I’ve been following the news about the sub-prime markets and foreclosures in the US. In a nutshell, here is what has happened. Companies that lend money for house loans had been doing very well, but their customer base was shrinking–there are only so many homes you can sell to one person.To compensate they started trying to sell to people who wouldn’t normally qualify for a home loan. For example, some companies would get a list of people who had recently had their cars repossessed and use that as a list of potential clients. (I’ve written a more detailed explanation of the subprime mess in a previous post.)
This is kind of what Citibank did in the 90s by offering credit cards to people whose application would normally be rejected. Citibank’s model involved looking more closely at this group. They even looked at things like whether or not an application was filled out in pen or pencil. (Applicants are more likely to not pay if they use a pencil.)
Unlike Citibank, these lenders were not applying careful statistical models to determine if someone could/would make their payments. However, they were using statistical models to determine the interest rate (more on that later). The logic was more on the lines of: “Houses always go up in value, so who cares if they can make the payments. They can always just sell their house and pay us back.” Of course this only works if their is an ever increasing demand for houses. The lenders created this demand by making it easier and easier to get loans.
Interest rates reflect the probability that a person will pay off the loan. If you have a high interest rate, it means the bank thinks you are risky. If you have a very low interest rate, it means the bank feels safe loaning money to you. Since the clients that lending companies were targeting were high risk, they had a high interest rate. The lending companies got around this by offering a 2 or 3 year “introductory” interest rate. After this period, the rate shot up to properly reflect the risk of the loan.
As large numbers of these types of loans switched to the higher interest rates, people found they could no longer afford to make payments and started defaulting on their loans.
What I have found interesting about this whole thing is the fact that everyone is blaming the lenders. In some cases I’m sure they didn’t act ethically. In other cases there may have been outright fraud. However, in most cases they simply sold people a product that they couldn’t afford.
The math required to work out your monthly payment isn’t exactly rocket science. I can’t imagine buying a house without making sure I understood exactly how much I would need to pay for insurance, taxes, utilities, and interest. When I closed on our first house, it took awhile because I wanted to read and understand every page I was signing–much to the annoyance of the title office woman. (The title office later sent us an apology for the way she was acting.)
I hear a lot of people talking about how the sub-prime market targeted poor people. To me, this seems incorrect. The term “poor” is a bad way to categorize people who are struggling from high interest mortgages. It appears to be designed to illicit sympathy more than anything else. “Financially unwise” or “math impaired” are probably better labels. Someone who earns $10,000 per year and buys a home where they can afford to make the payments may be poor, but they are wise financially compared to someone who makes $100,000 per year and takes on a loan for $10,000 per month.
If you dig deep enough, I bet you’d find that, for this group, the common thread has very little to do with income. It is very related to being unwilling (or unable) to do basic math.
Dave Child says
I agree that the borrowers seem to be let off rather easily in the blame game, but the lenders were the ones saying the house prices would continue to rise. Seems many people took out mortgages thinking they could remortgage at a lower rate later using the increase in their property value as the deposit on the new mortgage. When prices drop, they can’t remortgage and end up faced with paying the rate they never thought they’d have to pay.
“… It is very related to being unwilling (or unable) to do basic math.”
In the words of Larry David:
Don’t forget about good old fashioned greed as well. A lot of the people who are now losing their homes were the ones soaking up episodes of “Flip This House” on TV and saw nothing but dollar signs and early retirements.
My mom was living in a rented house that she couldn’t afford. She refused to look for anything less expensive (OK, she was being a snob, when you get right down to it, because the less expensive rentals didn’t have the address cachet that this house did).
As she edged closer toward bankruptcy and farther and farther into debt and denial, her landlady put the house up for sale.
Enter my bachelor brother, whose credit record would make any reputable agent have a heart attack on the spot. Evictions, late payments, tax liens, you name it, if it’s bad he probably had it on his credit report. This is a guy who will be down to his last $4 and will take that money to the racetrack.
Somehow, he managed to convince someone to give him a loan to buy that house. Two loans, actually, because he also got a loan for the down payment. The result is that the payments which for anyone else with decent credit would be less than $600/mo are costing him $1200/mo.
He wants to refinance now that it’s been two years, our mom has passed away and he’s living in that house.
