# Should we have bailed out the homeowners instead of the banks? **URL:** \ **Category:** Great Debates\ **Created:** [January 4, 2012, 8:42pm UTC](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424 "2012-01-04T20:42:47Z")\ **Posts on this page:** 7\ **Page:** 6
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [January 6, 2012, 8:01pm UTC](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424/101 "2012-01-06T20:01:39Z")
> [@FixMyIgnorance](#): > > Thanks for the detailed response. > > However, I am still confused on the first point. So there was a supposed discrimination problem. How did banks deal with it? It seems like on some level there had to be regulation to get banks to treat everyone “fairly” – but in what sense were policies changed so that things were “fair,” and how did that lead to the case where suddenly “loans were cheap to get” and people were living beyond their means on credit? Remember, the requirement wasn’t that minority borrowers got loans, just that they got them at the same level as non-minority ones. If banks wrote crap loans to everyone, this might actually become true. However, CRA passed over a decade before the crisis. I don’t know how well the banks did - perhaps they really did clean up their act, and the subprime problem started when the market for mortgages grew, and also because low interest rates reduced the profitability of prime mortgages. BTW, the lenders did not really clean up their act. In New York minority districts got a lot more subprimes written than non-minority neighborhoods with similar income levels. > [@](#): > > 1. I understand that if the entire neighborhood catches fire, the insurance company is screwed, but how does the magnitude of “screwage” change by allowing people to make bets on things they didn’t put any skin into? For instance, if I buy insurance on my house, say I pay X so that I receive Y in the event of burndown. I am assuming that if everyone else buys insurance on my house for X, it’s not like EVERYONE receives Y because obviously number of people \* Y \> way more than the cost of the loss. Was the main problem simply having risk parameters adjusted because of speculators flooding the market and distorting the “true” values of things? If we allowed others to buy insurance on their house, and their policies say they get Y, then they would pay out People \* Y. But that isn’t the problem. Insurance companies can’t have reserves for the worst imaginable catastrophe, just the most likely ones. If you let everyone buy insurance on any house, you are increasing the cost of various scenarios. If there are H houses and P people, in the current system worst case - where everything burns - is H \* Y. In the other case it is H \* P \* Y. We really don’t do this because while it is possible for a person to burn down his own house for insurance, there are negatives and it is relatively easy to catch them, while if everyone in town has a financial incentive for burning down someone else’s house, arson will increase. Before the crash I believe there was more insurance outstanding on bank debt than there was money in the world. There was no central clearing house, so no one could raise a red flag about it. > [@](#): > > 1. Still confused on this point. In my mind, “deadbeat” = someone who obviously can’t afford the loan or pay it back. If I give $100 to my deadbeat friend, I’m not expecting to ever get it back. Therefore I don’t understand how lending money to deadbeats is profitable in the first place. I think the idea was that the deadbeats could afford the low teaser payments, and refinance into other low teaser payments before they rose to the point where they couldn’t afford them. People are also hopeful that they’d get raises and stuff. It is usually good policy to buy as much house as you can afford, because I can testify that after ten years your payments look a lot better thanks to inflation. But here is the example I was thinking of using. Say you have a bunch of relatives of various income levels. Your deadbeat relatives - actually those with crap jobs - know that they will have to pay more for a loan. Say you can give loans at 3, 5 and 7% depending on the income level. Now, say you have found some suckers to buy loans from you. Since the 7% loans make them more money, they want them. Are they safe? No problem, you say, these are all my relatives. In any case I’ll mix in some safer 3% loans too. Sure one of the 7% guys may lose his job and default, but that will be a tiny portion of the loans package. There is nothing to worry about. All is fine, except that the low income relatives work on the line for a factory, which suddenly closes. Lots of them default, and the value of the loan package suddenly goes south. The people with the loans don’t get most of their income any more, reduce their expenditures, and stop buying. Now the 5% people, who are shopkeepers, take an income hit and start to default. And so it snowballs. A lot of the people getting foreclosed on now are not deadbeats, but people who got their mortgages legitimately and now can’t pay them due to being laid off from the crash. In any case, the mortgage companies got more money the worse the loans were - and the higher the interest rates they received - and the salesmen got bigger commissions selling loans to deadbeats. There was little downside so long as the market stayed strong, the number of defaults was low, and the paper could be shoveled into the hands of the investors. They made more money selling to deadbeats than to those with high credit scores, and send the risk elsewhere. > [@](#): > > 1. How does raising interest rates deflate the bubble (I’m assuming this just makes owning a home more expensive?)