… The White House may well be right that a moratorium would further rattle investors. But the economy is not going to rebound until the housing mess is resolved. What is needed, urgently, are laws and policies to give homeowners a better shot at reworking their loans so they can keep making payments and avoid foreclosure. Throughout this crisis, the Obama administration has been far more worried about protecting the banks than protecting homeowners. The big weaknesses in the administration’s main anti-foreclosure policy is that participation by lenders is voluntary and homeowners have little leverage to get better terms — especially reductions in loan principal when the mortgage balance is greater than the value of the home.
One way to change that would be for Congress to reform the bankruptcy law so troubled borrowers could turn to the courts for a loan modification if banks were uncooperative. Homeowners also need a simple process to challenge a bank if it uses incorrect information to deny a modification and justify a foreclosure, or if it refuses to divulge the facts and figures it used. The administration also needs to alter refinancing guidelines so that many borrowers who are current in their payments are eligible to refinance to lower rates, even if their houses have declined in value. It needs to provide more legal aid to homeowners, using money authorized by Congress.
This latest foreclosure crisis should settle one issue once and for all. The banks that got us into this mess can’t be trusted to get us out of it. The administration and Congress need to act.
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the borrower: I want to buy a home. I really have no real clue of what I can afford, or if I can even afford to buy a home. So I go to a Bank, and they tell me I can afford to buy a home that costs x amount with a loan that costs such-and-such per month. They look at my credit history and income and decide if they would lend my the money to take out a loan.
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the lender: I’m in the business of making a profit on loaning money, which means that I need to become an expert on how much a given person can borrow, and likely pay back. The forces that drive me are that I am only making money when it is loaned out – unless I make bad loans that default and I have to foreclose. Then I usually lose money.
As a non-financial person, naive to the ways of money, I’ve counted on the Bank’s self-interest in my paying off my loan to help me make my decisions. So it seemed win-win the way it was. The Bank lending me the money was invested in helping me make a realistic decision. Their mistake is their loss. When the Bank was dealing directly with me, they shouldered the risk of the loan. Too many risky loans and they were toast. Too tight the control on their lending and they made no profit. It reminds me of a code of morality for businessmen I recently read:
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"It is precisely the ‘greed’ of the businessman or, more appropriately, his profit seeking which is the unexpected protector of the consumer. It is in the self-interest of every businessman to have a reputation for integrity and a quality product. A company cannot afford to risk its years of investment by letting down its standards of quality for one moment or one inferior product; nor would it be tempted by any potential ‘quick killing,’"
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| Alan Greenspan [1963] |
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the borrower: I want to buy a home. I really have no real clue of what I can afford, or if I can even afford to buy a home. So I go to a Bank, and they tell me I can afford to buy a home that costs x amount with a loan that costs such-and-such per month. They look at my credit history and income and decide if they would lend my the money to take out a loan.
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the lender: I’m in the business of making a profit on loaning money, which means that I make loans, then sell them to somebody else, along with the risk. The amount I get for the loan depends on some rating of the risk made by a rating agency. So my profit is determined by making a lot of loans and selling them, minimizing their risk if possible. I might even coach my clients on how to fill out their applications, "helping them" get their loan. The more loans I make, the more loans I have to sell. The more I help people look less risky, the more I get for the loan.
As a non-financial person, naive to the ways of money, I’ve counted on the Bank’s self-interest in my paying off my loan to help me make my decisions, but that confidence is badly misplaced. If anything, I need to be vigilant that the Bank doesn’t allow me to borrow beyond my means, and I’m not really in a position as a young buyer to know how to determine that accurately. Worse, the Banker is in a position to underestimate the risk, because they aren’t directly involved in shouldering that risk. Speaking of Alan Greenspan:
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“What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” Mr. Greenspan told the Senate Banking Committee in 2003. “We think it would be a mistake” to more deeply regulate the contracts, he added.
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| Alan Greenspan [2003] |
That makes absolutely no sense at all. If the people making the loans aren’t going to have to deal with the risk themselves, and they are given an incentive to make lots of loans and make their profit by minimizing risk, it doesn’t matter one little bit what happens after that. It doesn’t matter what exotic ways people find to "hedge" the risk. Somewhere down the line, the "risky business" will catch up. And the cascades of increasing risk won’t hurt the people who took it. For example, Joseph Cassano, manager of the Financial Products unit in the London Office of A.I.G. sold the Credit Default Swaps that shouldered the risk on a lot of CDO’s where these risky Mortgages ended up. He was paid an average of $26 M yearly for his expertise. When everything collapsed, the US Government took ownership of A.I.G. and paid off the debt. Joseph Cassano kept his $208 M and lives in an expensive flat in London. I guess he was one of "those who are willing to and are capable of doing so."
I disagree with only your last statement that MBS have not served us at all. If it was not for the capital provided in this market it would be very difficult for many people who should qualify to get a mortgage. The other difference between the 20’s & now is that the banks don’t control most of the available capital anymore. Most of it is produced in the private sector and they are in turn purchasing these investments from the banks in packages that included both good & bad loans. They overlooked the quality of these investments which I can only imagine is due to getting a little careless during the boom years. One way or another underwriting guidelines should have been tighter regardless of how much capital the banks had access to.
Mickey, your talent for explaining complex things in a simple way really shines here. Thanks for writing this.
What keeps hitting me in the face, on the face, of it, is Greenspan’s reasoning in the last quote: “transfer risk from those who shouldn’t be taking it . . . ”
Why should our system make it possible for people to take risks that they shouldn’t take? I suppose that makes a little sense, like all insurance programs, of “spreading around the risk.” But that’s about insuring against the unpredictable bad luck or bad weather, etc.
Here we’re talking about people being able to get something that they really cannot afford. It’s not just risk they can’t afford; it’s the product they can’t afford. It’s buying a house that’s too expensive for this particular person’s income, and they really shouldn’t be helped to do what they can’t afford to pay back. Any means that tricks them into it should be condemned, not fostered.