One of the topics that I write about with some frequency is bankruptcy. And as with the current financial crisis, what's amazing about bankruptcy is how many people are willing to spend how many hours debating whose fault it all was. Were the people who borrowed the money irresponsible, or were they taken advantage of by unscrupulous lenders? Do the people who backed the reform want to help credit card companies rape innocent consumers, or did the people who opposed it want to help deadbeats shrug off debts for the fripperies they acquired? The main object in all of this seems to be to get the mob good and mad so that we can pick up a stick and whack whatever villain we've identified.
Almost no one ever steps forward and says, you know, hey, it might not actually be anyone's fault. Sometimes, bad things just happen. And at any rate, who cares?
It's surprising how often everyone in the debate over bankruptcy loses sight of a simple fact: bankruptcy is the legal recognition of the fact that a person or corporation cannot meet their obligations. It doesn't matter whether they spent the money on worthy education or a stupid attempt to corner the Pez market, or a giant-flat screen television; whatever they spent it on, it's spent, and their current income is not enough to pay it off. Nor is it relevant that they might not have borrowed the money if they'd been smarter or better read, or whatever; the did borrow the money, and spent it, and now they owe it. I'm not talking about fraud here, clearly; any borrower who lied about their finances, or lender who misrepresented the terms, deserves whatever they get. Just normal kinds of stupidity, venality, and unlucky accident.
It matters prospectively, of course: we don't want other people to get the idea that they should borrow, or lend, without thinking things through. But the current system works pretty well. Recognizing that we don't have any very good mechanism for picking out the profligate from the unlucky (most bankruptcies involve a little from Column A, a little from Column B), we let people get rid of their debts regardless of how they were incurred. (Except for special exceptions, most of them involving the government, such as taxes and student loans). Then, recognizing that it is not a good idea to make it painless to borrow money you don't repay, we make life a little bit miserable for people who declare bankruptcy--though not very miserable; the chief result is that it's somewhat harder to get credit. It's hard to overstate how well this works. America's bankruptcy system is the most generous to the debtor, the least interested in assigning fault, in the entire world. There's strong evidence that this is one of the reasons behind our high rates of entrepreneurship; it makes it easier to take economic risks. And yet we also have (until very recently) the most robust consumer credit market in the world. Why start assigning blame, when ignoring the question has worked so well?
I feel the same thing, writ large, about the housing crisis. Most borrowers probably borrowed in good faith, and most lenders probably lent in good faith; I've seen no evidence that the anecdotal fraud was widespread. The banks that securitized loans genuinely thought they were doing a good thing by spreading credit risk; the hedge funds and others that bought them genuinely thought that they'd accounted for default risk. So who cares about placing blame? At the end of it all, we'll still have a housing crisis. We'll still also have moral hazard, but that's an argument for making things a little unpleasant for anyone we bail out, not an argument for letting them drown.
Well, it seems you still can't post a link in the comments, so I would just recommend Andrew Leonard's latest "How the World Works" post at Salon, for a different opinion on predatory lending. It's a good capsule on bankruptcy reform and predatory lending.
For the record, I was against the bankruptcy reform for the same reason: there didn't seem to be any compelling economic reason for it, other than a feeling on the part of lenders that it just wasn't FAIR!
As for Leonard's article, I see two possibilities:
1) The borrowers don't need the money. I am very, very uncomfortable with deciding, in my olympian wisdom as an upper-middle-class white person, that poorer people with less education should be forcibly prevented from borrowing for their own good.
2) The borrowers do need the money. In which case, we don't make them better off by prohibiting banks from lending to them.
I am definitely NOT for bringing back debtor's prison, but a little more discomfort would be good. As a landlord, I've had good luck (with one notable exception), but that exception seemed to easily live with herself through multiple iterations of lies and fabrications. The onus continues to be on me (using our legal system) to now force her to recognize her sins which she steadfastly refuses to do. Her penalty seems light - credit more difficult to acquire over 7 years (if she changes her ways now).
Despite my dismay over my situation, I must agree with Ms. Megan that the system is probably about right because the alternatives seem too drastic. My former renter deserves a chance to let the market observe her behavior and allow redemption. In the meanwhile, I'll keep hoping to get my money....
Isn't it easier for corporations to declare bankruptcy than for individuals? Is that fair?
Two observations:
For commercial borrowers, it is VERY much harder to get credit if you have had a bankruptcy in the past.
Megan implies that spreading credit risk by securitizing mortgage loans wasn't a good thing. Why not? To the extent that the losses on subprime mortgage loans have been moved from federally insured depository institutions to wealthy hedge fund investors, why isn't that a good thing?
Thinking more on "..bad things happen..".
Yes, they do, but more often there's also been very little due dilligence on the part of borrowers in examining what bad things MIGHT happen. This is why you should ACTUALLY read the mortgage documents when you're at the closing for your new home.
'Most' seem to believe that the risks are taken on by others because they are paid to do so, or that the risk would be drilled into them because of some legal requirement. Of course, this is not true (ok, yes FNMA/GNMA do take on some of this risk on our behalf). This is why my sympathy for those suffering ARM Adjustment Syndrome is low. It's all spelled out in those documents. Real estate closing attorneys should be explaining, in detail, the risks instead of hurrying to the next closing. No doubt if they were paid by the hour and not by the deal, they would be. And if more legal documents were required to be written in a more straightforward way, debtors and creditors would all be better informed and better off. Isn't more information better?
