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March 27, 2009

Comments

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:

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.
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 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.

Posted by: Slartibartfast

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.

Someone else recently made the observation that these too-difficult-to-understand contracts are everywhere these days.

[snip]

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.

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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Why would you think that the average person is capable of understanding a fixed rate mortgage agreement?

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?

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.

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.

I mean, if you want to foist a crappy bad loan on someone rather than a good loan because you'll get extra cash

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.

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.

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.

If you are selling off the loans after making them, the only thing that matters is volume

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.

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?

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:

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.

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.

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.

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 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).

Posted by: Ravi

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.

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.

Posted by: hilzoy

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.

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.

I suggest that this is what slartibartfast is really talking about when he says this:

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.

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.

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.

Posted by: von

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".

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.

Posted by: TheWesson

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.

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".

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.

Hilzoy wasn't rewarded with her (considerable) professional status or good reputation as a blogger. She earned both.

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.

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.

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.

[email protected]: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.

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