by hilzoy
When I read blog posts or comments complaining about people who should have known better than to sign up for mortgages they couldn't afford, I'm always of two minds. On the one hand, I'm quite sure that there are a decent number of people who knowingly gambled on the proposition that housing prices would go up forever. I am not inclined to be particularly sympathetic to such people, especially if they had other options. (People who took this gamble because it was their only way to get a roof over their heads are a different story.)
On the other hand, some people who make these complaints seem to me to underestimate just how complicated and ghastly some of the loans written during the last five years were. Those loans made it very, very hard for borrowers to see exactly what they were getting into. And I can't think of a better way to illustrate this point than to link to this explanation of negative amortization option ARMs by the late Tanta at Calculated Risk.
It's very long: I pasted it into Word and it clocks in at 15 pages and over 3500 words. But there's not a lot that's superfluous: Tanta was a very clear writer and thinker, and I think she explained this about as well as possible. But option ARMs are very complicated. And if you're tempted to discount the possibility that people could have truly not understood what they were signing up for, I'd encourage you to really try to work through it, the way you might if it were a mortgage you were actually considering taking out.
Tough, isn't it? I note a couple of points. First, the payments, and for that matter the entire structure of the loan, can change unpredictably. There are no tables of payments with this type of loan; it would be difficult to work out what was going to happen to the payments, and when, unless you not only knew how much you would choose to pay every month, but had a copy of the loan document, a pretty serious calculator, decent math skills, and a fair amount of time on your hands.
Second, it's hard to imagine a person for whom this would be a good type of loan. You'd need to be strapped for cash for the first few months, but thereafter able to pay considerably more than you would have had you taken out a different sort of mortgage. Maybe this would be a good idea if you knew you'd win the lottery six months from now, or were the sole heir of a millionaire who was at death's door. Otherwise, this mortgage might have been designed to get people into a lot of trouble very fast. It's a sort of equity-extracting machine, and it's ugly.
And yet, strange to say, someone created this type of loan, and others adopted and marketed it. Funny thing, that.
Third, this type of mortgage is just plain hard to understand. I had a hard time wrapping my head around its resets and recasts and so on, and I construe texts for a living. Tanta:
"Has your head exploded yet?
But that’s the real point, isn’t it? If your head just exploded, and you’re the kind of person who usually reads CR, just imagine what the kind of person who doesn’t usually read CR makes of all this during some ten-minute spiel by some loan officer."
Fourth, about that loan officer: Tanta notes one case she's heard of in which a loan officer just did not understand this kind of loan, and misrepresented it to her clients. Given how complicated this type of loan is, this cannot be an isolated case. But besides simple misunderstandings, there's also active obfuscation. Here's a story on how Wachovia instructed its employees to sell their option ARMs (also via CR; bear in mind that this is a negative amortization loan, in which the amount you owe can go up):
"So if I'm paying that minimum payment, I'm not actually putting a dent in my principal though right? My principal and interest they're just going to keep climbing up right?" the borrower asks in the video tape. "It's optional," the broker in the video replied.
"What kind of answer is that?" said Brown [a housing advocate, ed.] after watching the video. "The answer would really be 'Yes.' That's the right answer, that to me would be the true clear straightforward truthful simple answer."
Now: one might think that people who take out mortgages should not rely on what their loan officer or mortgage broker says. They should read the documents for themselves, and if they don't understand what they read, they shouldn't take out the mortgage. I am tempted to agree with this. I have taken out a number of mortgages, and I always do read all the documents. My various loan officers have always reacted to this quaint habit of mine with astonishment, the way they might respond if I arrived at their office in a coach and four accompanied by liveried footmen. Some of them indulge my archaic eccentricities with good humor. Others, however, start conspicuously looking at their watches and tapping their fingers as I settle in with the Flood Plain Report, and make it very clear that they do not regard watching me wade through the details of the arbitration provisions as a productive use of their time. It takes a thick skin to keep reading despite that.
Besides, a lot of people find it hard to understand long, dry, complicated legal documents. We might wish this weren't true, but it is. Their only options are to trust someone to summarize a mortgage accurately, or not to take out a mortgage at all. And if the summaries they get are wrong, whether because the loan officers themselves do not understand the mortgages they are selling or because of outright deception, then those people are screwed.
There are quite a few of these loans out there: "According to UBS, gross issuance of securitized OA pools was $18.5 billion in 2004, $128 billion in 2005, and $175 billion in 2006." In the various debates about who is at fault for what, it's worth bearing in mind that some of the people whose mortgages are in trouble took out loans like these, loans that should never have been marketed outside very special circumstances, and that no normal human being should ever have to understand.
It’s a sort of equity-extracting machine, and it’s ugly
I believe the parlance is, “rip their face off.”
(commenting as a land use lawyer):
emotionally, it’s a terrible deal for the borrower.
financially, it’s just a really bizarre deal all around. The borrower is, essentially, renting. (Neg. Am. Option ARMs usually cap at 115% LTV, so the borrower is paying at least most of the rent.) If property values are rising rapidly, then at the end of the initial 5 or 7 year period, the bank gets its loan (including the neg. am. component) paid off, and the borrower gets the rest of the increased equity, captured either by the sale of the house or the refi into a traditional mortgage (using the new equity as the downpayment and her improved financial situation — 5 years later after the first loan — to pay a real amortizing mortgage.)
If housing prices remain flat to rising slowly, the borrower gets nothing and even the bank takes a loss. If prices go actually down, the bank gets clobbered.
Now, think just how crazy you have to be as a lender to go long on residential price increases without having an equity stake in the underlying residence. The cost of money has to be so low that you’ll lend money to anyone who can cover the rent.
What I have yet to understand is why bankers thought that tying up their capital in neg. am. option arms made more sense than in commercial / industrial loans. what ever happened to building stuff?
“What I have yet to understand is why bankers thought that tying up their capital in neg. am. option arms made more sense than in commercial / industrial loans. what ever happened to building stuff?”
Posted by: (The Original) Francis
Isn’t the answer: they didn’t. weren’t these mortgages bundled, sliced into tranches, and sold off so the bankers could do the same all over?
I’m sorry. I just cannot agree with many points here.
First, people don’t have to buy homes. They can rent. Owning is optional. It is voluntary.
Sure, mortgage documents and home purchase documents in general are complicated. There is no question about that. But again, home ownership is voluntary.
Generally when there is a swindle, the swindler ends up with the money. Here, the borrower has the money or the fruits of what the money bought yet he is charging the lender with being the swindler. How can it be that the lender, the one who wrote the big check, is the swindler? He is out the most money.
Or, if someone asks for a loan and is financially qualified for the loan yet is too stupid to understand the loan agreement, the lender is stuck. He can’t withhold the loan based on his opinion that the borrower is stupid – it would be breaking fair lending laws.
If you buy something with your own cash and the value of the thing declines, it is your loss. Oops, you misjudged it. Yet suddenly if you do the same with borrowed money, it is the banks fault. How does that make sense? Sure, the bank took a risk. And the bank loses money. But how can all the fault or even most of the fault be put on the bank? It seems to me that the buyer is 100% at fault in either scenario. I would add that the bank is some percentage at fault in the second scenario. So that we have more than 100% at fault in the second scenario, if that makes sense. Said another way, each is fully responsible for his own loss.
Did lenders take stupid risks? Yes. Did many of them lose all there money? Yes, and more. They lost fdic money. The lenders are at fault for that.
But the borrowers are at fault for borrowing more than they could repay. Period. And what is the consequence of that? The borrower loses the house. That’s all. They don’t lose their life, or their job, or their family … just the house. They can go back to the condition they were in before the home purchase – they can rent. Why is that so bad?
d’d’d, I strongly recommend that you read up on the securitization of mortgages before you go making assertions like the following:
Mind you, the securitization of mortgages only explains why many mortgage lenders in fact did not risk being “out the most money”; the first half of your assertion is at least equally flawed.
Although some wastrels no doubt got to buy homes they couldn’t otherwise afford, and some might even have then resold the properties and thereby realized a genuine profit, many of the people receiving the unsustainable loans did not in fact “enjoy the fruits”; in many cases they’ve briefly felt affluent and later realized that they face a crushing debt burden. And that doesn’t just mean that they borrowed foolishly to live high and now just face the future they always actually had, in a sort of “easy come easy go” situation; many people who were victimized with these loans had assets and prospects before the loans that they forfeited when they entered into these ill-advised lending arrangements. In no small number of cases, elderly people who owned their own homes or were paying affordable mortgages were encouraged by fraudsters to remortgage or to refinance for some short-term cash or a short-lived drop in monthly payments, and thereby lost homes and other assets that once seemed secure. Consider the stories in this article, for example.
“‘What I have yet to understand is why bankers thought that tying up their capital in neg. am. option arms made more sense than in commercial / industrial loans. what ever happened to building stuff?’
Posted by: (The Original) Francis
Isn’t the answer: they didn’t. weren’t these mortgages bundled, sliced into tranches, and sold off so the bankers could do the same all over?”
Keep in mind, however, that under GAAP guidelines banks can book the fully amortized payment amount as income even if borrowers make only the minimum payment. That said, these loans were for the most part what Calculated Risk calls “affordability products”, intended to feed the mortgage securities beast.
…and don’t forget in all this, the role of alan greenspan, who actively & publicly discouraged people from taking out traditional, simple, easily understandable, fixed interest loans.
Did lenders take stupid risks? Yes.
I’m not sure d’d’d’dave quite gets who the “lenders” were. The loan issuers and the loan securitizers were not, actually, the lenders — they were not lending their own money. They got their fees and their bonuses for lending Other People’s Money.
Those Other People were willing to let the financial engineers lend out their money because the financial engineers promised them nice returns on it. The financial engineers had all sorts of clever explanations for how those high returns were possible, and the Other People fell for it.
Remember: the clever, clever financial engineers were not selling mortgages to prospective homeowners. In the technical sense, it was the Other People to whom the financial engineers were “selling mortgages” — or more accurately slices of pools of mortgages.
Caveat emptor is a fine rule of thumb, but the emptors here were the Other People. They bought a Big Shitpile of bad mortgages from the financial engineers, under the impression they were buying a goldmine. If I was one of those Other People, I would be indescribably pissed. But pissed at the financial engineers, not the homeowners.
–TP
A homebuyer doesn’t have to have assumed that house prices never go down. Only that the price for this one house is certain to go up over a defined period of the very near future. With only the immediate past and present market as a guide. And the various real estate professionals telling them that your openng play has to be something of a gamble, but only for a short time, after which you can step over the gap into the ownership society. I can’t blame anyone for trying.
Dave’s right though, that one shouldn’t over-dramatize the loss of such a gamble. People are losing houses — houses they haven’t lived in all that long — along with their modest down payment. OK, it’s sad, and there are legitimate public policy reasons to try to mitigate the impact (specifically, I’d support an earmark subsidy for someone who’d buy my house at the value at which the county taxes it). To the extent that they’re not coming out ok, it’s because of the general economy, not their own lost gamble on home ownership.
(I’ve mentioned before that I have some professional experience with “predatory” loans. Each and every one had a short statement in the file, in the borrower’s handwriting, swearing to an annual income that wasn’t even close to reality. And whatever tearful narrative the borrower had for the media, or whatever they might say about how complicated the thing is, they were actually trying to get out of the loan on the silliest of technicalities: eg, ‘the settlement company gave us 2 identical copies of a certain disclosure form rather than 4 identical copies of that form’ [which worked, by the way]).
OK, it’s sad, and there are legitimate public policy reasons to try to mitigate the impact (specifically, I’d support an earmark subsidy for someone who’d buy my house at the value at which the county taxes it). To the extent that they’re not coming out ok, it’s because of the general economy, not their own lost gamble on home ownership.
Don’t forget that people losing their homes through foreclosure also take a hefty hit to their credit rating, which in the current environment means they may not qualify for any credit.
Also, many who took out option ARM loans during the height of the bubble would have had trouble paying off their loans regardless of the general economy once their loans recast.
Remember, too, that all this took place in a context in which rapidly rising real estate prices were disguising falling real incomes for the middle class. Your paycheck doesn’t go as far as it used to, but you have a lot of apparent equity in your home. What do you do? And it’s a funny thing, but frugality is a lot harder to practice when it means that your kids have to go without the things you had when you were growing up.
Yes, purchasing a home is a voluntary act.
The choice of financing is a voluntary decision.
But, in the instances Hilzoy cited, there were crucial pieces of information undisclosed to the customer about how these financial instruments worked.
No doubt some anodyne music was playing in the background and the loan officer was smiling a mega-watt smile while his or her hands were busy working overtime. Meanwhile, behind the scenes, an entire edifice of financial artifice was humming along, a swift origami of fancy paper derived from fancy paper derived from fancy paper derived from fancier paper, all quietly placed in the mortgage borrower’s cash equivilancy money market fund, with check-writing privileges for a small annual fee.
Buyer beware. But, of what?
Your honor, he seemed like a gentleman. We had a nice conversation in the bar and he invited me back to his place for a drink, one drink ……. I volunteered to go … the next thing I know I woke up the next morning in an advanced state of grogginess with my skirt over my head.
The suspect said he was looking for WMDs.
I blame the Flip This House people.
Oh, my. What a CF. Hindsight lesson: actively avoid contracts of any sort that are too complicated for you to understand. Run away screaming if it’s too complicated for the guy on the other side of the desk to understand.
This makes me feel a little smarter about my 10-year fixed mortgage, but that doesn’t help the people who, in hindsight, were not so smart. I’ve always avoided ARMs because I vividly remember what happened to interest rates in the 1980s.
Well, my head didn’t explode, but only because I guessed which wire to cut as the clock was ticking down.
Details aside, what strikes me as likely is this: these loans are specifically designed to create a certain type of MBS. If investors want a five year-security backed by mortgages then you want to create mortgages that last five years or less.