He keeps working with the people who got him that Shylock loan in the first place. I guess they have Professor Harold Hill on the staff and they keep convincing my brother to buy band instruments. Or something.
Greedy agency + naive, underfunded buyer = disaster.
Elizabeth Gage says
I still lean towards faulting the lenders, because they should have known better. Leaving aside ethics momentarily, being aware of the borrowers incomes and other financial details they should have been able to predict that when rates adjusted, the borrowers would be strapped.
The borrowers get a little sympathy at least because here where I live, in central California, a house with an introductory-rate mortgage could cost less in monthly payments than a rental. So greed and ignorance were probably part of it for the borrowers, but I believe they wanted a better life for their families as well.
Also, for many people this was their first major loan transaction. Even if you are smart, read all the fine print, and so forth, you are at disadvantage going up against a lender who does dozens or more every week.
If the lenders had done THEIR math, and worked a little probability into it, they could have seen what their risk was if 5%, 10%, 25% of loans defaulted. They could have looked at statistics on how many people who get in trouble actually do sell to pay off the loan. They could have seen that since they were financing poor-credit-score people, the spread between the intro rate and the “real” rate would have been unworkable,
Sorry, I gotta point my finger at the lenders for most of this mess.
Mark Shead says
@Elizabeth – I would fault the lenders for putting their companies out of business, but I still think it is the borrowers responsibility (not the lenders) to make sure they can afford the loan.
It use to be very difficult to get a loan–you had to pay 20% to 50% down. In recent years it has been easy to get a loan. Personally I think that is a good thing for borrowers.
@Dave – The lenders thought the housing prices would keep going up so they made it really easy to borrow money. This was a good thing for borrowers with basic math skills and a bad thing for borrowers who refused to apply basic math skills to their decision making process.
There is a false sense in this country, that all people are equal. Our education system has failed on so many levels, which has led to the majority of the population not being able to make simple judgments about things like whether they will be able to afford something, not to mention make the most simple calculations.
I want to blame the borrowers for being buffoons that thought that housing prices will go up for all eternity until the average price is in the trillions, kind of reminiscent of a ponzi scheme; but – and this is going to be unpopular – many people in this country need to be protected from being taken advantage of and they don’t even know it. The lenders have the highly educated professionals (lawyers, mathematicians, statisticians, accountants, etc.) that devise ever more complicated and convoluted contracts and traps for the gullible, how is an under-educated person supposed to even realize they have a target on their back? These people should have not ever even been considered for loans and now everyone is suffering because some executives wanted to get rich quick. If I was able to figure out this was nothing more than a pyramid scheme back in 2004, i am sure that the banking executives and housing industry robbing the economy of unearned wealth knew it too.
There is no doubt that in this case, as all the others, the heads of the whole shit pile, will not be held accountable and millions of people’s lives will be seriously impacted instead. There is no accountability in this economy. If you want to be paid criminally high compensations, I say tie it directly to responsibility and accountability. And don’t let anyone tell you that nobody could have known how this would turn out. They all knew how it would turn out and they siphoned off their bonuses and compensation from your investments and wealth before it all collapsed too. What do they care, they aren’t held responsible!
In America, the deck is stacked against most people; the economy is built on how to siphon the most money from the most people, to make the few rich. The housing bubble is just the latest installment of this rinse and repeat get rich quick cycle.
This is by far not over and it is going to get more ridiculous and hilarious, wait!
Mark Shead says
@Marc – i agree that there are some major problems with our educational system, but still pretty much anyone who went through high school should be able to understand how a mortgage works with minimal effort.
If you are saying that most people can’t understand enough math to know if they can afford a mortgage or not, then I would disagree. I would contend that many of them are just to lazy to sit down and try to understand it.
This article fails, like so many “blame the borrowers” mortgage fallout articles fail, because it assumes that the borrowers had perfect information of their situation. When you say “even someone with a high school information can understand a mortgage,” you are coming from a position of untenable privilege, because the issue is more complex than just interest rates.
Your viewpoint ignores that in many cases the lenders did not just act irresponsibility, they acted downright unethically. People were scammed. Minorities and immigrants in underprivileged areas were sought out by banks, who offered them lending terms on refinances that the banks KNEW would lead to foreclosure. But the banks–who should have seen the writing on the wall for the housing bubble–thought that owning the borrower’s home would lead to more money in their pockets at the end of the day.