In the meanwhile, there will be bargains galore for those not yet owning.....
I largely agree with you on the relative (lack of) usefulness on apportioning blame. However, a couple years ago a major bankruptcy law that clearly favors creditors went was passed by a Republican Congress. In that context blame matters a great deal. What did you think then?
This is really going to demonstrate my naivete and ignorance. But can someone explain to me what actually inspires people who are in serious debt to go into bankruptcy? What I mean is, what actually is seen as so bad about being deeply in debt that forces their hand. Is it the calls, or visits from debt collectors? Or do they get taken to small claims court? Can creditors garnish their wages, somehow? It seems to me that if you aren't particularly fazed by the harrasment, there doesn't seem much that creditors can do. But like I said, I'm ignorant to the process.
"It doesn't matter whether they spent the money on worthy education or a stupid attempt to corner the Pez market, or a giant-flat screen television"
"But the current system works pretty well."
When Dr. 90210's patient's I.O.U. gets sausaged into the a Mezzanine tranche of an ABS and stuffed into the under-funded pension plan of Bobby Bureaucrat, what do you tell lil' Johnny College Grad trying to pay off his student loans/buy a car/take care of the 'rents in the face of the imbedded tax hike to payoff BB's PF Mgr.'s breach of Fiduciary Awareness?
Direct comparisons between bankruptcy and the housing crisis are somewhat misleading. Bankruptcy has many causes, but one common theme is irresponsibility. Most - by no means all, of course - people who file bankruptcy showed some degree of irresponsibility in running up excessive debts. The key element behind the now-popped housing bubble was not so much irreponsibility, though I suppose it was a mild form of that, as a naive belief that prices would keep going up and up and up.
The problem, as I see it, is not that permissive bankruptcy laws hurt creditors (theoretically, they shouldn't hurt creditors in a competitive market, should they?), but that they raise the cost of credit for responsible borrowers. My private student loans have rates of 8-9%, because, unlike federal loans, they are dischargeable in bankruptcy.
Also, I don't think it's correct to say that people who file for bankruptcy can't pay their debts. They can't pay all of their debts, but usually they can pay some of their debts.
This is where the issue of fault comes in. If bankruptcy is generally the result of bad behavior, we can reduce the incentive to engage in that kind of behavior and also make life easier for responsible borrowers by making it harder to discharge all of your debt and easier for creditors to collect some of it.
Also, I suspect that there are many people for whom ending up with bad credit really isn't much of a disincentive. In any case, it's certainly a less efficient way of making people miserable than garnishing their paychecks.
I'm glad to read this:
So who cares about placing blame? At the end of it all, we'll still have a housing crisis.
...but this part
Most borrowers probably borrowed in good faith, and most lenders probably lent in good faith; I've seen no evidence that the anecdotal fraud was widespread. The banks that securitized loans genuinely thought they were doing a good thing by spreading credit risk; the hedge funds and others that bought them genuinely thought that they'd accounted for default risk.
...seems a lot like the end of "The Music Man", where it turns out that, sure, he was conning everyone, but they were happy being conned! So where's the harm?
This is really going to demonstrate my naivete and ignorance. But can someone explain to me what actually inspires people who are in serious debt to go into bankruptcy? What I mean is, what actually is seen as so bad about being deeply in debt that forces their hand. Is it the calls, or visits from debt collectors? Or do they get taken to small claims court? Can creditors garnish their wages, somehow? It seems to me that if you aren't particularly fazed by the harrasment, there doesn't seem much that creditors can do. But like I said, I'm ignorant to the process.
Yes, most states allow garnishment of wages depending on the debt. Some states allow debt collectors to file leins on your house. Garnish your bank account. You name it. So there is a good reason people file bankruptcy. As you may know, a lot of people file because of health care related debt(which means that bankruptcy and housing can't be compared that much).
Megan_McArdle's perplexity regarding the blame game should be pretty easy to rectify. I'll type slowly:
1) People want to know who's at fault because it's helpful, though not sufficient to determine what if anything should be done.
2) This does not overlook the fact that maybe "nobody" was at fault; but you have to look.
3) Even if it were the case, that nobody was at fault, that still doesn't mean homeowners are entitle to ANY help with my money. When you buy a home you take risks -- INCLUDING RISKS YOU HAVE NO CONTROL OVER. The fact that you have no control over them, is no claim on my money.
4) Most subprime mortgages were speculative investments, the buyers hoping to flip or otherwise receive and easy profit. Why the hell else would you take a mortgage at 10%, or an adjustable when you haven't even worked through the obvious results at the adjustment phase?
Keeping 3) and 4) in mind: Last Christmas, I lost some money (thought not much since I got a refund) trying to scalp a PS3 when I happened to be in a store that got a rare delivery. Was I unhappy? Sure. Were there a lot of people like me? Yes. Did that entitle me to other taxpayers' money? NOPE! The only difference between me and the subprimes is that my speculation *at worst* deprived a kid of a fancy toy at Christmas. In contrast, irresponsible bubble buyers have significantly forced up living costs for EVERYONE.
Hold them accountable for whatever the contract says.