But very few people want or can afford actual five-year mortgages. So create something that doesn’t look like one but puts huge pressure on the homebuyer to sell, refinance, or be foreclosed in five years or less. If you assume housing prices will go up then something will work. If they drop, it all goes sour.
To talk people into taking out these kinds of loans you set up the payments to be very low initially and then to jump sharply after five years. When they jump the homeowner then has to do something about it, and this particular mortgage goes away. Of course, the logical customer, the one to whom the low initial payments are attractive, is the marginal homebuyer. So when things go bad, they go very bad.
It would be interesting to see the disclosures on this type of loan.
First, people don’t have to buy homes. They can rent. Owning is optional. It is voluntary.
True. But we live in a society where it is hammered into everyone from cradle to grave that you need to buy your own home at some point or you are not fully American.
A question for the lawyers:
Who does the mortgage broker represent, the borrower or the lender?
If all information in America was intended to be transparent, above-board, and honestly presented, why the need for small print, teaser rates, babes draped over hoods at the auto show, all-expense paid trips for doctors to pharmamceutial presentations, loss leaders, $800 undercoating, the best foot forward (I wanna see the other feet; why can’t I see the other feet?), guys dressed like enchiladas waggling their butts on street corners, late-night info-lies, four out of five anonymous dentists, fishing lures, hunting blinds, Jim Cramer, sales training, celebrity endorsements, hurry-for-a-short-time-only-offers, the world’s most famous cheeseburger (in every state), silicone, Botox, the Budweiser twins, mugshots of realtors smiling the smile lined up in the Sunday paper, junkmail, chain letters ………………?
……… did ya know Mr. Ponzi’s wife was one of his biggest victims?
She shoulda known …. she shoulda known. For God’s sake he walked around the house in his boxer shorts, scratching himself, his guard let down.
She shoulda known.
……….
I think an easy way to understand the neg am OA mortgage is to think of it as a “Flippers’ Loan.” You asked who’d want to take out something that had low up-front variable payments that ballooned over time and then didn’t address the principal and saw a huge jump in monthly payments.
How about someone who thought they’d buy a house, renovate and then flip 3-6 months later?
The logic behind it even lines up with the time series, as flipping gained mainstream cachet and grew substantially from 2004-2007. That the loan was marketed to those who couldn’t afford the house under a traditional 30-year fixed-rate mortgage yet weren’t going to flip is obscene, but the industry only cared about the fees and feeding the securitization machine.
I agree with this. But. Someone else recently made the observation that these too-difficult-to-understand contracts are everywhere these days. I can’t download some product without having to click through the legalese. And it’s not just that these contracts are difficult to understand; you’ve really got to pay attention to the wording. IIRC, there was a recent kerfluffle on Facebook because the click-through agreement was reworded slightly but significantly so that anything that was posted there became the legal property of the site owners to do with as they wished.
To cut a long discourse short, the phrase ‘you shouldn’t have signed the contract if you didn’t fully understand it’ is right up there with ‘if you’ve got nothing to hide, you shouldn’t mind if we search your car/house/office’ for dishonest intellectual shorthand.
It is the borrowers’ fault, obviously. People who are too stupid to read contracts they sign deserve to get taken. It’s like the so-called “victims” of Bernie Maedoff. They voluntarily invested their money; they knew the risk. So called “Ponzi” schemes are only illegal because the government wants to run its own ponzi scheme called Social Security. Marxism is taking over this country and we need to go back to the free market.
I think these two things are completely different, because fixed-rate mortgages are still commonplace. You do, in fact, have a choice that’s not damned-if-you-do, and if your only path to getting a loan means involving yourself in a financial agreement that you don’t understand, alarm bells should be going off.
Obviously, they didn’t go off for a great many people. I know, hindsight is wonderful.
I get your message about dense legalese being everywhere, but that doesn’t mean one should succomb to glossing over the details when something like one’s house or car is at stake.
All right, I confess. It was me.
I took out an 80/20 0 down loan with a balloon payment on the 20 after 5 years on January 19th, 2001. And I was unemployed (last semester of school).
And I was amazed that anyone was dumb enough to loan me $250k when I had no job (though good prospects). I was fully aware that it was a gamble that I could get a job good enough to refinance before the balloon was due, or that the market would continue to rise, or both.
In my case, both happened, I sold the house for $413k 4 years later. And recognizing that the market made no sense, did not reinvest it in another house, and instead became debt free (except for that nasty student loan).
So, eyes wide open, read and understood the documents, gambled and won. So blame me.
Second, it’s hard to imagine a person for whom this would be a good type of loan.
As I understand it, Neg-Am Option ARMs were originally designed for people with high but very irregular income. Good examples would be independent contractors who spend a lot of time between good paying contracts and salespeople who sell big ticket items on commission. When the money isn’t rolling in, they can make the minimum payment to preserve their savings. When it is rolling in, they can make the maximum payment and pay down the principal.
The problem, of course, is that “high but irregular income” describes a tiny fraction of the population. These were supposed to be obscure specialty products for people with unusual finances. Instead, the banks decided to market them as “affordability products” under the bizarre theory that somebody who could make the first few months’ payments on a house by taking advantage of the negative amortization feature could actually afford the fully amortized rate.
tony p
// The loan issuers and the loan securitizers were not, actually, the lenders — they were not lending their own money. They got their fees and their bonuses for lending Other People’s Money.//
This is the very nature of banking. Banks borrow from depositors via CD’s and demand deposits, from the fed at very low rates, from the federal home loan bank, etc and lend it at higher rates. The rate spread stems from different levels of risk, differences in the time length of commitment, and economies of scale.
And yes, I do realize the loans were securitized and resold. The loan originators didn’t have to worry much about creditworthiness of the borrower; but only whether the loan met the criteria for reselling.
IMHO the concept of securitized mortgages is sound. The problem came from it’s success. It decreased the cost of mortgages to the borrower in a valid way and increased the amount of money available for mortgage lending. Neither one of those is inherently flawed. The resulting effect was that more home could be afforded with the same payment and more people could afford houses than previously. This drove home prices up because new construction was not able to keep pace with the increased demand. It went the way of every natural process in creation: boom and bust.
You don’t like boom and bust? It’s unpleasant but waves are an essential feature of our world. Pressure builds until a critical limit is reached and the bounds are broken. The pressure collapses to establish a new equilibrium. Gases, fluids, biology, animal populations and ecosystems all experience this.
Oh, my. What a CF. Hindsight lesson: actively avoid contracts of any sort that are too complicated for you to understand. Run away screaming if it’s too complicated for the guy on the other side of the desk to understand.
This is good advice, but in practice, I think there are a lot of people who can’t follow it. You’ve built a career around being (compared to the average person) shockingly good at manipulating numbers while also reading impenetrably dense specification documents to get precise details right. Most people are functionally innumerate. Most people are literate, but not sufficiently so to be able to interpret the hundreds of pages of legal documents associated with a mortgage. A large fraction of people who can do simple arithmetic and are literate completely fall apart when they have to deal with numbers embedded in a complex document. I know, this makes no sense if you assume that people are machines and that metal skills should be orthogonal and composable, but that’s not actually true.
I think these two things are completely different, because fixed-rate mortgages are still commonplace.
I’m sure this is true for a guy such as yourself (or myself — we’re not so different except for the fact that I’m shiftier). But I’m not sure it was true for minority folks who weren’t as well off as myself. Stories like this make me question it. I don’t know that what the NAACP is alleging actually happened but I think the incentives line up so that it could easily have happened. Brokers were incentivized to move crappy loans over fixed rate loans so that’s what they did, and they were likely to be most successful when dealing with marginalized populations that had little clout. I mean, if you want to foist a crappy bad loan on someone rather than a good loan because you’ll get extra cash, would you choose a middle class white professional who has got lawyer friends or a lower class black woman with a high school education? Again, I don’t know how common this was, but I’ve heard enough anecdotes to be really suspicious of your claim.
You do, in fact, have a choice that’s not damned-if-you-do, and if your only path to getting a loan means involving yourself in a financial agreement that you don’t understand, alarm bells should be going off.
Why would you think that the average person is capable of understanding a fixed rate mortgage agreement? They may be simple in comparison, but the average person is still incapable of reading dozens of pages of dense legalese, right?
Someone else recently made the observation that these too-difficult-to-understand contracts are everywhere these days. I can’t download some product without having to click through the legalese.
as a small software publisher, i’ll just come out and admit that most of our legalese is defensive. it’s to deter people from trying to sue us if they use our product in ways it wasn’t designed to be used, and end up doing something catastrophic to themselves.
Oh, my. What a CF. Hindsight lesson: actively avoid contracts of any sort that are too complicated for you to understand. Run away screaming if it’s too complicated for the guy on the other side of the desk to understand.
I forgot to add: another factor is that people often don’t know what they don’t understand. Have you ever worked with people that were losing their hearing? You tell them something and they nod and act as if they heard you when in fact they don’t have a clue what you said. I don’t even think that’s always conscious, but it is very human. Most people have no training or experience reading or understanding dense legalese, so there’s no reason to expect that they’ll be able to do so correctly when they get a mortgage.
Another way of looking at it is that we really discourage people from signing plea agreements to marijuana possession without the aid of an attorney. Aren’t mortgage agreements much more complex than most plea agreements? Why don’t we encourage borrowers to get counsel reading their agreements and explaining to them what’s going on?
You do, in fact, have a choice that’s not damned-if-you-do, and if your only path to getting a loan means involving yourself in a financial agreement that you don’t understand, alarm bells should be going off.
One reason I think that many people don’t really understand their fixed rate mortgages is because many people haven’t read them. Judging by hilzoy’s comments and what real estate agents have told me, very very few people seriously read their mortgage paperwork before signing it.
Some states and jurisdictions do require legal counsel to buy and sell homes. I had to shell out $600 for my first home in NY for an attorney to bless the deal. Which actually worked out for me because there was a misunderstanding in the purchase price, and the attorney made the brokers eat it.
In WA, not only did I not have to have an attorney, but we did not even do closing in person.
“I get your message about dense legalese being everywhere, but that doesn’t mean one should succomb to glossing over the details when something like one’s house or car is at stake.”
Slarti: I agree, at least as far as my own life is concerned — which is why I can speak with authority about what loan officers do when I decide to read through *all* the mortgage docs. However, I think I have a whole lot of advantages here. I’m good at understanding documents, and have some understanding of legalese. I have a large vocabulary, so words like “amortization” are not strangers to me. I’m patient. I have a very thick skin, so loan officers looking at their watches don’t bother me. Etc., etc.
But I think about people I’ve known who are perfectly literate, but not all that good at whatever it is that lets me read through legal documents and actually understand them, and wonder: wtf are they supposed to do? Never buy a house? — Well, one answer is: hire a lawyer, but (a) costs money, and (b) how do you find one you can trust? (Easy for me — I know a bunch of them –but, again, I’m not everyone.)
If the actual loan officer explained the mortgage to me, I might assume that s/he knew what s/he was talking about. That would be a mistake, but I think it would be a comprehensible one.
I note, not for the first time, the many unexpected ways in which privilege replicates itself in my life. Having a good education means I can understand the docs myself, and don’t have to hire a lawyer — which means that the loan application process, done right, costs less for me than for others. It also makes me less likely to screw up, which makes my whole life less costly.
And that’s without getting into the much greater advantages conferred by having good credit and relatives who were willing to cosign my first mortgage (I hadn’t taken out credit cards until a couple of years before that — I hate borrowing money — so had very little credit history.) Also, knowing people who probably would not lend me money if I e.g. gambled everything away or developed a crack habit, but would if I were hit by a bus.
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If the average person is incapable of understanding such a thing, then the average person should not be taking out mortgage loans. At least, with a fixed-rate mortgage, the amortization schedule is set out pretty clearly. If there are people who don’t understand that, they shouldn’t be borrowing money.
That’s my opinion, anyway. Why would you ever enter into an agreement where you don’t understand what your obligations are?
Most of the details in a mortgage contract are not, if I’m recalling correctly, centered on the details of the financing, but are more focussed on what homeowner obligations are under the contract, and what the lender recourses are if the borrower fails to comply with the contract. I have to say that I didn’t exactly pore over these parts, because they mostly involved situations where I’d be on my way to foreclosure, and I’ve been-there-done-that.
I don’t disagree that mortgage contracts can be daunting, but I’m talking specifically about the parts that discuss payments. In a fixed-rate mortgage with no balloon, you know exactly what your payments will be, apart from taxes and insurance.
Mortgages should probably be less complicated, but I don’t have any good ideas on how to make that happen without removing necessary teeth from the contract.
Chris Chandler: I’m banning you for violating pretty much all the posting rules, with the exception of the one that says: no advocating assassination.
It is all well and good to ask people to pay attention to the contracts they’re signing, but that completely ignores how intentionally deceptive the mortgage industry has become – even about their own terms of art!
For example, what is a “30-year fixed rate mortgage”? If you’re an ordinary human being, you think it is a mortgage that has an interest rate that is fixed for 30 years. That’s what it used to mean to a mortgage broker, too (with the addition of 30-year amoritization). These days, what plenty of mortgage brokers call a “30-year fixed rate mortgage” is a mortgage with 30 year amortization that has an interest rate fixed for a portion of the loan (i.e. 2, 3, 5, 6, or 10 years). Ordinary people would call that a “hybrid ARM” or even just an “ARM” since almost no-one wants a mortgage that has variable payments from day one (so they don’t consider that possibility).
For that matter, even the Option ARM has had other names “pick-a-payment” and a few others I don’t remember. It gives the impression that mortgage lenders and brokers were changing the name of the product to stay one step ahead of the consumer watchdogs that were trying to warn people about “dangerous loans”.
It was also common practice for brokers to lie about the documents as they were being signed. For example, if you had to sign a “variable rate disclosure” because you were getting some variety of ARM, but you thought you were getting a fixed rate loan, a broker would often say it was a generic form that didn’t apply to your particular loan. The correct response might be to not sign it, but how many people are used to pointless paperwork in other aspects of life and wouldn’t ask more questions?