I’m sorry, but don’t we usually prosecute people who act as shadily as these banks have done? If someone sells worthless commodities to senior citizens “who don’t know any better,” it’s a crime, and we don’t blame the elderly, and say that they deserved what happened to them, do we? To see the level of blame heaped on borrowers for being scammed is just disgusting.
The subprime mortgage crisis is not, I repeat, not about people buying more house than they can afford. What is driving it, in very large part, is refinances, not new home purchases, which, as I said above, were sold to people who did notunderstand their mortgage terms. Why is something not WRONG with that?
Mark Shead says
@Lise – I’m sure there were some people who were scammed by lenders. Yes I think the lenders that actually scammed people should be prosecuted. However, a lot of people are mad because banks loaned money to people who couldn’t afford it. They took a risk on someone who probably couldn’t pay.
Years ago credit wasn’t as easy to get. You had to pay 20 to 50% down to get into a house. Many people couldn’t afford a house. Back then people were complaining that it was too hard to get credit.
In recent times, credit has been extremely easy to get. Banks are paying for this because they are losing money. They are at fault for losing money, but the fact that they were willing to loan money to people who were considered more of a risk is a good thing for consumers. It is up to the person taking out the loan to determine if they can afford it.
Yes the lenders have responsibilities to explain mortgages. The ones that didn’t follow the law in this area should be prosecuted. However there are many (I would even say the majority) of people in trouble because they committed to a loan that they simply couldn’t pay–even though they had all the information available to them to understand it.
The point is that it is the responsibility of the person who is taking out the loan to understand the terms. If they agree to pay $3000 per month, they better have a plan for what to do if they lose their job. If they agree to pay $1000 per month for three years and then adjust to the market rate, they need to have a plan for what to do if interest rates go up.
How difficult is it to understand mortgage terms if you put some effort into it? And no I’m not coming from “untenable privilege”. I put a lot of research into my first mortgage–research that just requires basic math and a few books from the local library. This is hardly a “privileged” position.
Lets say that a lender is trying to avoid loaning money to people who don’t understand mortgage terms. What if they gave every prospective customer an IQ test. If someone scored lower than 100, they wouldn’t give them a loan. The idea would be that someone less intelligent than 50% of the population has a lower chance of understanding the terms of the loan.
People would be up in arms about that sort of treatment. Why? Because it doesn’t allow people to make their own choices. It treats people differently based on how smart they are. People need to be allowed to make mistakes, but they also need to be made to take responsibility for their mistakes. The the lenders did something illegal they need to take responsibility. If the borrowers did something stupid, they need to take responsibility.
Show me someone who:
1. carefully read their mortgage agreement they were signing
2. asked questions about anything they didn’t understand
3. made sure they understood how everything was being calculated
If the lender still managed to deceive them and I’ll agree that it probably isn’t their fault. In that case there is a lender that should probably go to jail.
Do you really think that most people fall into that category? Or do you think most of the people in trouble skipped a few (or all) of those three steps?
(There are some people in trouble who understood their mortgage but lost their jobs, had health problems, etc. But this is nothing new so they don’t really fit into this conversation.)
I’m sure that the people in trouble skipped a few of those steps. Did you expect me to say differently? Scams are always based on the victim not knowing enough to extricate themselves from the situation.
I am maintaining it is a scam because all evidence points to the fact that the banks KNEW these people would not pay them back, and proceeded anyway. It was, you might say, taking candy from a baby. How is it the baby’s fault?
When banks are set up as figures of authority, people tend to say to themselves, “Why would they loan me that much money if I couldn’t pay them back?” If, as it’s been stated, some of the people targeted were immigrants, maybe they didn’t know enough English to ask the right questions. If you live in a culture where you’re the first person in your family to buy a home, maybe you don’t know better. Maybe they were intimidated by the sheer quantity of paperwork. Again, you’re assuming borrowers have perfect information.
Tell me you didn’t have a few questions about what certain charges were on your loan documents – title searches, charges to pull your credit report, etc. Now imagine having those problems from a point of view of someone who doesn’t speak English, or someone who doesn’t read well, or someone who’s intimidated by being surrounded by lawyers and realtors.
