Monday, December 10, 2007

"Predatory Lending"

An editorial in today’s New York Times by Paul Krugman today listed three concerns about the current mortgage crisis. The third one was this,

Finally, there’s injustice: the subprime boom involved predatory lending — high-interest loans foisted on borrowers who qualified for lower rates — on an epic scale. The Wall Street Journal found that more than 55 percent of subprime loans made at the height of the housing bubble “went to people with credit scores high enough to often qualify for conventional loans with far better terms.”

He calls it “predatory lending” but I submit that, in most cases, that term is far from accurate. It would be more accurately called, “serving the borrower’s greed.”

Why did those borrowers not take out the “conventional loans with far better terms?” Clue number one is that many of them replaced just such loans with the subprime ones. Doing so gave them a lower house payment for a year, or a few years, and allowed them to live a more affluent lifestyle. Their assumption was that before the reset occurred “something would happen” to prevent it. They took a gamble for the sake of immediate gratification and, inevitably, many of them lost.

Paul Krugman regards that as injustice and thinks we should bail them out.

My nephew bought a house for his young family in the San Diego area some time ago and last year I rather casually asked him what kind of mortgage he had on it. He looked at me like I had lost my mind and said that “of course” he had a thirty-year-fixed, and added some remarks about not being stupid enough to go for any of those “crazy loans.”

He is a young man, very much enthusiastic about life and adventure, full of plans and upwardly mobile. And he lives within his means. He doesn’t have to have what he cannot afford. How strange. Downright un-American. How dare he display the flag?

I do agree with Krugman that the Bush/Paulson plan is a bad one, but not for the same reason. He thinks it doesn’t rescue enough borrowers. I think it rescues too many.

The victims of this crisis are portrayed as the people who are losing their homes, but they are preponderantly victims not of predatory lenders but of their own greed and/or financial mismanagement. The main victims of the lack of regulation are the investors who purchased those “innovative instruments” which were preordained to become worthless.

Unregulated capitalism becomes predatory.

You either believe in the “free market” system or you do not. (I do not.)
This bunch, including Krugman, wants to have it both ways. They'd like the market to be free to create the kind of “innovate market instruments” that created the mortgage crisis, but when that inevitably turns to destructive chaos they want to be able to step in and make whole those who were burned in the flames.

And, of course, they want to do that without taking away the riches from those who profited in the process of creating the destruction.

No one in the government or business communities is even talking about any plans for making whole the people and institutions who bought the instruments that have turned to junk. And probably no one should be. If you put lipstick on a pig, it’s still a pig. These investors failed to look past the lipstick and bought the pig.

Caveat emptor, baby, caveat emptor.


  1. Anonymous12:29 AM

    Hi Bill,

    I understand your point about lots of naive (or stupid or greedy) people taking loans out because they wanted to get in on the scam, but I do think there were more than a few that got scammed because of the way things were set up - and I don't believe that they should be blamed as stupid victims. Here's one reason I think that from an article from a NY Times article earlier this year:

    The company’s incentive system also encouraged brokers and sales representatives to move borrowers into the subprime category, even if their financial position meant that they belonged higher up the loan spectrum. Brokers who peddled subprime loans received commissions of 0.50 percent of the loan’s value, versus 0.20 percent on loans one step up the quality ladder, known as Alternate-A, former brokers said. For years, a software system in Countrywide’s subprime unit that sales representatives used to calculate the loan type that a borrower qualified for did not allow the input of a borrower’s cash reserves, a former employee said.

    A borrower who has more assets poses less risk to a lender, and will typically get a better rate on a loan as a result. But, this sales representative said, Countrywide’s software prevented the input of cash reserves so borrowers would have to be pitched on pricier loans. It was not until last September that the company changed this practice, as part of what was called in an internal memo the “Do the Right Thing” campaign.

    The other aspect is how many people who will be hurt by the devaluation of their neighborhoods (even if they have been living there for years) because many of their neighbors default. The mess is much bigger than the individuals - and it affects many people beyond the silly/greedy/gullible borrowers.

    Thanks for providing an excellent discussion about this topic even if we never do agree about why it is happening....

  2. Anonymous11:19 PM

    I heard about a mortgage company (perhaps local to Salt Lake City) that was refunding money to borrowers. It was part of a settlement in a class-action suit over fraudulent lending practices. 1) they had deliberately hid from the borrowers that their loans had variable interest rates. The borrowers thought they were fixed. 2) they bribed appraisers to over-value the properties, so that the borrowers had "instant equity". That enabled them to qualify for no-[or low-]down loans.

    Also see the article linked by "mary" (the first commenter). Her link goes to a post on "Pacific Views", which links to an article on the Washington Post site, and another on the New York Times site. Both document deceptive and fraudulent quoting and Underwriting practices.
    I, like Bill, have little patience with those who's greed led them to ruin. But I do have some sympathy for those who are a lot less smart than he and I, who were deliberately tricked by the greedy