Caveat emptor may be all well and good, but how much sand does the seller have to throw in the buyer’s eyes before they have to take some responsibility for the long-run outcome of the transaction?
as a small software publisher, i’ll just come out and admit that most of our legalese is defensive. it’s to deter people from trying to sue us if they use our product in ways it wasn’t designed to be used, and end up doing something catastrophic to themselves.
As an attorney working primarily in Internet and technology law, I can attest to the fact that I am responsible for including that language in order to defend the cleeks of the world from potential lawsuits.
Hm. I have to say I can’t envision an environment where crappy loans are worth more to the lender than solid ones.
Re: the Chandler guy, I think he’s doing some kind of satire thing. But he’s still violating the posting rules with that last one; less obviously doing so in his other comments if he is being satirical.
weird–i had thought chandler was just your average spoofer, making fun of right-wingers by parody. it’s a genre much in vogue over at john cole’s site, and it’s good for laughs, every now and then. (in smaller doses than most spoofers like to use, alas).
but…that last fit or seizure or paroxysm was just not even plausibly funny. oh well–we still haven’t reached peak wing-nut, i guess.
“Hm. I have to say I can’t envision an environment where crappy loans are worth more to the lender than solid ones.”
Try the last few years. The Yield Spread Premium (i.e. the mortgage broker’s kickback) was higher on everything that *wasn’t* the 30-year fixed-rate loan. Generally speaking, the Option ARM was highest of all (at around 3-4%). Why? Because those were the loans the securitization market wanted. They may have looked cheap up front, but they embedded higher interest rates, fees and prepayments penalties that made the loan worth more in the long run (as long as the borrower didn’t default, but they thought they were covered by rising house prices…). ARMs are also more valuable than fixed rate loans generally because, in the long run, the borrower is bearing the interest rate risk, not the lender.
I get most of this from Calculated Risk and other mortgage-related blogs I’ve read over the years. But then I’m not other people. I start an extensive research project involving blogs and other information sources before I even consider buying a house (which is why I didn’t) – most people don’t. Drives my wife nuts, but it is worth it in the long run (and she’s coming around, too).
Roger got it in one. The neg-am ARM with 3 year ‘conversion to fixed’ feature is all our fault because we’re one of the 4356 families in the US who actually wanted and needed the right to pay down our house as we collect on outstanding invoices from our business.
it’s hard to imagine a person for whom this would be a good type of loan.
So that’s solved.
The other issue worth exploring here is the difficulty that those of us with strong credit score and intermittent (high) income–which describe an increasing percentage of high-earning Americans since the late 90s–face in trying to get any mortgage at all, in the absence of short-term ARMs.
My credit is next door to perfect. I have 20% cash and 2 years of reserves in FDIC insured accounts. But I can’t buy the house I want because my income is from the LLCs I’m part owner in, therefore my Sched C represents too much risk for lenders. Over 30 years, they may be right.
Finally, brokers were getting spiffed to sell exotic products that they didn’t understand themselves…what are the odds those products were comprehensible at all to their customers, who either believed (people of color and immigrants) or experienced (me and my ilk) that traditional banks wouldn’t lend to us at all?
I’m not condoning the loan steering condemned by the NAACP and MALDEF, which is clearly racist and immoral. I’m not condoning wage-earners, who have every damn reason to be able to predict the potential upside to their income over the coming 36 to 60 months, gambling that the new house will pay for itself.
But while the creation of this type of loan was driven by the suppliers’ Real Customers (the secured debt buyers), there was also some legitimate demand for the product driven by the demographic that no longer gets W-2s because employers find it more profitable to exploit our expertise on a no-commitment basis.
Oh, and the whole ‘just-rent’ objection to the existence of ARM products designed to make me a potential borrower rather than a tenant for life?
Tell me where in the US I can access a safe neighborhood (def. safe as ‘I can leave my car outside and find it there intact in the morning’) that is racially integrated, has some or lots of households run by same-sex couples, in which I can also expect to rent a house or apartment that allows pets from a landlord who sees my income SO differently from the way Wells Fargo sees it that s/he is delighted to have me as a tenant.
Also bag some snipe while you’re out.
Hm. I have to say I can’t envision an environment where crappy loans are worth more to the lender than solid ones.
I can. We just lived through it. Because they could offer those crappy loans to more people and make them seem cheaper than a regular mortgage. Ergo, more mortgages to slice and dice and sell to hedge funds.
But nobody could have predicted that making excessively complicated mortgages widely available and dishonestly presented could have led to foreclosures!
hilzoy, I understand your comments about advantages, but I’m not sure what the alternatives are. If you don’t understand how mortgages work, and can’t figure out how to learn, and can’t afford to pay someone to understand them for you, I’m not sure what’s left.
Part of being financially successful in our culture is learning how the financial system works, at some minimum level. I, despite Turbulence’s supposition to the contrary, don’t understand much, nor do I have patience or interest that drives me to try. So I miss out. Buying a house, though, requires that I acquire some minimum level of interest and understanding, so I had to obtain that somehow.
If your only gateway into home ownership is one of these crazy NAARMs, you shouldn’t be buying, because you can’t afford to keep a house.
We just lived through it.
And now we’re seeing what happens when “it” goes away. Not pretty. Disastrous.
I’d think assessment of portfolio risk would involve some examination of the assumptions under which investments were made, and what happens when those assumptions fail. But again, this is all in hindsight. Maybe passing on the risk to the taxpayer was in the plan all along.
If your only gateway into home ownership is one of these crazy NAARMs, you shouldn’t be buying, because you can’t afford to keep a house.
I don’t think this works out. If you have bad credit, no money down, and no other way to own a house, what is the risk of rolling the dice on being able to refinance in a couple years because of appreciation? It is perfectly sensible. The foolishness is on the lender, not the borrower.
If there was money down, plus the NAARM, that would be foolish for the borrower, but in this case all the financial risk is really on the lender, and the upside is for the borrower, if there is an upside.
slart,
If you are selling off the loans after making them, the only thing that matters is volume
I don’t disagree that mortgage contracts can be daunting, but I’m talking specifically about the parts that discuss payments. In a fixed-rate mortgage with no balloon, you know exactly what your payments will be, apart from taxes and insurance.
Why do you assume that the average person (1) knows that most of the mortgage paperwork is irrelevant and (2) is able to pore through it and find the bits that really matter, especially when the broker, agent, and seller are all there tapping their feet and looking at their watches?
Hm. I have to say I can’t envision an environment where crappy loans are worth more to the lender than solid ones.
The lender isn’t doing the foisting: the broker is. The broker has no skin in the game, they’ve got no money on the line. All they’ve got are commissions and fees and some lenders were effectively paying brokers more for exotic rather than fixed loans. Since many of the lenders were going to securitize the debt anyway, the fact that the loan was crappy didn’t really matter to them…except insofar as the market was demanding higher yielding riskier MBS for securitization, which made crappy loans for marginal buyers preferable to fixed rate loans.
Since I took out the traditional 30-year fixed-rate mortgage, it’s no skin off my nose to agree or disagree(although I can’t claim any particular wisdom in avoiding the more esoteric products; they simply weren’t on the radar when I applied.) But I think it’s important to emphasize that there are different ways to not understand something. One way, the traditional way is too have jargon that’s too far away from everyday experience: “In general, the Weak Nullstellsatz does not hold for polynomials in infinite fields that do not split over themselves, though the statement may be reformulated for irreducible projective varieties”. Something like this is really not that complicated – it simply means that in most cases, sets of polynomials have a common solution.
Now, that’s an easy explanation, but if you were to sign something on the basis of my translation only to be caught up by some detail later, people would quite rightly shrug and say, hey, you shouldn’t have signed the paper[1].
But how about the type of misunderstanding that goes like this: “I swear under penalty of perjury that there wasn’t a single person on the dock that night.” Our witness is known to have told the truth, yet it takes Columbo 40 minutes(and Monk 43)to figure out that there was, indeed someone on the dock the night the DA’s secretary was murdered. But the killer wasn’t single, he was married.
Not quite so clear-cut, eh? Or how about
“A chicken and a half can lay an egg and a half in a day and a half for a dollar and a half. Payment for all the eggs nine chickens lay in nine days will be due in full at the end of that period.”
These examples of the second sort are rather contrived, but they do illustrate some of the different types of misunderstanding that are possible. So now I can quote a fellow Missourian and say it’s not what you don’t know that’ll trip you up, it’s what you do know that ain’t so 🙂 I submit that a lot of the problems with these types of loans (and of contracts in general) involve a misunderstanding of the type II sort. The sort of thing where you think you understand what is being spelled out, but not really. In fact, for students away from home renting for the first time, for example, this sort of thing happens with dismaying frequency. It’s not an academic theory.
[1]Hence my observation on an earlier thread that people used to be able to rely on the fact that the bankers they were trying to get a loan from could be counted on not to damage their own interests by issuing a loan they knew could not be paid back.
“the foolishness is on the lender, not the borrower.”
Not quite. If you go into foreclosure, you’re screwed for the next several years. Also, you may just find out that PMI doesn’t insure your mortgage, it insures the bank. The PMI company can come after you for the outstanding balance, after the property’s been auctioned.
Which, sure, might just force you right into bankruptcy. But that’s another level of hell.
So, it’s not as if there aren’t any consequences.
I suppose that if someone in the chain of investment thought to themselves: gee, it wouldn’t be so bad to stumble into a whole pile of real estate if these loans went south, this brings us all the way around to the need for examination of the assumptions underlying a given investment strategy.
See, someone in that chain thought that it’d be a good idea to sell loans that were, too some degree, nearly guaranteed to go into foreclosure.
I don’t know any average people, nor do I assume anything about average people. If average people aren’t equipped to understand a mortgage loan contract, they shouldn’t be signing them. There’s a whole lot we could be saying about making that process simpler, but I honestly don’t, as I’ve said, know how to make that happen.
All of ScentOfViolet’s 11:48 comment read and acknowledged, this part I thought was interesting:
Some things have changed since then, no? Didn’t banks actually loan you money, and then administer that loan until you paid it in full? Something important has changed, I think.
Video the whole signing procedure, with bank-supplied counsel if necessary. If a prospective client asks what this form means, the one that says “variable rate disclosure”,and is told that it’s just a general piece of paperwork that doesn’t apply to them because they’re getting a traditional mortgage, this would be actionable, with the lender taking over all payments on the property and the buyer becoming the full owner with his debts discharged in full.
Iow . . . penalties. Stiff, enforced ones that don’t put any of the onus on the buyer, such as having a lawyer present.
3 years ago, our mortgage broker told us we could get a $750K loan, on the strength of our good credit. OTOH, we are a one-income (< $150K) family, with two grade-schoolers. At the time, my husband hadn't even started his new job. We said heck no, and bought a house for about $530K. (30 yr fixed, 20% down) I honestly don't know how the offer was justified to begin with. 🙂
A few Observations:
1. This post reminded me of my first home loan was a version of a 5/1 ARM back in the early 90’s. Only the broker sold it as something much different than what it actually was (I understood it as being recast after 60 payments and fixed thereafter). The language probably wasn’t impenetrable, but I had a short time frame in which to close. Points being that a) broker can misrepresent; and b) reading through a loan agreement is not for the faint of heart. Sure it was my fault for not reading the thing all the way through. But when I went back and read it was pretty confusing.
At the same time, I bought a really cheap house. Even had the rate adjusted upward I would have made it.
2) My pet peeve with mortgage loans is that it is difficult to shop the market. It’s frustratingly slow because you have to adjust each and every loan for conditions. And that’s just for fixed rate conventional mortgages. Not a very efficient market except for those trying to hide the true differences in their products. Thus, the neg am option ARM.
3) I remember a “financial planner” in Reno spouting the benefits of interest-only loans about one year before the fall. It wasn’t only the banks and brokers that were in love with these products. I remember at the time thinking how foolish it was to push ARMs in the way he was doing it. I’m sure a lot of people came into the bank primed for an ARM before the broker said a word.
4)Has anyone actually read a prospectus of a financial product investing in pools of neg am option ARMs? I’d love to see how they disclosed the risk to investors.
I think that we are supposed to assume that this sort of behaviour is the default, when in reality it’s anything but. Also, as Hilzoy say, it highlights some unexamined advantages that people here may not realize they enjoy.
For example, my loan wasn’t quite the standard 30-year fixed-rate mortgage; I got extra help from a neighborhood renovation program because I was one of those greedy people who wanted a bigger house in a better neighborhood with a good school. So there was some extra paperwork involved which I pored over before finally having a lawyer look at it. The unexamined advantage? The fact that he did it for free, because we go way back, because our daughters occasionally played together, and because we went to the same church. Which goes back to where I went to school, the neighborhood I lived in, etc.
Now, I grew up for the first part of my childhood in a working-class Catholic neighborhood. If you needed someone to lay some brick or work on your car, the long odds were you knew someone who would help out for less than market rates. A lawyer? Forget it. Plumbers and electricians were the highest status guys we knew on a first-name basis. Despite this handicap, my Dad bought his first house at the age of 24 with not even a high school education. Why? Because the culture and the institutions protected him in ways that they simply do not now.
Those are the sorts of unexamined advantages we’ve let slip to everyone’s detriment.
The ability to handle money – another unexamined advantage 🙂 I don’t carry a credit card any more(I use a debit with overdraft protection when necessary) because it’s too easy to use as if it’s just money. In my case, my rate suddenly jumped when I went over my credit limit by something less than $20. And I was charged something over $100 for some sort of ‘blah blah fee’. The problem here was that I thought I had bought overdraft protection, was in fact paying extra for the privilege ‘just in case’. Turns out that even though they had continued to deduct the monthly fee, the one-time fee was actually a yearly fee. And they did not notify me when the year was up. Or the next year or the next, for that matter 🙁 Need I say that I read that section of the agreement, that it was embedded in about three pages worth of legalese, that a superficial reading seemed to imply a one-time fee, whereas a close critical reading did indeed state that it was a yearly fee without anywhere using the word ‘yearly’?