Well, the other differences between you and subprime borrowers, Person, are that the loss you sustained on that PS3 isn't going to make you and your family homeless, and that there weren't so many people who took out massive loans to buy PS3s in the expectation of scalping them that their abrupt inability to repay those loans resulted in a worldwide liquidity crunch, while the prospect of their defaults threatened to plunge the US and possible the rest of the world into recession. Also, I doubt anybody sent you spam or made cold calls to your house begging you to accept a loan in order to run out and buy PS3s in the expectation that their value would rise forever.
Other than that, you're totally right.
So I see a number of posts have come in since I wrote below, so take it for what it's worth... I certainly hope that most of you who think it's all about irresponsibility, never have to go through it... because having your eyes opened in that way is most painful...
The thing about bankruptcy is that it happens a large percentage of time for medical reasons, and from divorce. The two easiest ways to have all your net worth destroyed. In the one case nobody will let you die, but they may charge you more money than you have a hope of repaying EVER. If you are really sick, with Cancer or AIDS, you may not be able to work, and then, double wammy.
In divorce [and yes this IS personal experience] Courts can assign you to pay more than you can afford in alimony and child support. The laws are written SPECIFICALLY to say that your consideration of children TRUMPS EVERYTHING ELSE. If your ex is a deadbeat or goes the under employed route the weight is shifted to the partner with the job, regardless of their total ability to pay. If you inccur a lot of debt in the divorce, you face the unenviable task of deciding WHO to pay, since everyone has their hand out. You can certainly pay a lawyer to try and get the table re-balanced, but it's a gamble. AND if you are broke, how can you afford the lawyer?
It's hard to talk to people who have gone through bankruptcy because for the most part they don't mention it or want to talk about it. They feel shamed, because they couldn't carry it all, because they couldn't figure a way out.
As with most things, people only remember the bad, never the good. So people who are serial filers are legend, but I'd be surprised if they number more than 1%. [unless they are business people, who finance business personally]...
But people, and congress, obviously, both only remember the few multiple filers.
Because of the shame, and the difficulty, most people try and hold on far too long, when there may have been another way. And THEN you have sharks swimming arout promisisng you debt reductions, only to vicitimize the very people who need help.
Are you seeing the downward spiral?
When a corporation does this, there is almost no persoanal accountability. For an individual that's all there is.
The previous law was probably better, but it's been changed, and I doubt anyone in congress has the cajones to go back. The current law is still useful, just more difficult.
From what I see, a lot of this has to do with how the rules have changed over time. Time was that you couldn't buy a house without 20% down, and no more than 25% of your take home in mortgage. Credit cards were hard to come by, and like the house, it was tied to a real credit decision.
In the interest of profit, that all changed. Now you can get that credit card with the low intro APR, and then later, if you sneeze wrong, they can jack that APR to 32%. All in the name of helping you "pay it down". Yes I actually had that happen and yes the rep actually said that. Even when the company [Chase] agreed that they had made a mistake, they wouldn't give me the low APR back. So I cut the card up. After having had it in good standing for 20 years. They offered me the low APR because I had no balance, but when I needed to carry one, they went the other way, regardless of being a good customer.
It may seem relatively easy to do bankruptcy in this day and age, but I think if you dig a little and see how it affects real individual people, you might come to realize that it isn't. There just isn't an easy answer.
brooksfoe - Your case would be stronger without the spam and cold call comment...both of which are propagated by evil-doers.
Yet, I agree with the overall point...to a point. My earlier comment suggested that *some* consumers weren't too zealous in evaluating the risks. Buying a home with a 30 year commitment (or any of its variations) should have entailed some due diligence. If you lack the ability to read and understand the documents, or at least ask an attorney to explain it, then...well...why should the taxpayer be asked to then make up for that. Renting is not a sin, and those who do can spend the time they don't spend fixing-up their home reading up on mortgages.
brooksfoe: The fact that equate "renting" with "homelessness" was all I needed to know about the merit of your post.
Unfortunately, many people debating a bailout have the same misconception :-/
Correction: that should read "The fact that you equate..."
brooksfoe, I hope you would concede that any policy to provide additonal assistance to those who have freely chosen to take out loans that led them into bankruptcy will increase moral hazard. The more you shield people from the consequences of taking risks, the more likely people are to take those risks.
It might still be worth doing, but those who propose any such assistance ought to be frank about the costs associated with their proposals. We live in a world of trade-offs and it won't do us any good to pretend otherwise.
Yeah, it increases moral hazard. But what we're now discussing is mainly who the bailout should be directed towards, not whether or not there should be a bailout -- we all know the bailout will happen in order to rescue the economy (since a recession would also punish those of us who didn't take out foolish mortgages; we should not be made to suffer a recession brought on by those who did). And, with regard to this inevitable bailout, I think that lending institutions have the resources and the incentives to identify people who are not good credit risks, and bailouts targeted more towards lending institutions than towards homeowners will probably create greater moral hazard and will send money to people who really don't need it. Also, I don't see why people have such a metaphysical problem in naming con jobs; these 100%-plus mortgages with low initial interest rates that skyrocket after a few years were simply a con, and would be recognized as such if only they came verbally from a guy with a thick mobster accent. There's nothing strictly illegal about a good con job, either -- that's the whole trick of it.
Other than that, I think most of the points I've seen Megan raise have been pretty solid and interesting, especially the problem of the unfairness of the government helping out foolish borrowers while not helping out smart ones.