I think what’s really telling is that many of the people who were sold subprime mortgages could qualify for regular, prime mortgages–they just didn’t know any better.
So yes, they were ignorant. But being ignorant isn’t morally wrong–and the judgment that you’re putting on these people is a moral judgment. If you want to make a moral judgment, make it on the banks, who knew they were targeting people who couldn’t pay, and went ahead and did it anyway.
I’m sure that most of these people who are in trouble come from the camp of thinking “I can pay this off” rather than the camp of “I can’t pay this off, but I’m hoping that house prices will rise/hoping the government will bail me out.” Their intentions were better than the banks, at the very least. I’m sure most of them intended to pay the banks back.
It’s all well and good to say they should be responsible for their losses–and they should be, up until the point where they can’t pay anymore. At that point their foreclosed houses become a drain on the neighborhoods around them. They are being bailed out for everyone’s good. Yes, that’s taxpayer’s money, but you know, your money also pays to support a lot of services you will probably never need yourself, but support a civil society. I would rather see my tax money invested in bailing out borrowers than in more conflict in Iraq.
Easier-to-get credit is only good for the consumer if the consumer has perfect information in making a loan choice. That situation, I’m hoping to show, doesn’t exist. This is why I think the credit industry needs to be re-regulated.
Government demanded these loans be made. After that how can you blame banks, etc. ? They knew it was bad practice, but what can you do but grab what you can. It is that simple, defy the government, make bad loans and eventually go out of biz, or give the government what it wants and gorge while you can. As far and buyers. Who cares about the math? They couldn’t afford it but they were getting the loans anyway. What were they losing ? Nothing. Besides anyone watch “Flip that house” ? We’re supposed to bail them out ? I have no sympathy for anyone, they were played, some lost money, some made millions. The very people who created this mess, Frank, Dobbs, Obama, Clinton, Carter, etc., are touting how they’re fixing it! AND they ARE getting away with it! So who cares? Apparently not the American people. If the American people cared they would hold politicians and the their lackey media accountable. Maybe Americans are as stupid as people make them out to be. In which case we are getting what we deserve.
carol gibson says
O.K., now that we have done the simple math and realize that the real estate buying market is shrinking – what imagined scenario would solve this problem?
I believe everyone is missing the point. Doesn’t anyone reading this understand that lending institutions hire well educated staffers with years of experience and razor sharp intellect to run their businesses. How naive do you have to be to believe companies who have been in existence for well over 100 years and have made billions of dollars loaning money would suddenly lose their minds and give away the store, lending all their money to people who they knew full and well would never be able to pay these loans back? Do you really believe that companies who bought up these loans, knowing the packages were heavy with bad debt, were just stupid? First, lets all assume for the sake of argument that these banks and investment groups are ran by people who know far more about finance than you or I will ever know. Lets also assume that these businesses were not suicidal. That in mind, why would these companies do something that anyone with a rudimentary understanding of business never do? They had to know these loans would default. They had to know that the prices of housing could not continue to inflate indefinitely. Now let’s look at where they are now. How did these CEO’s and CFO’s make out. Don’t you find it at least curious that both the Democrats and Republicans in an election year would bail these companies out even when 90% of the calls, letters and emails from their constituents told them not to? What on it’s face seemed to be an act of suicide buy these businesses, in fact turned out quite well in the end. All the lenders made their billions on commissions originating these loans, banks made their money selling these junk loans and the people left holding the bag in the end was bailed out without a whimper by Congress and the President. You wonder why businesses give politicians millions of dollars to finance their campaigns. Surely you don’t believe it’s out of the goodness of their hearts. These are the same people that agonize over the cost of toilet paper for their bathrooms. The reality is, it’s a wise investment, insuring that with the government in their back pocket, they can rape and plunder at will and never be held accountable. We Americans have funded this artificial prosperity enjoyed by the well healed and well placed few. Our children and our children’s children will be paying for the windfall enjoyed by the top 0.1% of this nation, and we sit back powerless to do anything to stop it. When will America wake up? When will we reach the “Tipping Point”? It’s not a matter of if, but when.