Way back when I was buying my first house (10 years ago…time flies) the in-thing at the time was a deal where instead of getting a regular mortgage with a deposit and a fixed rate for a number of years, you instead bought yourself an “investment opportunity” over the same number of years, in which you agreed to pay so much per month and, when 25 years were up, the investment you had made would be – they said – probably MORE than the value of your house, wasn’t that a good deal?? The mortgage adviser I went to see spent half an hour trying to get me to take this kind of loan, even though I steadily kept refusing: the more he explained it, the more it sounded like a gamble.
I love gambling so much I have a rule that I never start a game without deciding exactly how much I can afford to lose – and quitting the game as soon as I lost it. In this instance, though, the amount I was being invited to gamble was more than I could ever afford to lose, and quitting the game meant losing the house I wanted. So I kept saying no, and finally they let me have the kind of mortgage I wanted… and within two or three years, the people who’d got these “investment opportunity” mortgages were losing their homes all over the place.
And yes, the thing sounded like a gamble, and that’s mostly why I said no. But the moment when I knew that no matter what I would say no, was when the mortgage adviser showed me a graph that purported to be an illustration of how my “investment opportunity” would work against the value of my home. And I could see – since my job entailed designing such illustrations – that it was a picture, not a true graph: someone with a neat hand for drawing had created a pic of an ideal graph.
But clearly, without a word being spoken that was untrue, I was meant to believe that this idealized sketch represented my investment against my future house.
One of the biggest banks in the UK, that was. Went bankrupt last year. Somehow, I was unsurprised.
I have just added up: that was twelve years ago that I had my first meeting with a mortgage adviser. 1997. Anyway, they were pushing deals that were bad for everyone then, too…
If you are selling off the loans after making them, the only thing that matters is volume.
Right. The only concern that any of the actors had in the last few years was to put a pretty bow on whatever pile of crap they had on their desks to move it to the next guy. The whole mortgage industry became a weird cross of hot potato and telephone.
While not excusing the behavior of a lot of the borrowers, we’ve gotten conditioned as a society to legalese being deliberately confusing and deceptive. People have seen enough lease agreements and 2-point font credit card “agreements” not to trust that the words legally mean what they read them to mean. If the broker tells the client “don’t worry about that, that’s just standard boilerplate that doesn’t apply to you”, most people won’t question.
That’s my opinion, anyway. Why would you ever enter into an agreement where you don’t understand what your obligations are?
As someone already pointed out, it’s impossible to get through life without entering into contracts written in a way that most people can’t fully understand. Aside from the example of software, credit cards agreements are written in legalese. Insurance, health, life, auto, you name it are, too. So are portions of the employee handbooks at many jobs. Buying a car.
Too dense language is now commonplace in our society. One consequence of this is that signing a contract without fully understanding it is the way people get through life. It isn’t possible for them not to. One might think that buying a house is sufficiently large scale that it would change the calculus of making sure you understand the contract, but, once you have accustomed people to signing things they don’t understand, they are going to sign things they don’t understand.
Simply saying that people are to blame if they sign a contract that’s too complicated for them is naive. The only way that would work is if we made the language clearer.
Part of being financially successful in our culture is learning how the financial system works, at some minimum level.
I can tell you what I would have thought one minimum level of comprehension of the financial system was: that bankers, when they considered offering me a loan such as this, were gauging the risk that I would not be able to pay them back. I would have thought that this was a basic definition of the enterprise. And that this selfish concern was a reliable pillar of motivation in this respect.
I hope I’d have carefully read the documentation, but that understanding would have, at the very least, greatly influenced my level of wariness as I did so, and as a person who did this for a living told me that such-and-such an arrangement, where they actually gave me their money, made sense to them under my circumstances.
The arrangements under which the lenders were NOT primarily concerned with whether I would have been able to handle the loan, under which the incentives were to simply make as many loans as possible while “selling the risk downstream”, are things that I only found out about during this process of learning about how this debacle unfolded. Before that point, I think that a lot of people assumed that the interests of bankers were what they had historically been. Am I supposed to paint this assumption as stupidity? The change was nonobvious and unadvertised.
I suggest that this is what slartibartfast is really talking about when he says this:
This is also what happens in the two-tier society. The people for whom hiring out lawyers to decipher this stuff is just a part of the cost of doing business will always be able to sneer and make a hard-nosed rejoinder about not signing things you don’t understand. That’s easy for them to say. Because a lot of these people who are wealthy either have become so on the basis impenetrable contracts or have a good friend who has.
This is goes along with the two-tiered society favorite in which monetary campaign contributions are ‘free speech’. The point is not so much that this allows certain people to spend a million dollars on a politician to get a return of a billion dollars. It’s to lock other people out of any sort of meaningful say in the political process.
Tanta’s explanation is not clear, and, although technically accurate, would be highly misleading to a first-time homeowner.
An option-ARM can be complicated, but it’s essential ingredients are not that complicated.
1. Like every loan, you are taking out a loan that includes money for interest and principal.
2. Unlike every loan, your initial payments will only go to interest.
3. Unlike every loan, your initial payments will not even cover interest.
4. Consequently, the amount of principal that you owe will increase, because the interest that you are not paying is being added to principal.
5. The bank will not allow your debt to increase too high; thus, if your debt hits a certain level (110%/125%), you are going to have to make substantially higher payments pronto.
6. Eventually, you are going to have to pay off all the principal and interest, which means that whatever you’re not paying today you’re going to have to pay tomorrow.
Option ARMs make a lot of sense if you expect your income to radically increase in the future. (For instance, you’re in law school; you’re in med school.) They also make sense if you believe that market prices are going to continue to rise and you have a short time horizon for selling the house, making your nonpayment of the principle less relevant. (For instance, you flip homes for a living.)
In judging the relevance of Hilzoy’s point, I’d be interested in knowing (1) the percentage of Option ARMs that are in the mortgage market and (2) what number of Option ARMS do not reflect people in the categories identified above.
Slarti,
If you go into foreclosure, you’re screwed for the next several years.
Sure, but the people who had to take these loans in order to buy a house were already screwed: they didn’t qualify for a regular mortgage presumably because credit was already bad, and income was low. By taking the risk that the home would appreciate, they had a chance they otherwise would not have had to own a home, and potentially get some capital gains. In which case they might in the future qualify for a more traditional mortgage.
I agree that there are unpleasant consequences to losing the bet, but it still does not seem irrational when they have little to lose, and a lot to gain if it works as advertised.
And you are right about the PMI, which is why an 80/20 loan to avoid the PMI even at the risk of a balloon in the future could make it an even better gamble for the borrower.
But when you really don’t have anything to lose, and you are getting a chance to win by betting someone else’s money, I think it is rational for people who could only get a loan through NAARM to take a chance. How much worse off are they really when it fails?
I’d be interested in knowing (1) the percentage of Option ARMs that are in the mortgage market
Business Week 9/06:
Because banks don’t have to report how many option ARMs they underwrite, few choose to do so. But the best available estimates show that option ARMs have soared in popularity. They accounted for as little as 0.5% of all mortgages written in 2003, but that shot up to at least 12.3% through the first five months of this year, according to FirstAmerican LoanPerformance, an industry tracker. And while they made up at least 40% of mortgages in Salinas, Calif., and 26% in Naples, Fla., they’re not just found in overheated coastal markets: Through Mar. 31 of this year, at least 51% of mortgages in West Virginia and 26% in Wyoming were option ARMs. Stock and bond analysts estimate that as many as 1.3 million borrowers took out as much as $389 billion in option ARMs in 2004 and 2005. And it’s not letting up. Despite the housing slump, option ARMs totaling $77.2 billion were written in the second quarter of this year, according to investment bank Keefe, Bruyette & Woods Inc.
I’d be interested in knowing (1) the percentage of Option ARMs that are in the mortgage market
In September, 2006, it looked like this.
Now, maybe 40.3% of the borrowers in Salinas, California in 2006 were expecting their incomes to radically increase in the future but that’s not how it went down.
The “Map of Misery” is interesting, in that it suggests that the mortgage crisis was only a crisis in a few key areas (Florida and California foremost among them). These are also the areas where home prices were going up, and, probably, expected to increase.
(Now-what writes “maybe 40.3% of the borrowers in Salinas, California in 2006 were expecting their incomes to radically increase in the future but that’s not how it went down”; actually, these homeowners more likely justified their belief on the basis that home prices would continue to rise, but, that too is not how it went down.)
A guess my bottom line on Option ARMs is that you don’t need to know all the details to be able to know the risks. If there was fraud, let’s punish fraud. If there were health problems or job losses, let’s show compassion. But the notion that option ARMs are so incredibly complicated that they can’t possibly be comprehended, is essentially a way to excuse everyone who ever got an option ARM from any responsibility (at taxpayer expense). I don’t think that’s either smart or ethical.
Chris Chandler: I’m banning you for violating pretty much all the posting rules, with the exception of the one that says: no advocating assassination.
Wait, you can’t advocate assassination at a site that has a “lone gunman” on the front page?
Ok, a lone gun”kitten”. But whatever. Geez.
But when you really don’t have anything to lose, and you are getting a chance to win by betting someone else’s money, I think it is rational for people …
… in the financial “industry” to get rich by ripping off both their rich clients and the would-be homeowners.
Do we really have to keep pretending that “managing risk” was the job of homebuyers and investors — and not of the highly-paid financial engineers?
–TP
Hm. I have to say I can’t envision an environment where crappy loans are worth more to the lender than solid ones.
There’s a bigger picture element to it than others have said. There was so much money floating around that it was pretty much guaranteed to get invested in something crappy, because all of the good investments were taken. The gross incompetence is responsible for making this crisis as severe as it is, but there was going to be a problem even if they had been good at it.
The underlying reason is the huge trade surpluses a lot of countries have run with the US, particularly Japan, Korea, China, and Germany. They built their entire economies around exporting things to the US, and not importing things. Of course, if you sell a lot of stuff to Americans, you end up with a large pile of dollars. If you aren’t going to spend it, you need to invest it somewhere.
Well, “somewhere” turned out to be mortgages, though it could have been any number of other things. When you *have* to invest a huge pile of money somewhere, quality goes out the window. Sure, there were a lot of people who stopped and made the bad assumption that house prices would never go down. There were others, buying the securitizations, who never really asked that question at all, but bought something simply because it was denominated in dollars.
There is a lot of financial regulation we need to do. However, until something is done to change the structural current account surpluses a variety of countries are running, this is going to happen again, even if on a smaller scale. Roughly speaking, China and Japan have to start consuming more if they want to build so much stuff.
TP,
Managing the risk was the responsibility of the lender. I am only commenting that the people who took these onerous loans, even assuming they understood them completely, were making a rational bet. And many people won that bet. The market did continue to rise for years, and even now many people who took these loans in the early 2000s are not under water. I think where I live we are at 2006 values today, so loans before that were still a good deal, if that was the only loan you could get.
I am not giving a pass to the people who designed the system and leveraged themselves out of existence, nor blaming the people who took the loans. I am saying that people taking the loans were not necessarily stupid or ill informed, just trying to take advantage of something that was offered to them that might make them better off in the future if it worked out.
I’m rather tired of the “homeowner responsible” vs “financier responsible” debate.
Can we just agree on the obvious:
In our society there are centralized positions where a lot of inputs come together and much power and responsibility is exerted and assumed.
The occupants of those positions are rewarded with status, power, wealth etc.
In return they are actually more responsible (and should be held to be more responsible!), because they have more influence over the course of events (!!!)
Yes, a prospective homebuyer should be careful about their mortgage. A banker SHOULD be careful who they lend to. A broker SHOULD be careful what loans they securitize.
Is this an obscure point, that there are varying levels of responsibility ‘required’ or ‘expected’, associated with the quantity of money (or other resources) being involved?
Good god.
The occupants of those positions are rewarded with status, power, wealth etc.
Pet peeve: There are some folks who might be “rewarded” with status, power, wealth, etc. But many folks earn whatever status, power, or wealth they have. That’s true of the posters on this blog.
Hilzoy wasn’t rewarded with her (considerable) professional status or good reputation as a blogger. She earned both.
Publius wasn’t rewarded with his new job as a law professor. He earned it.
Eric Martin wasn’t rewarded with clients or a prosperous legal practice. He earned them.
I wasn’t rewarded with my legal practice. I, too, had to earn it every day. Still do.
This isn’t to say that people don’t fall on hard times despite their best efforts, and shouldn’t enjoy our sympathy and support when they do. Folks can fail despite doing everything right. But let’s not pretend that the fates control all.
I don’t think “rewarded” is significantly different from “earned.”
Reward: Something given or received in recompense for worthy behavior or in retribution for evil acts.
Thanks for dusting off some of Tanta’s posts, generally exceeding most people’s attentions spans (there were complaints at CR’s, even then, when it had manageable thread lengths and…more community spirit and less pot shots), including mine at times.
Her line, “We are all subpime now.”, I thought was pretty good at the time and continues to make an impression…a growing impression.
The exotic mortgages, the razamatazz (Fannie’s “American Dream” my favorite illustrator) don’t get going without an inadequate ability (wages) to afford regular mortgages….on regular houses with regular prices…in a regular market where there are similar $500,000 capital gains exemptions on other investment opportunities…so that nobody gets crowded out and we have a balanced economy…and possibly less disparity…and more innovation…and less risk…and more accountability and less signage proclaiming it.
actually, these homeowners more likely justified their belief on the basis that home prices would continue to rise, but, that too is not how it went down
In other words, a Minsky moment had been reached.
Let’s not pretend we are all captains of our own destiny. I’m curious; Sebastian seemed to concede at least implicitly that loans much more complicated than reading a figure off the table was a bit beyond what you could expect of someone with only a high school education.