Hm, if what we're concerned about is: a) moral hazard, and b) broader financial collapse, I think I have a GREAT idea.
a) bailout all homeowners who would otherwise have to be foreclosed, by paying them what they need to stay afloat
b) increase marginal tax rates on everyone who was bailed out -- say, 5%.
c) divert that money to every household that rented and did not buy a home between ~'04 and the present, in proportion to the cost of living in the area.
Then we've got all bases covered:
a) no broad economic collapse
b) we still reward those who were responsible and punish those who weren't
c) those who were bailed out will work the same, because it's just a stupid right-wing crank theory that any of those people would in any way work less in response to taxes.
Sounds like win, win, WIN!
Who's with me?
I don't believe that anyone is entitled to a bailout. For one, consumer lending is already highly regulated and the loan docs are not legally enforceable unless they clearly spell out all of the pertinent details of the loan, especially the rates. I don't have much sympathy, nor do I feel compelled to pay for the ignorance of borrowers who sign docs that they don't understand, through either a direct taxpayer funded bailout or through higher borrowing costs that increased regulation would bring (the lending institutions will pass the regulatory costs directly to the consumer.)
As for the investors, they clearly understood the risk they were taking when buying sub-prime paper and were paid higher returns for bearing the risks. Caveat emptor.
MM posits:
"We'll still also have moral hazard"
I wonder, by which mechanism is she referring?
judson: "Isn't it easier for corporations to declare bankruptcy than for individuals?"
How do you mean? Is it easier for the corporation to navigate bankruptcy? Perhaps, but that's really a matter of resources.
As far as the bare logistics of filing, I could get your Chapter 13 (or 11, if your debts are high enough) bankrutpcy case filed in an afternoon--but you probably don't want to pay what I would charge. There is no way a corporation with much in the way of assets or liabilities could get prepped and filed for an 11 in 4 hours (altho it often happens over a weekend). There are a couple of hurdles to a Chapter 7 since the last change in the law. A business filing a 7 would certainly have an "easier" time than an individual, but a company filing a 7 effectively ceases to exist upon the filing, so it's not a fair comparison.
If you mean that a company has a better result goign through bankruptcy than an individual, that depends on whose perspective you take in considering the company. If you consider the company as a stand alone entity, sure, they often come out of an 11 better off. But if you look at the company as its owners, the shareholders, they are almost always wiped out and replaced by former creditors. Kind of a bad deal for the owners. At least in a personal reorg bankruptcy (a 13), one can keep their assets.
Moral hazard is inherent in the system for the following reason: if enough people go bankrupt then everyone is screwed. The economy falls apart. That is in no one's interest. It is a lose, lose, lose, lose scenario.
This is what the big concern is now. We may have enough personal bankruptcies as a result of this credit crunch that the bankruptcy courts are clogged for years.
The logical way to avoid that is to have the banks renegotiate all the loans.
The easy way to do that in one fell swoop is to cut interest rates so that real interest rates on short-term Treasurys are negative. Which is what I predict will happen. (Right or wrong. That is what is going to happen.)
brooksfoe: [bail out individuals, not lenders]
Okay, but HOW? What's a mechanism for bailing them out that doesn't just shift the problem?
Person (@3:04): "[people on the verge of foreclosure should be bailed out, renters get a benefit, everyone else gets nada] Then we've got all bases covered . . . Who's with me?"
I'm not with you. The thought that that covers the bases is a bunch of hooey:
1. More than just those who "would otherwise be foreclosed" have gotten screwed by the credit bubble. How do you draw the line? What about someone who has adjusted their life/budget/income to barely afford their mortgage, but is still upside down?
2. More than just renters acted responsibly--even many who bought houses in '04-'06 did so responsibly--maybe not in South Florida, DC metro and SoCal, but plenty of other places. Why restrict the transfer payment to so few recipients? Self-interest?
3. What qulaifies as "paying them what they need to stay afloat"? Does that require picking up their mortgage payment? Or the excess over some percentage of income? Sounds like a plan ripe for abuse.
4. 5% marginal tax rate hike as "punishment" for spending way too much on a house? And they get to keep it? Doesn't sound like too much punishment to me. Also, another plan ripe for abuse--especially in the way of tax evasion.
zaleriana: In response to
1), 3), and 4): Let me first clarify the size of the payment I had in mind: I would figure the monthly payment on a 30-year fixed that the family can truly afford (based on whatever rule of thumb is recommended generally), and their bailout would be whatever is enough to establish the equity they'd need to refinance to that kind of loan.
4) only: In order to keep the the house, you'd have to continue to stay current on that.
2): Speculation you can afford to lose is still speculation, and it still drives up housing prices for the rest of us. While that doesn't describe everyone, I don't know of a way to reliably distinguish them. Plus, it required more restraint *not* to buy into the "American Dream" spiel. On top of that, the transfer payments don't start until the government's total bailout payment PLUS interest is paid off.
The plan isn't a punishment to "responsible bubble home buyers"; rather, it's neutral to them. No bailout, no tax hike, no transfer payment.
"... We'll still also have moral hazard, but that's an argument for making things a little unpleasant for anyone we bail out, not an argument for letting them drown."
Of course it is an argument for letting them drown (or for making things more than a little unpleasant for them). Of course there may be counter arguments leading to a balance around the little unpleasant point. But moral hazard is best prevented by letting them drown.
McArdle claims:
"2) The borrowers do need the money. In which case, we don't make them better off by prohibiting banks from lending to them."