? Weren’t interest rates REALLY low after the dot-com bubble burst? I remember hearing that technically we wanted to lower rates… even when we were already at or near zero. Not sure if my facts are straight and how this works. Did any of it have anything to do with government spending/taxation/deficit levels? If interest rates are higher, the cost of owning a home increases, there are fewer people who can afford to buy a given home, and with fewer buyers prices decline. Yes, after a recession it is standard policy to lower interest rates to increase the money supply and make it cheaper for consumers and businesses to buy more. That is from Friedman, but even pure Keynsians agree these days. The problem was that Greenspan did not increase interest rates as the economy recovered, possibly because we were heading into the 2004 election and a slowdown would be seen as a bad thing for Bush. I’m not saying Bush (or someone who understood this) told Greenspan what to do. Not necessary, any more than Romney has to tell his buddies what to do with their Super PAC money. ---
**Author:** ![Linden\_Arden](https://avatars.discourse-cdn.com/v4/letter/l/53a042/32.png) [@Linden\_Arden](https://boards.straightdope.com/u/Linden_Arden)\ **Post date:** [January 6, 2012, 8:02pm UTC](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424/102 "2012-01-06T20:02:48Z")
> [@MOIDALIZE](#): > > You’re parroting Bernanke’s position. The Fed IS the lender of last resort. In a fractional reserve system this is a necessity. By law if a bank is chartered to operate here it is a US bank. It serves US customers and a run on a bank with US customers is the situation to avoid. It must operate to US regulations and laws. I am a liberal by any measure and I see frustration on the part of others regarding the banking situation. I see liberals taking Ron Paul’s position on the Fed. This is preposterous. The Fed made all these emergency loans to banks who posted sound collateral and the Fed profited from these loans. The profit in 2009-10 amounted to $125 billion and that entire amount was returned to taxpayers. The Fed is the largest single contributor to the Treasury (although now the Treasury pays coupon to the Fed on bills/notes). Unfortunately, the Fed was run by a Rand acolyte named Greenspan for a long time who neglected his regulatory duties. His philosophy was that “markets always self correct”. This naive philosophy is our enemy - not central banking and its rescue capability. ---
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [January 6, 2012, 8:07pm UTC](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424/103 "2012-01-06T20:07:08Z")
> [@Cheesesteak](#): > > You lend $100 to your friend because he wants to buy a baseball card worth $110. At the end of the year, he’s supposed to pay you back $105. If he doesn’t, you can force him to sell the card, and get your $105 that way. So, it’s pretty much guaranteed that you’re going to make your 5 bucks. > > On top of that, you have a big business going, so you package his loan with a bunch of others, and sell it for $101 two weeks after you make the loan. Quick $1 profit, no need to worry about pesky details like him actually paying you back at any time. Remember when Beanie Babies were big? Some of them were going for outrageous sums, their prices were increasing, and I even read about people buying them to retire on. Lend the friend $100 to buy Beanie Babies, and sell the loan assuring the buyers that even if the guy defaults they can take the Beanie Baby and sell it for more than the loan value. Then all of a sudden the Beanie Baby is worth $20. They guy stops paying, says come and take the doll, and loan purchaser gets screwed. ---
**Author:** ![MOIDALIZE](https://avatars.discourse-cdn.com/v4/letter/m/e274bd/32.png) [@MOIDALIZE](https://boards.straightdope.com/u/MOIDALIZE)\ **Post date:** [January 6, 2012, 8:15pm UTC](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424/104 "2012-01-06T20:15:19Z")
> [@Linden\_Arden](#): > > The Fed IS the lender of last resort. In a fractional reserve system this is a necessity. > > By law if a bank is chartered to operate here it is a US bank. It serves US customers and a run on a bank with US customers is the situation to avoid. It must operate to US regulations and laws. > > I am a liberal by any measure and I see frustration on the part of others regarding the banking situation. I see liberals taking Ron Paul’s position on the Fed. This is preposterous. > > The Fed made all these emergency loans to banks who posted sound collateral and the Fed profited from these loans. The profit in 2009-10 amounted to $125 billion and that entire amount was returned to taxpayers. The Fed is the largest single contributor to the Treasury (although now the Treasury pays coupon to the Fed on bills/notes). > > Unfortunately, the Fed was run by a Rand acolyte named Greenspan for a long time who neglected his regulatory duties. His philosophy was that “markets always self correct”. This naive philosophy is our enemy - not central banking and its rescue capability. As I said above, the decision to bailout the banks was the right one. But as the lender of last resort, the government should _own the banks right now_!!! The taxpayers bore all the risk. But fine, that will piss everyone off, so at the very least I would have settled for the government lending freely but in such a manner as to allow the banks to merely tread water during the crisis, to give them the ability to get back onto their own feet. They have not done so. That’s what’s driving everyone crazy. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [January 6, 2012, 10:27pm UTC](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424/105 "2012-01-06T22:27:36Z")