You seem to have a much higher standard. In particular, you seem to believe that contracts written in a deliberately obfuscatory way and ‘interpreted’ by people whom the buyer did not know they could no longer trust are fair game.
Why? Certainly this is not the standards our parents and our parents’ parents had to live up to.
I’d also be a little leery of claiming that I ‘earned’ something, as if you had done it all on your own with no help from anyone. That seems to be something of a double standard, unless you can in point of fact detail exactly how you did this with no help from anyone.
Pet peeve: There are some folks who might be “rewarded” with status, power, wealth, etc. But many folks earn whatever status, power, or wealth they have.
Tony Soprano’s crew talked about “earning” their money, based on the unarguable fact that they worked hard and took risks for it. The meaning of “earn” is sufficiently elastic that I think you ought to give “rewarded” a pass, in context.
–TP
It’s like this: Hilzoy has great power, and with it, comes great responsibility.
It is a scandal if Hilzoy says something moronic, but on the other hand it’s pretty much routine if a commenter says something moronic.
That’s because Hilzoy (due to her power and influence) is being held responsible for being intelligent. There are actually higher standards for her.
I’d also be a little leery of claiming that I ‘earned’ something, as if you had done it all on your own with no help from anyone
Kind of reminds me of the old line, “Some people are born on third base and go through life thinking they hit a triple”.
No, it’s a point that some people will try to pretend not to get. More tellingly, after pretending not to get it, they think they have ‘won’.
This is of course not true. The notion of varying degrees of culpability is embedded in both our culture and our law, for example, manslaughter vs willful negligence, etc. Anyone wanting to claim that they can’t see the difference, well, the burden of proof is on them to explain this odd exemption for homeowners, that in this particular case, responsibility is an all-or-nothing thing.
I am awaiting anyone pushing this odd notion to make a real attempt to convince me that this should be the case.
Because, after all, if they can’t . . . I win.
Sorry, but if these are the rules these people want to play by, we’ve got to even-handed, right 😉
I don’t think “rewarded” is significantly different from “earned.”
Reward: Something given or received in recompense for worthy behavior or in retribution for evil acts.
Oh, there’s clearly a difference. The person giving the reward is not the same person receiving the reward (a “rewarder” and a “rewardee”). The “earner”/”earnee” is the same person.
Roughly, “earn” is the conscious application of effort to achieve something that is, by right, yours. “Reward” may (or may not) involve the conscious application of an effort, but not necessarily to achieve what is gained.
I reward my political allies with positions in my administration. She earns her degree. I reward the police officer for catching the burglar, but he earns his pay for the same act. In the case of reward, the dispensation is optional and, in part, discretionary on the part of someone other than the “rewardee”. In the case of earn, the dispensation is acquired by right by the acts of the earner (who is also the “earnee”).
Or, from Wiktionary:
Earn: to gain (success) through applied effort or work; to receive (money) for working; to deserve (something); to receive money for working
Reward: Something of value given in return for an act. The result of an action, whether good or bad.
Let me announce my pet peeve: inconsistency. It seems that some people will concede that, yes, there are some people who have enjoyed rewards all out of proportion to what they did to earn them. And questions about what to do are waved away as something to do with envy. Okay, fair, enough. I disagree, but I’ll go along with it.
What’s not okay is to then fail to concede that there are large numbers of people who, despite working hard for these rewards, never get their just desserts. That is, they fail to concede that unfairness goes in the other direction as well. And that to the extent that it appears, well, shrug, you can’t do anything about it.
That’s contradictory. And not right.
Sure, there are folks like that. But they aren’t people who work for a living — i.e., who make the money that they need to live based on what they do today based on what someone did yesterday.
As for SoV’s point: it’s not at all profound to accept that, for most people, (1) we have been advantaged in some way but (2) we wouldn’t be were we are or be doing what we’re doing unless we had earned our position.
There’s a recent phenomenon of those in positions of great authority / influence ducking the idea of their responsibility.
Condi Rice: “No one could have predicted their flying planes into buildings.”
Wall Street: “No one could have predicted a nationwide housing decline.”
Wrong. It is your fault because you are in charge. Sorry.
This is where I am pushed towards war on the upper classes: Most everybody is more or less OK with the idea of unequal power/status/authority/money as long as those at the top are aware of their responsibility and execute it faithfully.
Recent years have been characterized by an attitude of complete irresponsibility at the very top – in business and in politics.
There’s only so far the bottom 50% or 80% or 90% will go along with that.
So – yes – if you want to bring class war another step closer, then, yes, let’s please blame the homeowners.
If they want to maintain the current system, the “bosses” need to accept responsibility and take the blame and the consequences.
In fact, they would be quite wise to take ALL the responsibility and bear as much of the blame and other costs as they possibly can. That is how you maintain the social contract and thereby get to keep your authority in the long run.
Von,
So your argument is that the people who leveraged their companies out of existence “earned” status and power? In this context, by your definition, reward seems even more appropriate, since they gained something they did not deserve.
I think at best you can argue that Hilzoy both earned and was rewarded with her status. Many people may earn something, but not actually get it. Hilzoy got both.
Umm, my comment above should read: who make the money that they need to live based on what they do today and not based on what someone else did yesterday.
Roughly speaking, China and Japan have to start consuming more if they want to build so much stuff.
I’m not sure if that’s such a clear relationship. I mean, if China were to shut down its factories, there’s no reason why they wouldn’t move to Indonesia and Vietnam (a lot of them already have) Certainly, the availability of cheap goods was able to mask the stagnation in real earnings, which made houses as a source of equity, or even as a source of revenue via flipping, which fueled the housing insanity, which encouraged the creation of tranches, which apparently insulated everyone from risk, which caused the kingdom to fall.
This may go back to the question of who to blame that seems to be the theme du jour here lately. I’d suggest that one test for deciding blame might be if one had removed X from the chain of events, the chain of events would not have occurred. Of course means that if Stan Getz hadn’t intimidated Alan Greenspan so much, we wouldn’t be in the mess.
I think I’ve seen Hilzoy admit, in this very thread and others, that a good part of her lot in life is not just a result of her work, but also her connections and that of her parents.
No, that’s contradictory. Almost by definition in fact.
Convince me otherwise, or at least make some sort of honest attempt. Otherwise all you’ve got is a self-serving bromide that has no basis in fact.
So your argument is that the people who leveraged their companies out of existence “earned” status and power? In this context, by your definition, reward seems even more appropriate, since they gained something they did not deserve.
Nahh: people who leveraged their companies out of existence didn’t earn their pay; they were insubordinate.
“It is a scandal if Hilzoy says something moronic …”
Uh oh.
More seriously: I think that everyone should read mortgages, etc. But in deciding what to conclude from the fact that someone didn’t understand something, I tend to think it matters whether what they didn’t understand was something they ought to have understood — which, of course, involves knowing something about them and something about what they didn’t understand.
The reason I posted Tanta’s post was just to say: this is not something I think anyone who is not selling those kinds of mortgages (or buying them, or securities based on them) ought to be expected to understand. Other kinds of mortgages, yes: for instance, if your mortgage comes with fixed payments, you should be able to look at the table and see whether you can pay it. But not this.
Next question: if you don’t understand this, are you to blame for relying on the explanation of your loan officer? I don’t think that’s a crazy thing to do, especially if you didn’t know what I didn’t know until I started reading CR, namely: that the whole business model for mortgages had changed, so that lenders were not going to hold onto them (and thereby have a stake in my actually paying my mortgage), but rather sell them to people who would slice, dice, and securitize them (which meant they only had a stake in my mortgage not being obviously ludicrous.)
I wish we lived in a world in which it was possible for ordinary people, with ordinary educations, to understand all the contracts they signed, and/or in which enough information was widely available that everyone would know when business models for mortgages changed. But we don’t.
Oh, and I should add, in terms of consumption, the Japanese would, person for person, kick everyone else’s butts.
SoV@3:26, why do you think my statement is contradictory “almost by definition”? (And if it’s contraditory, how can it also be a “self serving bromide”? Do you know of many contradictory, self-serving bromides?)
And robot for robot, too.
people who leveraged their companies out of existence didn’t earn their pay; they were insubordinate
If only the cossacks hadn’t misled the Czar, Batiushka, the Little Father, he would have done the right thing and all would have been well.
I wish we lived in a world in which it was possible for ordinary people, with ordinary educations, to understand all the contracts they signed, and/or in which enough information was widely available that everyone would know when business models for mortgages changed. But we don’t.
When it comes to buying a home, I think most folks have the capacity to understand enough of the basics to know whether, for example, an Option ARM is a good idea for them, or at least ask for an explanation.
Now, if a broker lied to them and defrauded them, that’s one thing. But we shouldn’t presume that Option ARMs are so unbelievably complicated no one could have understood their salient points,* and thus, by implication, everyone is excused. (As this post comes close to doing.)
*Again, salient points, the ones I lay out above, not Tanta’s overly-complex explanation.
Bromides are never false?
And please, I asked you first. Not only that, you’re the one who made the statement. You’re perfectly free not to attempt to justify it, of course. But to make no attempt whatsoever would seem to indicate a complete lack of basis for this belief.
P.S.- now that I know that you’re a lawyer, I’m going to assume that you know about various burden of proof requirements. I’ll also assume that if you duck them, it’s strategy.
It’s hard to sort out what I earned and what I didn’t. I worked hard, but it was very, very lucky for me that I had the education I needed to be able to do that work. Moreover, I was a problematic kid: bored to tears in school, had a very, very hard time making myself do things I hated, tended to have teachers either love me or hate me, didn’t work well at all for the ones who hated me, was miserably unpopular for most of school, etc., etc., etc.
I did not, in short, have an easy time with school. But it has always been incredibly easy for me to see how much worse things would have been if my parents hadn’t been willing to find genuinely good schools for me to go to, and able to afford them. I hated those schools anyways, but really bad schools would have been much, much worse, and might have done me lasting damage. I mean: I am exactly the sort of kid who could have been turned off school for life, or flunked out, or something. I probably would not have been the sort who ended up getting into sex & drugs & rock & roll out of boredom, but only because no one liked me enough to propose any of those things. But ending up all screwed up: easy. (Fwiw: I would much rather have been one of those resilient kids for whom none of this would have been true. But I wasn’t.)
Likewise, I had really great parents, who did their best to get me through all that, and to teach me to make efforts I deeply did not want to make. Different parents, again, could have made things vastly, vastly worse.
So what do I deserve? Damned it I know.
Chris Chandler, also posting under the name “ryan smith”, IP Address 208.53.157.xxx, out of the western suburbs of Chicago (although registered to a server on Jackson Street in Chicago):
I suggest that you stop.
Our latest bout of Chandler visitations seem to be coming from a different IP, hilzoy. I’m thinking that I’ll just copy and paste one of those into an email to the abuse line at, just to pick a place at random, fdcservers.net.
Bromides are never false?
SoV, whaddaya talking about “false”? You said that my comment was contradictory (“almost by definition”) and a self-serving bromide. I asked two things: How is it contradictory? How many bromides are contradictory?
You’re eliding the second question. Fine. At least explain what you mean by answering the first question.
So what do I deserve? Damned it I know.
I think we should separate the question of “dessert”, “earn,” and “reward.” It seems that they are separate issues.
I reported the new Chris as spam, which should have made all those comments vanish.
von, please stop trying to evade the question. You said:
Now, since I asked first, I think it only fair that you attempt to justify this statement somehow(which you as a lawyer should know you have to do anyway.)
So. Make at least an honest attempt to explain this rather odd statement – it shouldn’t be that hard since you think it is true. After that, I will answer your question.
And I’m fine with thinking that I earned some of what I have: the job, certainly. I just also think it’s worth bearing in mind what helped get me there when I’m tempted to start thinking what other people did or did not earn. I don’t have a problem saying that people who were flat-out dishonest do not deserve much sympathy, or with thinking: there are levels of dumb that are, well, really dumb. But when it comes to, say, my ability to parse a document, it’s hard not to be aware of how much things I did not do for myself play into it.
Plus, part of the point of bringing up school was to say: I can really easily see how without a lot of very good luck, I — the selfsame me — could have ended up as an utter failure at everything. The teachers who did inspire me could not have been there; the schools could have been a whole lot worse; I could have sat there sullenly in the corner; my parents could have not given me either the encouragement to try harder or the books etc. that I spent my time reading when I wasn’t doing my homework; etc. etc. etc.
I mean: I see myself, rightly or wrongly, as a person with a certain somewhat peculiar configuration of talents, and a temperament that could easily have made it more or less impossible for me to put those talents to use. (I think you might have had to know me as a kid to appreciate this.) Some kids just deal with stuff; I required careful handling, a lot of love, and wise people around me not to come out catastrophically wrong. (I do not like this about myself.) I got all that. I was very, very lucky. I try not to forget that.
I’m sorry, but these products aren’t that complicated. People who bought them often probably did not understand them. But that’s because they were deliberately mis-sold, not because you need to understand Tanta’s explanation to understand what you’re getting into from a borrower’s perspective.
From the borrower’s side, there are really only a few salient points:
1. The fundamental underlying loan is designed to be repaid over 30 years.
2. The interest rate is variable, so on top of the principle payments, you will have to pay a variable amount of interest.
3. You have the option to choose not to pay some of the interest and instead have it added to the loan balance.
4. You have the option to choose not to repay the principle, and instead leave it as part of the loan balance.
5. Whenever you choose not to pay either principle or interest, interest will be charged on the increased balance, increasing the amount due over the 30 years of the loan.
6. If you choose not to pay the principle or interest for long enough, the bank will restructure the loan to ensure repayment.
There. Its not that hard.
SoV, a couple-three points:
1. I don’t see a need to explain my comment because it seems self explanatory. On one hand, you can gain certain advantages from your parents or upbringing. But the fact that you gain certain advantages from your parents or upbringing does not mean that you are heretofore incapable of “earning” anything in the future.