Sure you do when the cure is worse than the disease.
"... I've seen no evidence that the anecdotal fraud was widespread. ..."
Really? I thought the illiquidity was primarily due to the fact that no one is willing to buy possibly fraudulent pools indicating widespread fear of fraud at least.
There is one flaw in your argument. You say after bankruptcy "it is not a good idea to make it painless to borrow money you don't repay, we make life a little bit miserable for people who declare bankruptcy--though not very miserable; the chief result is that it's somewhat harder to get credit"
You should have written that at one time it was harder to get credit. With the sub prime market, the credit came whether one was bankrupt or not. Tha is what we face now: painless bankruptcies.
How about the following:
1. require the distressed homeowner to go through foreclosure or a short sale
2. forgive the taxes due on the short sale
3. give $5K to the distressed homeowner to get them safely out of their house and into a rental
This method doesn't avoid recession, but it's not clear that there is any way out of that. It does have the benefit of getting homeowners out of homes that they can't afford, but not leaving them homeless or in dire financial jeopardy (unless they've got some other issues).
One thing that I have to admit to being shocked in omission is the tax burden of renting. Lots of people buy homes (myself included) because they itemize taxes. I would be swamped by tax penalties if I didn't have that.
"Yeah, it increases moral hazard. But what we're now discussing is mainly who the bailout should be directed towards, not whether or not there should be a bailout -- we all know the bailout will happen in order to rescue the economy..."-brroksfoe
We all know do we? I don't know it--I guess I'm the only one. I don't see a need to help borrowers or lenders who got themselves into trouble. Unless, of course, people are in such a bad way that they are forced onto the streets; but such dire straits are not common and could be dealt with fairly inexpensively.
If we prevent people from feeling the painful consequences of their own decsions, then we will have this problem again in a short time.
Sorry, I care who to blame. The people at fault deserve no help at all.
I don't care if countless families go homeless because they can't meet their mortgage. They've been living beyond their means the last few years in houses they couldn't really afford and living lifestyles their income couldn't support.
Meanwhile, I waited until I could put 20% down. I bought a house I could actually afford. I clip coupons. I shop at thrift stores. I buy used cars. When I travel I stay in hostels and take night buses. I pay my credit card balance every month. Why? Because that's the only way that make sense and which I can afford.
Sorry, I know there are limits to what I can spend. If you're so greedy and impatient you can't manage your money and live within your means, it's your problem. No way am I bailing your irresponsible ass out.
So now it's time to pay the price for overdoing it. Enjoy your box under the bridge.
Oh... if your lender really defrauded you, he needs to be relegated to the box next door. But if you weren't bright enough to realize that Joe's Payday Loans & Mortgage might try to lure you into a bigger loan than you can afford, I have no sympathy.
We'll still also have moral hazard, but that's an argument for making things a little unpleasant for anyone we bail out, not an argument for letting them drown.
I don't understand -- if my coworkers and I can't make things fly (see your recent link to Derek Lowe for a good example of how that might happen) we drown. Why on earth should hedge fund managers making far more money than me not be expected to drown because of horribly misguided bets on mortgage securities? I might have sympathy for homeowners, but why would I possibly have any for bankers and hedgehogs?
The problem, as I see it, is not that permissive bankruptcy laws hurt creditors (theoretically, they shouldn't hurt creditors in a competitive market, should they?), but that they raise the cost of credit for responsible borrowers. My private student loans have rates of 8-9%, because, unlike federal loans, they are dischargeable in bankruptcy. - Brandon Berg
A couple of things:
(a) As I stated in an earlier bankruptcy post comment section, the credit card companies have essentially secured these unsecured debt (or partially secured this debt) by making it much more difficult to file for Chapter 7. So all sorts of people acquired credit cards, spent on them under the understanding this was unsecured debt. But now, thanks to the Bankruptcy Reform Act, unless you are desperately poor, your unsecured debt will not be discharged, but rather, it will be secured by a court ordered mandatory payment plan. Essentially, unsecured debt is now secured by a judicial mandated receivable. Granted, not as strong a real asset or personal property, but stronger than before the act. However, this reduced the risk to credit card companies. But did they lower the rates on these debts to reflect this reduced risk... I am still waiting.
(b) The reason it is important to find out if there was a villain is because it could help prevent future episodes. For example, the villain may not be an industry, company, institution or borrowers, but rather, may be the process or legal constructs within the lending industry providing incentives to specific parties to act in rationale but, long-term wise dangerous ways. A perfect example is the ability to re-sell the obligations as collateralized debt obligations. By reselling the debt, lenders had more of an incentive to make the deal, but less of an obligation to worry about whether or not the borrower really could repay it. Or maybe the villain is the lack of educating borrowers before they enter into agreements. The fact that so many debtors signed promissory notes without reading or understanding the final payment structure is technically their fault. But is it not the fault of the industry (through the Warrant of Fitness) required in so many other contracts that they should only sell such notes to borrowers who completely understand the risks. So many borrowers took on lower, introductory rate loans being led to believe that they could refinance the loans in the future. Yet, how many understood that the ability to refinance at lower fixed rates depended on (a) continued low interest rates and (b) continued availability of credit?