> [@FixMyIgnorance](#): > > From my understanding, the government wanted more homeowners in the US, and so they forced banks to make it easier for people to get loans. What I don’t understand is why they’d enact this without understanding that it’s a time bomb. If I keep lending money to people who are high-risk… I mean, shouldn’t this have been an obviously bad idea? In the 1970s congress passed the Community Reinvestment Act which prohibited redlining. Banks had gotten it into their heads that blacks were bad credit risks and homes in black neighborhoods were insecure assets so they wouldn’t finance home purchases in black neighborhoods. As a part of this policy, the GSEs bought or guaranteed subprime mortgages from these neighorhoods. In this case, subprime meant less than great credit but you still needed to meet the loan to value ratios (down payment), income to expense ratios, fully document your income, expenses and assets and conform in all other ways besides the credit rating requirement which was lowered for borrowers in poor black neighborhoods. The interst rate charged was higher and over time people realized that you could make more money from these mortgages because the increased interest rate more than made up for the increased default rate. It turns out that even poor credit black folks don’t want to get evicted from their home. Fast forward 40 years and the Republicans are trying to blame a 1970’s peice of legislation for the subprime crisis when banks were not being pressured to lend to black neighborhoods under this 40 year old law. In fact the majority of subprime mortgages were originated by lenders that are not subject to CRA. The way the CRA contributed to the crash is that it provided enough data that the actuaries on Wall Street thought they could model how subprime mortgages would react under different economic scenarios. And then they applied these models which applied to otherwise conforming mortgages on primary residences to other types of subprime mortgages. > [@](#): > > 1. As far as I’m concerned, derivatives don’t actually add value. They’re just bets/hedges that shift risk from one party to another. There’s always a winner and loser, and so I don’t understand how value is made unless the winner does something with the earnings that is value-adding, etc. There was a lot of talk about how Goldman Sachs siphoned out a huge sum of money by betting the right direction in assuming the housing market was going to collapse. In other words, it’s like taking out an insurance policy on someone else’s loss. It’s like me being able to collect if your house catches fire and burns to the ground. Classically insurance requires that you suffer the loss before they will write you a policy. Otherwise you are correct, these were largely used for speculation. Speculation in and of itself can provide a useful market function but in this case speculation wasn’t just driving the market, it WAS the market. > [@](#): > > . I don’t understand how ratings agencies slapped on AAA ratings to these securities when they actually weren’t. I don’t understand the justification for taking something that isn’t technically idiosyncratic risk and acting like it can be diversified away. Aside from the flood plains issue (if you insured 100 homes in a flood plain with flood insurance, you aren’t really insuring 100 different homes, you are insuring a single flood plain), the reason you can slap AAA on a tranche of subprime mortgages is that they would take a bunch of mortgages and put them in a trust and the trust would issue several certificates with different seniority and on top of that they would frequently purchase some form of credit support in the form of insurance ofr credit default swaps. > [@](#): > > 1. I don’t understand how lending to “deadbeats” turns a profit. If the interest rate is high enough, you can absorb a lot of defaults. > [@](#): > > 1. What was it that actually caused the collapse? I know prices suddenly plummeted, but why? Was it just an eventuality of the market, i.e. people were no longer willing to buy at those high prices? Why didn’t it just sink down slowly instead of drop like a stone? Thats what happens with bubbles. The bottom falls out. > [@newcomer](#): > > 1. I don’t see any proof that US Debt shrunked based on those payments. Any information on that? What do you mean? > [@](#): > > 1. You seem to ignore the role of Federal Reserve in picking up “troubled assets” from various financial companies (Citi, AIG, Bear Sterns …) and paying for them with cash (out of thin air, of course). [Take a look at Feds Balance Sheet](http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab2). Where do you think these financial companies came up with billions of dollars in such a short order? I think you are referring to this: [Maiden Lane Transactions - Wikipedia](http://en.wikipedia.org/wiki/Maiden_Lane_Transactions) [http://newyorkfed.org/markets/maidenlane.html](http://newyorkfed.org/markets/maidenlane.html) I might be misreading this but our financial system recovered sufficiently so that we are not losing a lot of money on this and in every case our collateral seems to be worth more than the remaining balance of the loans. > [@MOIDALIZE](#): > > But there were numerous other “backdoor” bailouts of the banking system, perpetrated by the Fed. The Fed audit revealed that $16 trillion in emergency loans were made to prop up the banks, American and foreign. cite? 16 trillion sounds like a lot. > [@](#): > > To take TARP in isolation, and claim that the government turned a profit on the program, is pure obfuscation. We’ve all been conned. When you take government involvement in the banking sector as a whole, you find that the government and the taxpayer continue to be the lifeblood of the banks, that nothing has really changed and that we’re still at risk for another crash. TARP has a recoupment provision that puts any of the loosses from TARP on the banking industry. The Fed reserve actions