To take a very obvious example: Barack Obama was blessed with a wonderful mother and a great set of grandparents, without whom he may not have done anything of note. But it seems crazy to think that he didn’t “earn” a huge number of the good things that followed, including, in large part, the Presidency.
2. Because my comment seems self evident, I still don’t understand why you think its contradictory. Could you help me out?
3. Your comments regarding “I’m going to hold you to X” and your express and implicit appeals to your own authority are not worth much on a blog where you are an anonymous poster.
This is very true, Simon. The products really aren’t that complicated. Writing up the contract in language that is technically correct, legal and easy to misunderstand – I distinguish this from hard to understand – that’s where the wheeler-dealership comes in, the coaching of the reps in their company – issued polyester jackets to imply one thing while saying another in a nonactionable way. To suggest that ordinary people then ferret out the plain meaning, and that if they don’t it’s all on them, that’s sanctimonius. Let’s look a little closer at one of Hilzoy’s links:
C’mon, fess up; does anyone really believed this gentleman signed on to loan he knew that he couldn’t afford? And does anyone really think that the borrowers knew that they were in a much more adversarial relationship?
As for SoV’s point: it’s not at all profound to accept that, for most people, (1) we have been advantaged in some way but (2) we wouldn’t be were we are or be doing what we’re doing unless we had earned our position.
My intuition about it is that for anyone not at the very top or very bottom, privilege levers talent or hard work, and anti-levers laziness or instability.
In other words, privilege amplifies the positive consequences of work and talent, and diminishes the negative consequences of screwups.
Is this a controversial point of view in any way?
In other words, privilege amplifies the positive consequences of work and talent, and diminishes the negative consequences of screwups.
Is this a controversial point of view in any way?
I don’t think so.
So do you concede then that ‘earning’ something is not an all-or-nothing proposition? That one can responsible for 20% of their success, or 88% or 3%? And that to say one has ‘earned’ something in blanket statement as if their success was due entirely to their own efforts is, at best, misleading?
This isn’t difficult stuff. But getting you to explicitly admit this sort of thing is like pulling teeth.
You seem to want to have it both ways. If Obama had been born to illiterate sharecroppers in which alcoholism figured in the death of his mother at when he was eight and his father when he was ten, do you think he would currently be president? Most people would credit his winning high office in part to his parents; they wouldn’t try to minimize their part the way you seem to be trying to.
Now, the larger picture: if I can get you to admit, however reluctantly that success comes in degrees, why do you think culpability is binary in nature?
Really? I’m appealing to myself implicitly or otherwise as some sort of authority? Would you kindly quote the passage that leads you to believe that? Because I certainly don’t think so. Or intend to.
I’m merely pointing out – and you should understand this as a lawyer – that I have certain standards. If I assign a problem on an exam that says prove that all primes greater than three can be written in the form 6n+1 or 6n+5 (a trivial thing, really), and a student says he tried these numbers and it worked, it is hardly a ‘proof’, even if what he says is factually true.
You are perfectly free to make no attempt to live up to these standards of course. But I think most people would agree that these standards are reasonable and reasonably nonarbitrary(they’re the industry standards, after all!) So when I say that if you fail to live up to them I will infer this, that is hardly trying to ‘impose’ anything on you. You are also perfectly free to disregard what I have said, to complain that my inferences are unfair, etc.
But so are other people. If you repeatedly say that what I think follows from what you have said is unfair, and other people repeatedly disagree, well, that’s on you. It’s nothing I have ordered by imperial decree.
It shouldn’t be. Which is why I find such all-or-nothing claims like this:
to be very odd. Particularly when someone can stutter that they meant that they partially earned it, but will then turn right around use the word ‘earned’ to disparage people who aren’t so well-off in an all-or-nothing way. The same way they used the word the first time, in fact, if you didn’t let them get away with it.
SoV, I really can’t figure this out. Why do you think that The Wesson’s comment is inconsistent with my comment? Why did you think that my platitude — which you now seem to accept — was contradictory?
It seems that you’re missing the concepts of “necessary, but not sufficient” as well as “important, but not sufficient,” and all variations thereof.
When people who are bright enough, engaged enough and thoughtful enough to provide comments here talk about how straightforward mortgages are, I feel like breaking things. Since, however, I’m at work and don’t own anything in arm’s reach, I won’t.
Once again, I spend a measurable percentage of my professional career preparing for and attending public meetings of local governments. By my estimation, the average american homeowning, taxpaying, voting citizen is both innumerate and illiterate above, say, a 6th to 8th grade level. They also live almost entirely in the present.
The entire premise of the book “Nudge” is that most people spend most of their time not thinking, so those of us who do occasionally do so need to set up rules that try to prevent these people from screwing up their own lives.
People don’t know what they get themselves into and don’t want to know. What worked for their parents works for them. Credit cards and ATMS are wildly popular because they’re EASY! Cash money is everywhere, and if you run out anyway, you can still buy what you want.
But mortgages, the need to figure out what your future income is going to be, etc., all that stuff is hard. And people just plain check out. Brain off. Can they afford the starter monthly payment? If yes, let’s sign! The future will take care of itself.
Bankers and B. Madoff have made billions recognizing that the easiest way to steal money is with a pen. The entire system was rigged from the beginning; there was absolutely no logic to the idea that the owners of securities backed by residential mortgages as a whole actually wanted to be long on increases in residential housing above the growth rate of the economy. But the purchasers of each individual slice thought he only needed to be in the market for a little while, then dump it before the balloon went bust.
People on this thread have talked a lot about the responsibility of homeowners. What about the responsiblity of the purchasers of these securities? These were, supposedly, trained highly-competent sophisticated investors and they still bought untold billions of this crap. If we can’t get responsible behavior from the sophisticated investors who are supposed to be protecting our pensions, how the h*ll does anyone expect an average homeowner to understand he’s being played?
Some advice from Bruce Williams ( talkshow host)
“Never, never, never buy realestate without being represnted by a lawyer.”
Few people ever make a larger investment than a home. Whose job is it to teach a buyer that?
it’s not at all profound to accept that, for most people, (1) we have been advantaged in some way but (2) we wouldn’t be were we are or be doing what we’re doing unless we had earned our position.
I think it would be reasonable to put it like this:
S’ = S + S*X for positive X
S’ = S – X/S for negative X
(summed over all X)
S’ = your status
S = your parent’s status
X (if positive) means effort, talent, luck
X (if negative) means screwups and bad luck.
Thus, we’re basically at our parents’ status by default, but our inherited status (privilege) amplifies the effect of the good factors and reduces the effect of the bad factors.
So you can’t write X out of the equation (plenty of bankers/lawyers/doctors have made great efforts, for example) but S can have a very large effect on how S’ turns out.
Read what I wrote above. You seemed to be saying, and in more than one place and in more than one way that this is binary – you either ‘earn’ something or you don’t. For example, your statement about ‘earning’ your law practice seems to me to imply rather strongly that you credit this to nothing but your own efforts.
If you really think you can assign partial values to ‘earn’, why do you insist upon some rather absurd binary values for ‘fault’ and ‘responsibility’. This has gotten you into hot water more than once recently with more than one person, so this is an honest question, and this was why I was curious about your take on ‘earning’ something.
That do be a puzzler, don’t it? A lot of people would like to know the answer to that one.
SoV – I don’t think we disagree. Banks consistently mis-sold option ARMs to people who didn’t understand them and couldn’t afford them, because the banks were encouraged to do so by the secondary market. The legal/financial language is hard to understand, which is what allowed the banks to do this, but the underlying product actually isn’t if its explained correctly. I disagree with hilzoy that you need to understand Tanta’s explanation to understand these loans, and that there’s no-one who’d find a loan like this useful. Commission-based sales people, and anyone whose income comes mainly in the form of a bonus, for starters.
This whole mess is an argument for better regulation of lending – making sure loan originators keep some skin in the game, and statutory disclosures and illustrations beyond what’s currently required.
When it comes to buying a home, I think most folks have the capacity to understand enough of the basics to know whether, for example, an Option ARM is a good idea for them, or at least ask for an explanation.
The surest proof that most people do not understand basic math is the success of casinos and lotteries. If the “average” person can’t figure out basic percentages, what hope do they have with compound interest rates?
von, I believe you deal with a VERY different group than “average” people. I live in a fairly nice part of LA (not upscale by any means, but not South Central) and I doubt 1 in 10 of my neighbors would truly know if an optional ARM was good for them, especially with the lender at best obfuscating and at worst flat-out lying.
I learned early on to buy “2 years interest free” and pay off before the 2 years was up, but the stores don’tt make their money off of me.
I see a fair argument that someone who signed up for a loan that they couldn’t repay is responsible for the subsequent foreclosure and loss of their home. They made a choice to sign the contract, and as such, they should have ensured that they understood what they were signing on to.
I draw the line, however, at holding them responsible for the collapse of the global financial system. It is not a homebuyer’s responsibility to determine how their mortgage will impact the bottom line of Citigroup or AIG.
So if we’re talking about the reason that a specific person in a specific place is losing their home, then yes, I think that it’s reasonable to say that that person shares in the responsibility for their loss.
But when it comes to the greater crash? No. Nor does it make sense to spread the responsibility thin across “all of us” and hold the lenders no more to blame than the buyers.
Nahh: people who leveraged their companies out of existence didn’t earn their pay; they were insubordinate.
Insubordinate to whom?
Um, how do you know you understand something, as opposed to merely thinking that you understand something? In my experience, very few people would sign something they didn’t think they understood very well if it involved large sums of money.
I have an idea. Let’s assess the numeric competency of people right here, and see if they have the requisite smarts to understand one of those fancy mortgages:
Ted is as old as Alice will be when Ted is twice as old as Alice was when Ted was half as old as the sum of their current ages. Alice is as old as Ted was when Alice was half as old as she will become over ten years. How old are Ted and Alice?
This is a rather simple problem, and requires only basic algebra. No need to figure how changes in interest rates will change your monthly payment, no resets, jumps or weird behaviour. Just addition and subtraction, multiplication and division.
Would everyone reading this take a few minutes to solve this problem, then show their work and how they solved the problem? Please, don’t google around for a solution; I’m sure that there are plenty of sites that would show you how to set up the problem, if in point of fact this exact problem isn’t worked out somewhere. Just sit down and figure it out with pencil and paper.
(A+10)+2d=2A
A=10+2d
((((t+A)/2)-d)*2)-d = T
t+a-2d-d=t
t+a-3d=t
a=3d
a=30; t=40 (d=difference)
omitted obvious steps like: 3d=10+2d. Also, A and a are the same.
Um, how do you know you understand something, as opposed to merely thinking that you understand something? In my experience, very few people would sign something they didn’t think they understood very well if it involved large sums of money.
Well, obviously, you don’t.
If I drive too quickly and get in an accident, I’m responsible for that accident–even if I thought I was driving at a safe and reasonable speed. If post nonsense in a blog comment thread, I’m responsible for that nonsense, even though I presumably thought I was being rational.
At some point, if the concept of responsibility is to have any meaning, you need to assign responsibility even for unintended consequences of one’s actions.
Sigh. Damien, you’re switching arguments. I ask you again, if you think you know something, how do you know it ain’t so? Let me quote you:
Are you saying this is, er, nonsense? If so, by all means, let’s switch to a different justification. If not, please answer the question.
Thanks, Hilzoy. That is of course correct, not that you needed me to tell you that – I know you went back and checked the answer 🙂
What’s interesting is that one of the people who are arguing that people may have difficulty understanding these contracts is the only person who solved the problem.
The people who claimed that following the wording in complex mortgages? Well, they didn’t solve this rather easy problem now, did they? So I’m skeptical of these claims of expertise. Too bad these same people won’t extend unearned privileges they claim for themselves to other people.
SoV, with respect, I don’t think your word problem proves anything. If people here with lots of experience and education in mathematics solve it, all that tells us is that people with above average math abilities can understand math problems…that doesn’t tell us anything about what average or below average people can do.
Of course, I agree with you that there seems to be a lot of fail around here when it comes to imagining what it is like to live with innumeracy and functional illiteracy when it comes to complex legal instruments.
SoV: it’s also possible that they’re having fun on a Friday night. 😉
There was a study out in early ’06 that found (as filtered through USA Today),
“Nearing a diploma, most college students cannot handle many complex but common tasks, from understanding credit card offers to comparing the cost per ounce of food. . . .
More than 50% of students at four-year schools and more than 75% at two-year colleges lacked the skills to perform complex literacy tasks. That means they could not interpret a table about exercise and blood pressure, understand the arguments of newspaper editorials, compare credit card offers with different interest rates and annual fees or summarize results of a survey about parental involvement in school.
The results cut across three types of literacy: analyzing news stories and other prose, understanding documents and having math skills needed for checkbooks or restaurant tips.
. . . Almost 20% of students pursuing four-year degrees had only basic quantitative skills. For example, the students could not estimate if their car had enough gas to get to the service station. About 30% of two-year students had only basic math skills.”
I ask you again, if you think you know something, how do you know it ain’t so?
And I say again, obviously if you think you know something, you don’t know it ain’t so. If it ain’t so, then you’re wrong. That happens.
I suppose we could say that you never really know anything, but that’s getting awfully metaphysical, isn’t it? Or we could all be Fair Witnesses, and when asked the color of a house declare, “It’s white on this side.” There’s a time and a place for that kind of precision.
But, in general, I think that it’s reasonable to take it as read that the verb “to know” carries with it an implication of “to the best of one’s ability” and “so far as one has been able to ascertain”.
Anyway, I don’t think your real complaint is about this tight parsing of “to know”. I think you’re arguing that a homebuyer who believes, mistakenly, that they understand their complex loan agreement and have the ability to meet its terms then holds little or no responsibility when they are, in fact, unable to meet the terms of the loan. Is that right?