I understand Megan’s reluctance to go after specific parties, especially when her position is compromised by her likely numerous contacts and other relationships with people directly involved in this industry. Business reporters (she wrote for the Economist prior to this) are much a like sports reporters. Witch-hunts are tough for them to do because they often cannot do so without the fear of retribution or being shunned by the very contacts he/she has developed. But in this age where large industries and companies often lobby government to establish statutory frameworks which may benefit them at the expense of society, this is an important issue to investigate.
Sorry, I know there are limits to what I can spend. If you're so greedy and impatient you can't manage your money and live within your means, it's your problem. No way am I bailing your irresponsible ass out.
And if things had played out differently in recent years (Bush and Rumsfeld had succeeded in Iraq in 2005, Katrina had hit a patch of cold water before landfall) and real estate prices had continued to soar and you couldn't afford to buy even though interest rates stayed low, do you think all the people with the risky mortgages would be celebrating their good fortune by kicking over some of their profits to bail you out?
Brad: So all sorts of people acquired credit cards, spent on them under the understanding this was unsecured debt.
WTF?????
borrowed and spent on the understanding that this as unsecured debt? Is this the latest euphemism for "stiffing lenders so you can buy stuff you can't afford"???
"Oh, I borrowed that money on the understanding that if I couldn't pay it back, *other* people would be screwed, not me! Why on earth should *I* have to suffer, just because I buy a new car every year??? This IS SO UNFAIR!!!!"
If we prevent people from feeling the painful consequences of their own decsions, then we will have this problem again in a short time. - Iso
I am mainly interested in preventing me from feeling the painful consequences of decisions taken by other people, which I thought were stupid at the time.
In that sense, this is all highly similar to the Iraq debate.
if you weren't bright enough to realize that Joe's Payday Loans & Mortgage might try to lure you into a bigger loan than you can afford, I have no sympathy.
Not having any sympathy for people who aren't as bright as you are is...I don't know how to put this. How about "A highly respected moral philosopher named Jesus Christ would feel you have a very serious problem there."
Person:
I do not agree that people should take on debt with the idea they will discharge it in bankruptcy. However, regardless of scienter, everyone of us accepted the terms including higher rates of interest for that debt precisely because it was unsecured debt. The Bankruptcy Reform Act did not grandfather in these unsecured debts. They literally allowed the creditors to change their risk without a subsequent change in the cost of that debt to Americans.
Not having any sympathy for people who aren't as bright as you are is...I don't know how to put this. How about "A highly respected moral philosopher named Jesus Christ would feel you have a very serious problem there." - brooksfoe
I could not agree more, except let’s leave Christ out of this and just use rationale thought to dissuade people from this viewpoint.
Libertarians and more anti-regulation types love to argue that we should make society where there is an equality of opportunity, but not an equality of outcomes. They argue this in part because from their standpoint, not everyone is created equal, and some have additional talents, intelligence or education and others do not. Fine, and in some respects, I am with them on this. But here is where these people are not intellectually consistent.
If the case is that not all of us are on the same level in terms of intelligence and knowledge, then why are we expecting that all parties entering into a mortgage agreement are of the same competence? Anecdotally, the NY Times two weeks ago had an article where they highlighted a young, mid-20’s air-conditioner repairman who lost his financing for a house but was going to continue to look for other financing in order to purchase a house. Let me ask all of the let them swim in their own mess this: do you think that a mid-20’s something air conditioner repairman is sufficiently educated on the difference between a fixed and floating rate, the impact of the Federal reserve and inflation on interest rates as well as what the economic consensus was on the direction interest rates were going?
I have a feeling that young man was not even aware of the risks of buying at the peak of the housing market as he was trying to do.
So if we agree that many mortgagors enter into agreement they are not sufficiently educated to understand, then the question comes as to what we can do about it. At this point, any bailout seems the wrong move, as it may create more problems than it is worth. But, I think Donald Trump’s comment about how if you owe the bank $1,000 it is your problem but if you owe them 1 billion dollars it is their problem fits here. If the mass amount of foreclosures results in depressed housing prices and a significant decline in the economy, then the impact on our own lives may be enough that a government bailout may be necessary.
But regardless of a bailout, we need to review the regulatory environment in order to try to limit the number of borrowers who are ill-informed and enter into agreements they cannot sustain.
But now, thanks to the Bankruptcy Reform Act, unless you are desperately poor, your unsecured debt will not be discharged, but rather, it will be secured by a court ordered mandatory payment plan.
Where by "desperately poor," you mean anybody in the bottom half of the income scale. The only people restricted from filing Chapter 7 are those whose income is above the median.
As you may know, a lot of people file because of health care related debt(which means that bankruptcy and housing can't be compared that much).
In a country of 300,000,000 people, even a small fraction can be "a lot of people." But only a small percentage file because of health care related debt, contrary to Elizabeth Warren's discredited study.
JSinger:
And if...real estate prices had continued to soar and you couldn't afford to buy even though interest rates stayed low, do you think all the people with the risky mortgages would be celebrating their good fortune by kicking over some of their profits to bail you out?
This scenario is unrealistic. Housing prices will can only continue to rise if people continue to buy them at ever higher prices. If housing prices were to rise to the level where no one except the rich could afford to buy them, then no except the rich would buy them, and prices would have to fall in order to allow the market to clear.
Also, it's not possible for all the people who bought houses to realize profits. It's possible to have a situation where everyone has unrealized gains on paper, but prices fall every time someone puts his house on the market, so most people would not be able to realize those profits (for an illustration of this principle, refer to the NASDAQ circa 2000).
