Should we blame the borrowers?

[Jeff Marshall]

Hi folks.

I recently got into a shouting match at work with another free market supporter like myself. Our disagreement centered around who to blame for the current financial mess. I argued that government intervention is the sole culprit. The other guy argued that the blame falls on the borrowers first and foremost because they should have known what they could and could not afford. I've always been better at arguing when I type it out so below is my response to his opinion which I sent to his email. Could you expert Objectivists let me know if I'm off base here?

100% loans, reverse amortization loans, interest only loans, sub prime loans, etc. were all made possible by government legislation subsidizing the risks banks took when issuing these loans. Like Glenn (the guy I argued with) said, decades ago no bank would lend to anyone without a 20% down payment. They were obviously protecting their investment in the borrower and hedging their risk by forcing the borrower to have equity in the home. Do you think that's because borrowers "back in your day" were smarter? Absolutely not, it's because they didn't have the opportunity to put less money down, which they gladly would have. Under the cloak of "affordable housing", government over many years slowly lowered the risk to banks for lending their money to less financially acceptable borrowers. It soon become profitable for banks to lend to 100% borrowers because the federal government (Fannie & Freddie) took the additional risk, not the bank. This led to more risky homeowners and super-inflated home prices.

I think we both agree on the cause of the problem. What we disagree on is how to fix it and whose to blame. You blame the homebuyers for obtaining a 100% loan but not the government for forcing/enticing the bank to make that loan. There are already financial repercussions to the borrowers for defaulting on loans; Credit score and bankruptcy. Under your thought process, you believe all borrowers should "do the right thing" and only borrow what they can afford. Well, as the bubble (home values) inflated due to Fannie, Freddie and the Community Reinvestment Act, they could afford it. Under normal circumstances (no government coercion), the bank would have never lent money to that borrower therefore avoiding the future foreclosure. That's why it is the lenders fiscal responsibility to lend to acceptable borrowers, and that process (underwriting) is destroyed when government is forcing them to do otherwise. Have fun blaming the borrowers, but that'll never solve the problem.

The current foreclosure mess is not the fault of the borrowers. It is the fault of the government. If I asked you three years ago if a $800,000 appraised house would be short-sold for $350,000 three years later, you would have told me I was out of my mind. How can any borrower plan for something like that? How can any bank plan for something like that? The answer is they cant because under normal circumstances the home would have never been worth $800,000 and the bank would have never made the loan. The entire stock market couldn't plan for it either, which is evidenced by the fact that the stock market dropped 6000 points in 1 year. There is always going to be borrowers who default on their loans for whatever reason. Normally, that risk is priced into the interest rate and the down payment. A small percentage of the current defaulters deserve it, due to the size of this problem, most are in their position as a direct result of government interference.

I do blame borrowers in trouble for credit card debt but that is hardly the same thing. Impulse buys on credit cards when you can't afford it should be punished, which they are. Banks close their cards and destroy their credit score. As far as I know, banks aren't currently forced to open credit cards for unacceptable applicants.

Sure, the average borrower should assume that getting a 100% negative amortization loan is a bad idea. Your solution is for the average borrower to get smarter. My solution is for the government to get smaller. As sad as it sounds, I don't see the possibility of either one ever happening.

[Mammon]

Hi Jeff Marshall, welcome to the forum!

I have to admit, I only read the first paragraph of your post because it's late, but my "expery Objectivist opinion" says that the blame rests with both parties. The government, more specifically, our monetary policy makers at the Federal Reverse, have made credit cheap and easily available for people to use. And some people used it. Some used it wisely and some didn't.

Americans have a made a habit of leaving outside their incomes, and the government has encouraged that through our policies.

That's it in a nutshell.

[softwareNerd]

Hi Jeff,

You seem to have it covered.

If I asked you three years ago if a $800,000 appraised house would be short-sold for $350,000 three years later, you would have told me I was out of my mind.

Good concrete. The principle is that the government's activities tamper with the "price-mechanism" of the market, and often in ways that make the details very difficult to unwind. Some economists -- e.g. Yale's Shiller -- were making the case that real-estate was over-valued; but, there was no clear consensus among experts. Many companies, run by businessmen with lots of experience, were investing their own money in ways that would be unreasonable if people like Shiller were right. When experts disagreed so much, how can one expect a layman home-buyer to make a better than average guess? That would be no different from asking him to have out-guessed the stock-market, foreseen that it would crash, and gone to cash.