are (AFAICT) at least breaking even. Where did our bailout actually cost the taxpayer money? > [@Voyager](#): > > As for why there wasn’t a soft landing, Krugman was begging the Fed to raise interest rates to deflate the bubble slowly for years before the crash. But that would have reduced the profits for the banks, and Greenspan just didn’t believe anyone on Wall Street was greedy. No bank could do it, since if you eschewed this market your profits would not match those of your competitors, your stock price would drop, and the CEO would be out on his ear - especially if a year passed and everything looked fine. That’s why the Fed had to do it, and if you have someone like Greenspan in control it wouldn’t and didn’t happen. +1 People don’t blame Greenspan and his ideology enough. > [@FixMyIgnorance](#): > > 1. Still confused on this point. In my mind, “deadbeat” = someone who obviously can’t afford the loan or pay it back. If I give $100 to my deadbeat friend, I’m not expecting to ever get it back. Therefore I don’t understand how lending money to deadbeats is profitable in the first place. There was some fraud but on paper everyone “claimed” to be able to pay it back. > [@](#): > > 1. How does raising interest rates deflate the bubble (I’m assuming this just makes owning a home more expensive?)? Weren’t interest rates REALLY low after the dot-com bubble burst? I remember hearing that technically we wanted to lower rates… even when we were already at or near zero. Not sure if my facts are straight and how this works. Did any of it have anything to do with government spending/taxation/deficit levels? No it had very little to do with taxsation and spending. Bernanke raised rates again. > [@FixMyIgnorance](#): > > So ultimately, we’ve lent out a lot of money to people, and there are many parties who own these packages. A lot of these guys are going to default, and so it sounds like a game of hot potato where the person holding the loan bundles gets screwed as he now holds a package of worthless IOU’s. Is that the gist of it? If so, why would anyone develop such a system? Is it really as simple as tragedy of the commons/self-interest at the expense of the whole? That’s pretty darn close. Now imagine if the guy that ends up holding the bag borrowed abunch of money from you and you borrowed a lot of that money from me and so on and so on. We’re all exposed. They were paying a lot of people very large bonuses. > [@MOIDALIZE](#): > > That’s because it involves things such as asset swaps and guarantees, not solely loans. But if the Fed buys garbage assets from the banks, it’s certainly of benefit to the banks. > > So saying “$16 trillion in loans” was inaccurate on my part. “Benefits” or “financing” is probably more accurate. Can you point to unrecoverable losses that have been sustained? ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [January 6, 2012, 10:34pm UTC](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424/106 "2012-01-06T22:34:35Z")
> [@MOIDALIZE](#): > > As I said above, the decision to bailout the banks was the right one. > > But as the lender of last resort, the government should _own the banks right now_!!! The taxpayers bore all the risk. But fine, that will piss everyone off, so at the very least I would have settled for the government lending freely but in such a manner as to allow the banks to merely tread water during the crisis, to give them the ability to get back onto their own feet. They have not done so. That’s what’s driving everyone crazy. Yes the American taxpayer took all the risk and they were charging very low interest rates and perhaps they should have extracted more from the industry but I would have been happy enough if they wouldn’t send millions of dollars to Washington DC to prevent Obama from enforcing regulations and staffing the CFPB. ---
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [January 6, 2012, 10:41pm UTC](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424/107 "2012-01-06T22:41:50Z")
> [@FixMyIgnorance](#): > > 1. Still confused on this point. In my mind, “deadbeat” = someone who obviously can’t afford the loan or pay it back. If I give $100 to my deadbeat friend, I’m not expecting to ever get it back. Therefore I don’t understand how lending money to deadbeats is profitable in the first place. Just thought of a better (I hope) answer for this. As you know, return on investments always depends in large extent on the risk involved. T-bills are safe with a low interest rate, junk bonds are risky with a high interest rate. If someone tells you that they can guarantee a 10% return per year with no risk, you say “Thank you Mr. Madoff, but I’ll pass.” Lending to deadbeats is risky, and so demands a high interest rate, which the deadbeats will pay, not doing better elsewhere. If the lender can get an immediate reward for writing this kind of loan, and is able to pawn it off on someone else, the lender’s risk is minimal, assuming they don’t keep a lot of this paper. The problem is that the people buying this stuff have risk allocation budgets. If you go to a financial planner, the first thing he asks (after your bank balance 🙂 ) is how much risk are you willing to accept. If the bonds were rates low, higher risk in line with their return, their market would be reduced. The scam came from the banks figuring out how to mix this stuff with other bonds to get AAA ratings - high return, low risk, and thus a huge market. Like suckers everywhere, buyers were clamoring to be taken. So you see, the more deadbeats, the more high interest loans, the more sales, the more profit. That is why the mortgage brokers didn’t reluctantly sell to deadbeats, they recruited deadbeats. [Previous page](https://boards.straightdope.com/t/should-we-have-bailed-out-the-homeowners-instead-of-the-banks/608424.md?page=5)