I don’t think I really buy that view. I think that if “responsibility” is to have any meaning, it needs to apply in cases of simple error. I forgot an appointment this evening and was half an hour late; surely I’m responsible for my tardiness, even though I didn’t intend it.
In case it isn’t clear, I’m not saying that it’s a moral failing to sign a bad loan in good faith. I don’t think that a person who does so should then be whipped through the streets or condemned to a life of destitution. And (my original point), I most emphatically don’t think that they should then be blamed for causing the fall of the global financial system. Ensuring the stability of gargantuan financial institutions was most assuredly not their responsibility.
I think that if “responsibility” is to have any meaning, it needs to apply in cases of simple error.
That’s fair enough if it’s a simple error. But as anyone concerned with health and safety or useability designs etc knows, there are ways a system can be set up which make errors likely and ones that make it less likely. If you have two identical switches next to each other and it’s a disaster if you use the wrong one, for example. And the system for selling mortgages seems to have set up deliberately to make errors easy.
It’s also not just the contracts that are the problem (at least in the UK). My husband and I made the wrong decision when we first got a mortgage: we got an endowment mortgage, where your payments only pay the interest and you also put money into an investment vehicle that is supposed to pay off the principal at the end of the term. We are well-educated and my husband is a solicitor: we understood the contract. But we were financially naive or over-optimistic. We took the independent mortgage advisor’s advice that an endowment mortgage was better than a repayment mortgage and we’s end up with a surplus rather than a shortfall (as we have). That was conventional wisdom at the time, and I suspect if we’d read up more in the financial press we’d still have been told the same thing. If you need to be able to good at predicting the future as well to be fit to take out a mortgage, that cuts out a whole extra swathe of people as well.
Slartibartfast: I can’t envision an environment where crappy loans are worth more to the lender than solid ones.
The environment that existed: one in which there was enormous demand on the part of investment banks for mortgage-backed securities, who paid bonuses to mortgage brokers and local bankers to deliver baskets of mortgages.
That’s an environment in which crappy loans are worth more to the mortgage writer than solid ones, because you can write more of them more quickly and get more incentive payments from securities bundlers more quickly.
If you don’t understand that that was the fundamental driver of at least the last three years of the bubble, when the greatest proportion of crappy mortgages were made, then you haven’t grasped what a house of cards this mess is.
If it were just the crappiness of the mortgages at the bottom, we’d be on our way out of this mess soon. Because pyramids of nonexistent wealth were built on top of those crappy mortgages, and Obama-Geithner want us to funnel real money to the gamblers to make up for that, we’re not going to be on our way out of the mess any time soon.
I bid 100%. My success would be absent without my full participation. Sure, I might have even more “success” if I had more focus on my career as a thing, and I’d be 100% responsible for that if I did.
My attributes are a gift; my faults are the opposite of that. We all do what we can with what we have.
You don’t have to explain what happened to me, Nell. Why these riskiest of mortgages became more valuable than the safe ones is the question. Why would you pay the highest commissions for the worst risk/return ratio? And why are these particular ARMs any easier or quicker to obtain than a straight-up 30-year fixed mortgage?
Let’s say you do have sporadic income. Don’t you have to, for instance, show a history of actually having made that income, previously? And if not, why not?
Why would you pay the highest commissions for the worst risk/return ratio?
I don’t think many lenders saw them as inherently riskier. Rather, they insisted on applying historical default models to those loan products that were largely shaped by fixed rate large down payment borrowers and concluded that these loan products were really quite safe! So the exotics were considered almost as safe as fixed rates and the securitization regime was desperate for higher performing vehicles (i.e., those that paid higher rates of interest).
Let’s say you do have sporadic income. Don’t you have to, for instance, show a history of actually having made that income, previously? And if not, why not?
No, you do not. Look up the history of “liar loans” or stated-income stated-asset loans or NINJA loans (no income no job). Slarti, if you’re asking folks questions like this on the forum, I suspect you have a lot of reading to do.
If we’re talking responsibility ….
According to me, I am morally responsible for something if there’s something I could have and should have done differently that would have prevented whatever it is from happening. The “should have” is important: if I buy a lottery ticket and it doesn’t win, I could have bought the winning ticket, but given what I knew at the time, I had no more reason to buy it than any other. So I don’t think I am responsible for failing to buy the winning ticket (though I am responsible for wasting my money on a stupid lottery that it was very unlikely that I would win.)
The lottery is unlike cases in which I didn’t know some crucial fact that I should have known: in that case, while (given my ignorance) it might not be right to say that I should have chosen differently, on some earlier occasion I absolutely should have dispelled my ignorance. (Compare: once I’m driving drunk, it might be that I genuinely cannot react quickly enough to avoid the kid who runs in front of my car. But that doesn’t get me off the hook: I should not have gotten behind the wheel while drunk, for that very reason.)
If this account is basically right then, as I’ve said before, moral responsibility is not zero-sum. It can be true (a) that I am responsible for X (there is something I could have and should have done to prevent it), and (b) you are responsible for X (ditto), etc.
When we get to the further question, how much is someone to blame for X? (which I tend to gloss as: how much should we take someone to be at fault for X? How bad is their failure to do the thing they should have done?), a lot depends on how much you think we can expect of people. Here, I tend to think it genuinely makes sense to apply different standards to oneself and to others.
In my own case, I am shooting, however laughable this might be, for perfection — not in the sense that I actually expect it, but in the sense that on a math exam, you obviously aim to get allthe problems right. And this means that I have a direct practical stake in identifying and taking seriously all the problems that my conduct reveals: my mistakes are the ones I’m most interested in correcting, and these are my mistakes. So if I take out a stupid mortgage, I would of course hold myself responsible, and really try to do something about whatever led me to screw up.
When I’m considering someone else, though, attitudes that don’t make sense in my own case make more sense. The role of generosity is different, for starters: I think it’s dangerous to be too generous to myself, or to let myself off the hook too easily, in ways that it’s not dangerous to be too generous to others. (Here the ‘in ways that’ matters: it’s not that we can’t be too generous to others — e.g., letting them off the hook whatever they do, even if they kill people — but that both the fault and the degree of generosity at which it kicks in will be different than they would be if it were me I was being too generous to.)
Likewise, while when I’m considering my own case, my ultimate interest in figuring out whether and how I’m at fault is pretty straightforward (namely: to fix whatever problems exist, which I can do because I am, well, me), it’s not so clear what my interest in figuring out how others are at fault is.
It might be that the other person is my friend, and she wants to know what she’s doing wrong the same way I might, and has asked for my help. In that case, I should consider her case as if it were my own. It might be, though, that I’m concerned with a question of policy: this bad thing (people taking out stupid mortgages) keeps happening, and I want to know whether (a) our current system is just suboptimal in a way that no one is to blame for, or (b) someone (or someones) is to blame for this, and if (b), who, and to what extent. And I want to know this in order to know what fix to advocate.
In that case, the question I am interested in will be very different from what it would have been had the borrower been my friend, as above. It could be that any number of people would, if they scrutinized their conduct, find something to blame in it. (I mean, that’s almost always the case.) But when I ask this question, it’s like looking at some complicated system and asking: what part should I fix if I want to prevent this sort of breakdown? Noting that there are minor flaws in a gazillion different parts, many of which played some role in this breakdown, is often not helpful. (Here’s the difference in the question you’re asking: if you were that part, your most direct concern would obviously be whether you were optimal.) You want a system that tolerates some normal amount of non-optimality. And what you want to know on this occasion is: what prevents this from being such a system?
I think part of what is going on in debates about who is responsible is a confusion between the system-level question and the question: how would I think of myself if I had taken out that loan? If I had, I would hold myself responsible. On the other hand, when I’m looking at the system, I think that it would be unwise to design it in such a way that taking out a mortgage actually required a set of skills that most people do not possess, and could not reasonably be expected to possess. But it does not seem similarly unreasonable to say, for instance: people who are hired for very lucrative jobs precisely because they are, allegedly, very good at finances ought to see that housing prices cannot go up indefinitely (in real terms), and thus they ought not to do things that only make sense if that assumption is true.
My 2 cents. 😉
That was not my point, however. My point was that the people who claimed that anyone should be able to accurately evaluate these sorts of complex mortgages in a hostile environment were themselves unable to do a rather simple math problem.
Which kind of undercuts their (unsupported)claims 🙂
Possibly. But given the backgrounds, that all of them are out?
“My two cents. ;)”
Now, see, this illustrates precisely what I’ve been trying to say.
The market’s pricing mechanism wouldn’t know priceless if priceless rose up and bit it on the nose.
Change subject: Above, SOV’s Ted and Alice word problem is all very well as far as it goes. However, Hilzoy’s equation unknowingly leaves out crucial information which has come to light too late in the going.
It turns out Ted was lying about his age, which gives us a variable of a totally different color, and worse, Alice, formerly known as Bob, has been surgically transformed into a winsome blonde Ph.d candidate.
Bob, formerly of Bob, Carol, Ted, and Alice is a complicated person, plus, as you know, Bob’s your uncle. Not that Aunt Susie would care to admit it.
No word from Carol, yet. She’s mum, but let’s leave me mum out of this.
It occurs to me that American financial education lacks what it used to —- the great vaudeville acts turned mainstream who we learned “Buyer beware” from in movie theatres and on Saturday morning T.V, like:
Moe Howard returning change to Curly: “Let’s see, you owed me a dollar and you gave me a ten. So that’s (doling out one dollar bills) two, three, four, nine ….. and ten will do it. (Takes back a dollar) And that’s the dollar you owe me.”
Chico Marx selling Groucho inside dope on horseflesh in telephone-book-sized manuals outside the race track: “What’s the name of the horse? Wait a second, don’t tell me. I have a feeling that information is in that book under your arm right there. And it’s going to cost me another dollar, right?”
Abbott and Costello had some good ones.
Jack Benny made his career joking about the value of a dollar.
Beats watching CNBC any day of the week.
And I say again, if that’s true, then how does this make any sense:
Or is this really nonsense? Repeating that they still have the responsibility is not answering the question, that’s just making an observation of currrent practices under the law.
Please don’t squirm any more. I’d like to get past this point and on to the next one.
Always a good assumption, Turb. No, I hadn’t heard of NINJA loans or liar loans. I think it’s absolutely absurd to make full-value mortgage loans based on someone’s word that they can make payments. Common sense says that markets eventually will fluctuate, and if you’ve built your entire income stream on monotonically increasing anything, sooner or later bad news is going to come.
We’re seeing that in Florida. A great deal of our economy is based on growth, you see, and so when the growth slows down, the homebuilding slows down, people lose their jobs, and (most importantly) property values begin to slide, and so the tax base goes to hell (because our tax base is mainly property tax), and all of a sudden the state goes from a reasonably balanced budget to being a billion in the hole this year with a projected deficit for next year of $5b.
Which doesn’t sound all that bad compared with California, I guess, but we’re already closing several area schools. I don’t know what’s going to give next.
SoV:
Just as a general comment, if someone’s responses are not satisfying to you, that doesn’t necessarily mean that they’re evading, or squirming. It might mean that they don’t know exactly what it is you’re looking for, or some other thing that you’ve managed to exclude from your consideration.
Oops. Let me continue:
No, I’m not trying to be metaphysical; got no time for metaphysics. Let’s use a Charles Bronson type of example. You say that if you’re driving faster than you think you are, and you get into an accident, that it’s still your ‘fault’.
But suppose someone had jiggered with your speedometer to make it read ten miles slower than your real speed, and suppose they had switched speed limit signs so that the posted limit was ten miles faster than it should be. Finally, our evil mechanic puts an icy patch in the road just where it bends, so.
Presto! You’re going at least 15 mph faster than you should be, you hit that icy patch, skid, and roll your car down the embankment, suffering massive injuries.
Now, according to what you have told me, this accident is your fault.
I don’t buy it. Or at least, you’re going to have to be a lot more convincing than you have been.
Was the accident I described due to a ‘simple’ error in judgment? Simon points out above that really, the overall idea and intent of these complex mortgages are actually rather easy to explain – if that’s what you want to do. If you don’t, if your purpose is just to move the product, you can write obfuscatory descriptions, give misleading answers to direct questions etc.
Which – surprise! – is exactly what we observe in the real world.
So why do you think the mortgages were written in this way, and the reps coached to respond the way they did, if the purpose was not to mislead?
@Slarti: Why these riskiest of mortgages became more valuable than the safe ones is the question. Why would you pay the highest commissions for the worst risk/return ratio?
The securities-bundlers weren’t ‘paying the highest commission for the worst risk/return ratio’, but paying the highest commissions for the highest volume of mortgages.
Mortgage writers earned the highest commissions by writing the most mortgages, which they accomplished by ignoring the traditional requirements. They wrote more ARMs than fixed-rate because customers were looking for the lowest monthly payments to start with, and ARMs have those — for the first couple to five years. The customers believed they’d be able to sell or refinance before the payments blew up big.
Yes. But by doing that, you might be removing some possibilities for people who can understand such things.
I don’t know how you check of financial-understanding prerequisites, though, without taking an exam.
Three of a kind beat a pair. Or, two Alt-A’s beats one fixed-rate. At any given time, all other things being equal, the market for the traditional mortgage is saturated. The market for the new ‘products’, is not.
The other side of this is the tranches. AAA’s are already at the top; one can ‘create’ some extra fat by moving B-grade stuff into the A-range. This gives you nice little profit margin that you don’t get with AAA-material.
Apologies if I haven’t explained this as accurately or as well as I should; I’m an outsider and I get my information, like a lot of other people apparently, from Tanta. So her words of wisdom may have suffered something in translation 🙁
Possibly(with a large chunk of salt.) But they aren’t the ones to be claiming that, given their hard-nosed stance now, are they? Let’s see what develops.
Oh my – that explains a lot. (I’m not trying to be cheeky – but I admit I’m slightly open mouthed, but let me explain to the best of my understanding.)