With that said, certain home-buyers and others also have their share of blame. Some people took deals that were unreasonable by "lay-person standards", that every reasonable home-buyer ought to understand. But wait... here too, the government is not completely off the hook. In our current system, the government has actually got into the business of making sure that things are reasonable: whether it is with interest rates, food supply or new drugs. The government has usurped the role that ought to be played by private entities, and has created a false sense of security and complacency that simply could not exist if it was clear that the the "emptor" needs to take "caveat emptor" much more seriously.

Still, even within that framework, there were people who acted very unreasonably: certain home-buyers and certain financial companies. Ideally, they should bear the cost of their mistakes. Instead, the government will try to cushion much of it. In doing so, the government simply creates one more layer of problem: years from now, wouldn't a reasonable market-participant need to take into account the probability of being bailed out? i.e. the whole "moral hazard" issue.

[D'kian]

Financial literacy is rare among most common people. Most of us learn it only through experience, by handling a chackbook, credit card, car loans, etc. Then you realize three credit cards are two too many, and that making small payments puts you in worse debt for longer, that borrowing from one card to pay another is worse than lapsing on one payment, etc, etc.

So if you take someone with little experience in his own personal finances, who may not ahve a credit card even, or ever taken a loan, and tell hima about no-money down loans, interest only laons, and so on, he will think he's getting a great deal and will take it.

So, is it his fault?

At least it is partly his fault. One should know about finances before taking out a loan. On the other hand if the schools don't teach you about it (I heard very little about finances in school), and the banks tell you there's no risk, everything's fine and he'd be a fool not to take it, well, they share in the blame too. And the government for making it all possible.

There's a good rule of thumb. Read the loan agreement/contract before deciding to take it. If you don't understand it, get someone to explain it to you. If you do't understand what you're getting and what you're required to pay and when, you shoulnd't take the loan.

[John Donohue]

Everyone here so far obviously understands the situation. I'll add one more thing, not a counter to anyone's argument:

I am close to the ground here because of a business I am in that sells an education product directly to loan officers, bankers and brokers.

The warping of the natural operation of the market set free this little devil, and this is not even a deliberate fraud attempt:

Borrower: "Well, if this loan officer has looked at all my information, and he and the bank's underwriters, who are professionals, tell me I am qualified, I must be. They are so experienced, they are not going to lend to me if I am likely to not be able to pay them back. I have this nagging little question, but I think I'll just park it since those above me are not worried; let's go for it."

Loan Officer: "Well, I can get this guy qualified and I have a product for it. The lender would not have made this product available unless it was reasonable and they can make money on it. I've laid out all the realities to the borrower and asked him if all his data is accurate. I've also asked him if he feels comfortable with the payment and schedule. He hasn't said no. I am following the rules so it must be okay."

Lender account executive: "Well, our people have told us this loan is a real, legitimate product. They wouldn't release it to us sales people if it did not make economic sense all around. Since it is good, I'm really going to push it and make everyone some money."

Underwriter: "The load officer has filled out all the forms properly and the numbers work out okay. The loan officer wouldn't lie, because the blow-back from a failed loan due to false information would ruin his reputation. Moreover, this loan fits into the criteria to slip right into a package of loans we are about to put on the market to Wall Street. They wouldn't buy our package if the guidelines they set were too loose, since their investors will want some assurance they are stable."

Wall Street bundler: "Okay all the loans in this bundle probably fit the guidelines; the initial lenders know they are responsible for assuring that. There are quite a few exotics in here, but so far our investors have not minded that; they think we know what we are doing and the value of the collateral keeps going up."

Investor: "The government cares about housing. Notice that tax breaks on it. They really want people to get into homes and are behind it. The yield is high on this bundle, and the government is backing it. How cool!"

etc. etc.

Because of the interference of the cartel/government power brokers, the vividly intense cleansing power of a true capitalist free market was missing. The urgency, the fierce drive to both protect the wealth you've already created and to earn more by risking exchange of value....this is absent. In the back of all the player's minds was: someone must know better than I, and anyway, I am not the only one taking care of me, there is a safety net paid for by others. Behind it all is the government.

In nature, an animal with that mentality is lunch for a predator.

That is exactly what happened.

P.S. now that the game has imploded, a re-construction of what constitutes fraud in the mortgage industry is happening as we speak. Much of the above, which was once not considered fraudulent, now is or will be.

John Donohue

Pasadena, CA

[dadmonson]

Anybody know the long run consequences of the artificial record low interest rates?

[utabintarbo]

Anybody know the long run consequences of the artificial record low interest rates?

In a word: inflation.