the chef can’t make a decent white sauce?

What about all of the people who made windfall profits on real estate, made possible by the price inflation caused by easy credit? They may not have participated in any of the shenanigans that other posters have described, but they certainly benefited from those actions.