I recently had a friend who works in a law firm as a librarian an old magazine from 1996 called “Mortgage Insight” which was a supplement to a Banker’s trade publication. Pretty much a rag, but it was interesting. It was discussing how the market in 2000’s was going to be a lot smaller and that sub-prime (B and C) loans were the only place to expand and that proper management, as well as efficiencies gained from the Internet and automated processing and risk assessment would keep the banks profitable. Seriously, only three ads from the entire magazine weren’t for non-conforming/sub-prime loan opportunities and partnerships for banks. Also, there were suggestions for mergers and selling loans to better capitalized banks so that you could make more loans. (Remember this is 1996.) There were warnings that immigrants weren’t going to be able to buy houses at the same rates.
Let’s fast forward 10 years. You have given mortgages to all the people who could put 20% down. 10% down. 5% down. 0% down, but hey they’ve got steady jobs and good credit history (this would be me and my soon-to-be ex-wife). 0% but they’ve got steady jobs and decent credit. Etc. etc. etc.
All the while the global market is screaming for more places to put its money, and so you’ve got this incredible pull demand curve. Not push (i.e, people who want to buy houses, though there’s some of that admittedly), but pull these huge hedge funds, pension firms, and other multi-billion firms screaming for more and better investments at higher and higher rates of interest.
Enter in stated income/liar’s loan where there was no validation of the person’s income. Along with NINJA loans. Yes, admittedly the people taking out these mortgages should have known better, but they are not the best and most educated – those people already have mortgages (hi!) or have stayed out of the market because they’ve seen the downsides (should have been me). So you are scraping the bottom of the trustworthy market, or rather, you’ve already scrapped the bottom of that barrel, fairly trustworthy, and are now at the bottom of the trustworthy-only-if-you-squint barrel.
This is why I place the majority of blame for the systematic issues on the banker and systems. The incentives were designed to encourage high risk, and the auditing/risk determining firms didn’t do due diligence.
I highly suggestion this video from crisis of credit.
The whole business of focusing on, and blaming, the people at the bottom of the pyramid deflects attention from where it needs to be paid: the predators of the financial industry.
At each step, corruption took hold, and it didn’t start with the people taking out mortgages. It started with the people who took mortgages, recombined them in ways that made them impossible to evaluate based on actual knowledge of the underlying housing market and creditworthiness of the debtors, and sold them as securities.
Their work was crucially facilitated by the ratings agencies, who gave these securities ridiculously, artificially, and fraudulently high ratings. Contributing factors:
1. Financial combines created after the repeal of Glass-Steagall facilitated false confidence in risky investments: the stability of one part of a business was used to justify high ratings for wild bets by another part.
2. Out-of-whack incentives: ratings agencies were (are?) paid by those whose securities they’re rating.
3. Irresponsible abdication of the agencies’ role as raters: “Our models don’t include housing prices going down” (from the Michael Lewis article). The supply was growing much faster than sustainable demand; how were prices not going to go down at some point?
This set in motion an insatiable appetite for mortgages to package, leading to the erosion and eventual abandonment of traditional lending and appraisal standards.
But even this vicious cycle wasn’t the worst of the problem, as I said in my first comment. The real damage was done the rest of the way up, entirely within the financial industry and the government that chose not to regulate it:
Way too much leverage by financial institutions holding these “AAA” mortgage-backed and other debt-based securities. Contributing factors: some explicit loosening of reserve requirements, lack of enforcement of existing reserve requirements, and inflation of asset values as institutions were allowed to abandon ‘mark to market’ accounting.
Credit default swaps: the majority were “naked”, i.e. purchased by buyers other than those holding the underlying security. The swaps were not a hedge or insurance-like instruments, just bets.
Hyper-leverage: institutions dealing in the CDSs held ridiculously inadequate reserves to cover failed bets.
Insanity on insanity: These bets, against inadequate reserves, were actually sold to other financial institutions, European banks in particular, as a way to allow them to evade their own reserve requirements.
So detailed scrutiny of the moral failings of people who took out mortgages they couldn’t afford seems very much beside the point. The working poor in this country take on a freaking ton of usurious, predatory debt: payday loans, tax refund loans, credit card debt, car loans, home equity loans. The solution to that does not lie entirely or even mainly in consumer education.
Thanks, Nell. That pretty much sums up my thoughts on the matter.
And I’m no DFH. If anyone asks me what I am, I reply that I’m an Eisenhower Republican, slightly updated.
Iow, I want to make plain that the people who are outraged by what has happened are Communists or Socialists out to destroy the system. They are, for the most part, people who believe in the system as it was explained to them. They don’t want to scrap the system, not by any means. They want to fix it.
Well-regulated Capitalism, baby. That’s where it’s at.
From the late 1970s on, a whole collection of trends hollowed out the productive parts of our economy and swelled the wealth and political power of the parasitic parts. The transfer of wealth upwards has been constant, accelerating under the last regime’s open looting and crony contracting.
Usury was legalized in 1978.
Manufacturing jobs were moved abroad.
Existing union locals were broken and new ones prevented from forming.
Tax rates of the highest-income 5% were repeatedly cut.
Wages stagnated or fell for three-quarters of the workforce.
Defined-benefit pensions were replaced by individual investment accounts (if by anything at all).
Businesses were deregulated across the board, including the financial ‘industry’. As new financial conglomerates were formed and new finanical instruments multiplied, they were largely unregulated.
This has been a predatory economy for quite a while. The current regime is no more committed to discomfiting the predator elites than the previous four; its commitment is to enacting just enough change to keep the hopeful masses making those payments.
‘Twas always thus, and thus it will ever be. On a more optimistic note, let me paraphrase someone else: Americans can generally be counted on to do the right thing, once they’ve tried everything else.
I honestly don’t know whether Obama is of and for the consensus, or whether he’s of the give ’em enough rope school. My preference was for Ms. Clinton, to give you an idea of how I thought the odds stood at the time.
I think that perhaps what you’re getting at here is prediction versus the actions which are performed in the light of those predictions. Here is something that is worth the quick read:
and:
Given that many, many people predicted what would happen when offering these sort of mortgage ‘products’ that were packaged just this way to the average buyer, I’m pretty certain I know where the bulk of the blame lays.
Way too much leverage by financial institutions…
Let’s be explicit about “leverage”. If you have $1B of capital, and you want to collect interest on $30B, you have two choices:
1. Find some Other People who have $29B and take them in as partners — e.g. sell them stock.
2. Find some Other People who have $29B and borrow it from them — e.g. sell them bonds.
The second option, leverage, is far more lucrative for you, if it works. You don’t give up equity in your operation. Whatever return you make, your ROI looks 30 times bigger — since you’re dividing by $1B, not $30B. If you’re a hireling, you can demand much bigger “compensation” based on that ROI.
The $30B of loans you make will do well or badly depending on various factors, but whether you financed them by selling stock or selling bonds is not one of those factors. Had the Other People bought your stock, they would know that their $29B was 100% at risk. But they bought your bonds: they loaned you their $29B, so they could collect interest with low “risk”.
THOSE were the “ugly loans” in this mess.
–TP
I wish I was as articulate as you, hilzoy, for you just said what I was trying to, only better and in more detail. 🙂
Tony P: The second option, leverage, is far more lucrative for you, if it works.
Which is presumably one of the main reasons why reserve requirements exist at all.
Taking a general financial management course in pursuit of my MBA you discuss a lot about financial and operational leverage. And it was interesting to listen to the professor speak about the benefits of leverage. I like the professor, and I believe that he is an intelligent and well-spoken man, but I’m not sure he had ever been pessimistic about what would happen to the markets.
Leverage is a lever. This seems tautological, but I find the basic statement helps people understand it. This means a little increase can make a huge increase in profitability; but the reverse is also true, and what seemed to be forgotten in the rush for huge profits, and demands of shareholders for 15-18% returns on investment.
Which is a huge point that I think hasn’t been discussed much – how much does this voracious need for abnormally high returns pushed planners into risky ventures, especially when combined with the short term tenures of large company CEOs.
Slarti: fwiw, I’m not in favor of anything like: requiring financial literacy tests for non-standard mortgages. I think that requiring those who issue mortgages to retain some stake in how they turn out (or something like that, something that removed any possible incentive to go for sheer volume of mortgages without any concern for their quality) would produce a lot of the same effects, without the annoying paternalism.
Which is pretty much what we had before, when we didn’t have those problems.
Otoh, not to drum up business for my own shop, but I think most of us can agree that what’s being taught in high schools to satisfy the math and science requirements are simply not adequate for the degree of basic competency that is supposed to be assumed of the ‘average’ person these days. From the non-attempts of some to solve my word problem, I’m guessing that even a lot of people who like to think of themselves as ‘competent’ . . . aren’t really all that competent as far as juggling figures are concerned.
We’re going to have to stop agreeing like this, hilzoy. People will talk.
DecidedFenceSitter: how much [did] this voracious need for abnormally high returns [push] planners into risky ventures
Quite a bit. Tom Geoghegan’s point about unlimited interest rates (linked also in a comment by me above) is that they habituated corporate planners to rates of return not available in actual productive industries, thereby sucking money away to the financial sector.
Just came across a window open to Frank Partnoy’s new afterword to his recently republished F.I.A.S.C.O., a blood-freezing cautionary tale from 1997 about derivatives and the damage they can do. (Like Sen. Dorgan’s 1994 book on the same theme, only with insider detail and lots of drugs and sex.)
Partnoy’s new afterword is as clear an explanation of the events behind the recent collapse as I’ve come across. Did someone cite it on this thread? I wish I’d seen it before making my first comment to Slarti, because it makes my exact point only much more authoritatively and colorfully:
Partnoy’s account of the way in which his warnings were blown off so often reinforces my pessimism that the regulatory or political changes necessary to prevent a replay will be forthcoming.
We’re all about looking forward and not criminalizing policy differences, eh?
The ratings agencies’ top people should be on trial every bit as much as Dick Cheney and the rest of his gang.
Nell: “and lots of drugs and sex.”
So, let me get this right. Not only did the Masters of the Universe score with the bonuses, but they did lots of drugs and had lots of sex …..
….. meanwhile, out here in chumpland, nice couples got married, bought too much house with too much mortgage, cut back on the drugs to pay the mortgage, and stopped having sex to work two or three jobs ……. and because they got married.
I think future regulatory regimes should require mortgage brokers and loan officers to explain this arrangement to prospective borrowers.
(Although, I read in the New Yorker that lots of drug money in Florida was laundered through subprime mortgaged real estate)
Due diligence. This is calculus the average schmoe can understand.
>>Kind of reminds me of the old line, “Some people are born on third base and go through life thinking they hit a triple”.
Sure, there are folks like that. But they aren’t people who work for a living — i.e., who make the money that they need to live based on what they do today [and not] based on what someone [else] did yesterday.
But that’s not how a liberal sees it. I’m not trying to convince you or tell you you’re wrong, but if you want to understand how other people think, you’ve got to be able to look at things as they appear from the eyes of someone without that sense of entitlement.
From where I sit, things look pretty arbitrary. 80% of families in a given income quintile are going to be in the same quintile or one step higher or lower a decade from now. There isn’t much social mobility in America compared to Europe or other industrialized countries, and there has been less each year since the early ’70s.
Luck matters. People who graduate from college during a recession have measurably worse future prospects than people who graduate at the top of the business cycle. Physically attractive people get hired before ugly ones. Some of the kids I hung out with as a kid died in front of me for making the same mistakes I enjoyed making. Some of the kids I hung out with as a kid enjoyed long prison terms for making the same mistakes I enjoyed making.
Class matters. Many women won’t date a dishwasher, even if he is a very intelligent, kind, and hard-working dishwasher. There are soccer moms who will not allow their children to sleep over with children who live in an apartment rather than a house (not to try to bring things back on topic or anything).
When I look at where I ended up career-wise, I think, “What a god damn lucky thing”. Do I “earn” what I earn? Sure, but I don’t think that it has nothing (double negative, I know) to do with what other people did (or didn’t do) yesterday. And a lot of it happened in spite of things I did, not because of them.
Somewhere out there, there is a lottery winner with a “system” for picking the winning number who is thinking, “You losers, I told you so”!
But me? I was born on third base, then I stole second, then I ran around like a moron in the outfield for a while, then while the umpires were trying to decide if that was even legal, I snuck into the stands and got a beer and some peanuts.
Nell: The securities-bundlers weren’t ‘paying the highest commission for the worst risk/return ratio’, but paying the highest commissions for the highest volume of mortgages.
Not exactly, as banks and mortgage brokers did pay more for option ARMs during the bubble. See this Business Week article from 2006:
Also, as mentioned earlier, option ARMs also had the added benefit of allowing banks (or whoever holds the loans) to book revenue in advance. Again from the Business Week article:
“Financial Advice Causes ‘Off-loading’ In The Brain
ScienceDaily (Mar. 27, 2009) — A study using functional magnetic resonance imaging (fMRI) shows that expert advice may shut down areas of the brain responsible for decision-making processes, particularly when individuals are trying to evaluate a situation where risk is involved.”
Nell: This has been a predatory economy for quite a while. The current regime is no more committed to discomfiting the predator elites than the previous four; its commitment is to enacting just enough change to keep the hopeful masses making those payments.
The adminisration still might support cramdowns on troubled loans, not only to save homeowners but also to avoid yet another huge US taxpayer bailout of the banks. While not as large a problem as subprime loans, option ARM loans represent a 500-750 billion potential wave of bad loans that is only now breaking on the economy as the loans begin to recast in large numbers.
How many option ARM borrowers would qualify for such treatment given pressures to punish fraud remains a question, particularly since 83% of Countrywide’s option ARM loans (Countrywide was the most profligate purveyor of option ARMs) reportedly provided little to no documentation. Some might see such efforts as attempts to extend debt servitude; others might see these as attempts to keep people in their homes. Either way, defaults on these loans punch additional holes into banks’ balance sheets.