Good faith pshaw....Sometimes an idiot's just an idiot and crook's just a crook.
Brad, so that I may better understand you, what investment decision do you think a mid-20s repairman *is* capable of?
College application is at least as complicated as understanding the difference between fixed and floating (or adjustable), but we expect people to have that down by ~17.
Is the repairman qualified to set up an investment account with an online discount brokerage? To choose his 401k investments?
To pick the right education method for this children?
This scenario is unrealistic. Housing prices will can only continue to rise if people continue to buy them at ever higher prices.
My point wasn't intended as a long-term policy prescription. It's that if the housing price / interest rate state of a few years ago had persisted until today, you can bet the borrowers and lenders wouldn't be calling for a do-over and offering to give profits away to fixed-rate borrowers and new home buyers.
Obviously this reversal was going to happen eventually.
But regardless of a bailout, we need to review the regulatory environment in order to try to limit the number of borrowers who are ill-informed and enter into agreements they cannot sustain.
Posted by Brad | September 12, 2007 12:05 AM
Ohhhhhh Brad, you've really stepped in it now.
To suggest we need to regulate an industry because customers can't read the language on which the economy is based is just going way out there.
Why not regulate that car dealers can't charge more than 1% over the cost to them? There are scads of ill-informed buyers in showrooms, after all.
No, this and other posts suggest that we need to be insuring against stupidity and that's just not the way to go.
That we should have better-informed consumers is a given. Why not take up the suggestion of many economists that we teach basic economics in High School (I believe Mankiw, for one, has suggested this)? I've recently read over the mortgage documents on all the properties I own. Yes, some of the language requires reading 2 or 3 times - written by para-legals with no interest in anything other than billable time spent on a task. But, in the end, it's all there. The interest rate (yes, you'll have to look up terms like "LIBOR"), the date of interest rate changes, the amount it MAY go up, pre-payment terms, etc, etc.
It's just not that hard for someone willing to make an effort. Home ownership with a 30 year obligation of paying a large monthly sum ought to necessitate study -- or, if you can afford it -- hiring your own attorney to do the studying for you.
Some kind of bailout will likely happen, but I, for one, hope it's limited. I'm still pissed about the 1979 Chrysler bailout....
Let me ask all of the let them swim in their own mess this: do you think that a mid-20’s something air conditioner repairman is sufficiently educated on the difference between a fixed and floating rate, the impact of the Federal reserve and inflation on interest rates as well as what the economic consensus was on the direction interest rates were going?
1) That's an overstatement of the proper question which is whether he should be able to understand that his payments might or might not significantly go up at some point.
2) If the answer is no, shouldn't everyone who believes that ARMs should be federally insured as a consequence have made that demand *before* things went south?
3) At any rate, Megan's point was that a securities trader at Bear Stearns also shouldn't be expected to make informed decisions about the effect of interest rate changes on mortgages, which strikes me as a much less defensible assertion than yours.
Let me respond all at once to everyone who had a critique of my post:
I. Bankrutpcy Threshold for Chapter 7 –
The median family income in Colorado is $66,000, so, most assume that anyone making above this is filing a frivolous bankruptcy. But this is ridiculous. The only way I could possibly consider this a fair way to gauge determining a Chapter 7 filing or not is if the debts were purely unsecured credit card debt and the goods/services received by the debtor were for vacations, luxury goods (which by the way cannot be discharged anyways) and non-essential goods to amounts way beyond what should be expected of someone at that income level. But when so many of the bankruptcies are being caused by rising home prices, exceedingly complex mortgage transactions (we will get to that below) as well as often times debts from either job losses or medical bills, well, the lack of judgment allowed by the court as to whether or not the debts should be repaid or discharged is disturbing.
What about the family of four, who each parent makes $70,000 in Colorado. They have had these jobs for a few years, are comfortable, and making ends meet. They purchase a house based on a combined income of $140,000 (pre-tax by the way), which happens to have a floating rate interest rate. One parent loses their job due to outsourcing of the IT functions in their company (something libertarians think is the best thing since sliced bread…open and free labor markets between wealthier countries and poorer countries causing labor cost imbalances). This parent has spend the last 20 years educating and training him/herself in the IT field – someone we would consider an upstanding citizen.
So what do we as a society do, when for no fault of this persons own, they lose their job due to trade agreements which are written in favor of owners of capital and not those who work for capital? We make it extremely difficult for them to overcome these social/economic constructs, by punishing them further for events out of their control (since their spouse still makes more than the median income.
My main complaint with current bankruptcy laws is we have made life much more risky for consumers/workers in the United States. Jobs are not longer secure like they were 30 – 40 years ago, so it is exceedingly difficult to plan you future income levels. Now, you could argue that people should take this into account when taking on debt? I mean, should I take into account that I may have to work a temp job making $9.00 / hour if I lose my current job, and therefore, take on only debt based on the worst case scenario? I think expecting people to take on debt based on predicting worst case scenario disaster is unrealistic.
And please do not bring up the means test for Chapter 13. It is close to impossible to have less than $10,000 discretionary income over a 60 month (5 year) period when making above the median income.
II. Regulation of the Credit Industry
Is this really that difficult a concept to comprehend? I am not referring to restricting loans from now on to government loans only, or to restricting the loans only to people above a certain income level. But why not require that an exam (covering an understanding of mortgages, interest rates, how the economy effects rates as well as bankruptcy and foreclosure laws) must be passed by a borrower or proof that the borrower has passed the exam within the last 5 years before allowing them to sign onto a promissory note with a mortgage attached to it?
Megan brought this up actually a couple of weeks ago. In Illinois, they passed a law mandating that certain borrowers have to take a class educating them on the types of loans available, the repayment structure and the impact these loans will have on their future (in terms of payments as well as the length of time before the principle is paid off). Amazingly, many of the mortgagees pulled out of these markets (such as inner city Chicago) because so few people after taking these classes were agreeing to these complex loan agreements. As Megan noted, perhaps the fact that the lenders could not sell these loans and the fact the potential borrowers would not sign on these loans is because these people should NOT BE BORROWING MONEY.
I do not think we can necessarily put the genie back into the bottle in terms of the Collateralized Debt market, and lenders are going to continue to resell their loans to other investors in these packages. And in some ways, the market is now going to re-evaluate how it values these collateralized securities. But this only takes care of the secondary, investment market. It does nothing to help mitigate the losses and pain in the future for future borrowers, and there are new ones born every day. Which is why I think a mandatory educational program as well as exhibiting proficiency in understanding both the structures and types of mortgages as well as a basic understanding of bankruptcy is a benefit to society that does not seem like a wasteful government regulation at all.
Michael and Singer:
As for regulating the education/knowledge of consumers in other transactions, I think rationale common sense can claim that there is a big difference between a $20,000 car loan and a $280,000 home loan.
Do I think Americans are somewhat at fault for their lack of awareness when entering into financial transactions? Sure I do. But if you accept that reality, then you can either use a common sense approach, and design regulations to help mitigate this problem before the transactions occur, or you can take your approach, where you apply no common sense and try to regulate buying chewing gum at the local store.
If you think of it, my regulation proposal does nothing to limit the amounts and types of products creditors can offer. The only difference going forward is that consumers will have more of an equal footing in the negotiations between the creditor and debtor. Seems to me this is actually a libertarians wet-dream. By educating the consumer, you are creating a more rationale market place, versus the irrational market place we have lived in the last 10 years, no?
And someone suggested that we limit the profit margins on cars. This is ridiculous. The fact is, getting competitive pricing information on a car as well as gaining an understanding as to what the general value is for such a car is easy, available, and actually, most consumers do it. And even for those who do not, and pay more than they should have, the impact of such transactions is such that it is not putting the entire US economy in danger of recession or worse.
Brad,
I foresee problems with your solution along the lines of such a test being viewed as discriminatory. When large numbers of non-native English speakers and poorly educated rural and inner-city residents are no longer allowed to take out mortgages because they can't pass a test on mortgages, I think many will cry foul.
Brad, your example of homewoners making $140,000 is flawed for one simple reason - part of your premise. You say the house "happens to have" a floating interest rate.
There's no such thing as "happens to have." The homeowners CHOSE that.
They bet on that plan. They lost. Their problem.
And people shouldn't buy homes that put them on the brink of bankruptcy. Buy a more manageable home so you have leeway if you get laid off. In the few months you have if you can't find a comparable job, sell the house and move into an apartment you can afford on your current salary.
Don' try and hold out in the house as if you have a right to keep it, even though your skills aren't worth as much on the job market anymore. Scale down your life.
No matter who is at fault, people are going to have to deal with the problem. The bail out question is an important one if we want people to learn from their mistakes. Check out: blog.ntu.org/main/post.php?post_id=2599
Patrick,
again, my assertion is that due to the complexities of home mortgages as well as the soothing reassurances from some commission based lender telling the couple that they can refinance when interest rates start to go up many people, even those who earn more than average but are not working specifically in a financial based field can often enter into agreements that had the mortgagor been more educated would have created a more rationale consumer.
My contention is that a lot of the mess we are in is because one side of the agreement (the lender) was always rationale in the negotiation of the loan, while the debtor clearly was not at the same level in terms of understanding the risks involved. The same could be said of the investors, but I frankly hold little sympathy for them, since their job is to understand their investments.
When large numbers of non-native English speakers and poorly educated rural and inner-city residents are no longer allowed to take out mortgages because they can't pass a test on mortgages
So have a fallback position where after taking the class and failing, they can appoint someone they trust to certify the mortgage they take out. As for the poorly educated rural and inner-city residents...maybe they really shouldn't be taking potentially exploitative mortgages from private lenders. Maybe federal agencies supplying or approving fixed-rate mortgages that are not exploitative could be allowed to lend to such people.
Identify the problem and fix it.
Brad, your point is well-taken. Yes, the lenders had expertise borrowers often do not.
But quite frankly, a borrower making a large investment, if they have any common sense, knows that the seller (of the loan or of the home) has an agenda that is different from yours. You have an obligation to educate yourself on the basics of the transaction.
If you make $70,000/year, I would hope you're intelligent enough to spend an afternoon reading unbiased materials about the dangers of different kinds of loans. If you can't be bothered with that, I'm so sorry your lazy uninformed flier didn't work out.
If all these mortgage options are too hard to take in, then be smart and go vanilla: 30-year fixed from a reputable bank.
But uninformed people have no business trying to get cute and complicated. That just makes it more likely they're in over their head and will pay for it.