Original title: Tyler Cowen, Apologist for Fraud?
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Over the years, I’ve noted the problems I’ve had with Economists in general seem to fall into one of three categories:
1) They are not particularly good at their jobs — assuming their jobs require them to review economic data and determine what it means;
2) Economists, like academics, can be "reality challenged." This typically involves a skewed conception of reality, often so divergent from the real world experience as to make their conclusions erroneous and their methodology suspect;
3) The abuse of economic data for political purposes.
Today’s example is via the Economic View column in the NYT. I usually find Tyler Cowen’s work at Marginal Revolution interesting and thought provoking. However, his column today is perfect fodder for our example of a "reality challenged" economic discussion (#2, above).
Cowen puts forth an argument that while "there has been plenty of talk about predatory lending, predatory borrowing” may have been the bigger problem."
How utterly silly.
This places Cowen in the role of being an apologist for the lack of lending standard’s worst excesses during the credit bubble. Even worse, it reveals his complete misunderstanding of what occurs in the real world of real estate agents, banking, mortgage brokers and predatory lending.
First the excerpt:
IT’S NOT JUST THE LENDERS
"As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default.
Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers. Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation of income and assets. As long as housing prices kept rising, it didn’t seem to matter."
Anyone who works in this area knows that the reality of the situation was far more blatant. To begin with, most people are naive when it comes to any financial product. They rely on the experience of the professional they are working with, even if this person is a SALESMAN or another party in an ADVERSARIAL NEGOTIATING ROLE.
I work with many builders and mortgage lenders; I take personal responsibility for a major builder selling much of his company’s stock in 2005 (more than $100 million worth). The rest of the family hated me — for about 6 months. I know how their company works, and I know what they and others in their field do in actuality.
During the hey day of the no-income verification, "No Doc" loans, the builders finance people, as well as other mortgage brokers walked people through the application process. Mr. Cowen writes that "Too often, mortgage originators and middlemen looked the other way." That’s a rather generous read on it. The reality is that THEY TOLD PEOPLE WHAT INCOME TO WRITE. They used sentences such as "Put down $150k." OTHER TIMES THEY APPLICANTS LEAVE THE INCOME SPACE BLANK; The reps later conveniently filled in the data on the own.
To claim mortgage originators and middlemen only looked the other way is putting too fine a point on it. THEY WERE ACTIVE COLLABORATORS IN ANY FRAUD.
Oh, and, don’t take my word for it — find some people from the industry and ask them yourselves. This is a very well known fact amongst real estate agents, mortgage brokers, and builders.
If you thought the reality challenged Mr. Cowen was merely repeating the data of an industry shill, that’s just the first half of it. Consider the next paragraph:
"In other words, many of the people now losing their homes committed fraud. And when a mortgage goes into default in its first year, the chance is high that there was fraud in the initial application, especially because unemployment in general has been low during the last two years."
I have noted that of the 3 million new homeowners the credit bubble created, I expect half to two thirds to ultimately return to their prior status as renters. That’s what happens when you buy a property you cannot afford. And, i don’t think the government should bail these people out. However, I find it utterly contemptible to accuse these people of fraud.
Mr. Cowen should be ashamed of himself . . .
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UPDATE2 : January 14, 2008 5:22pm
To clarify one point, I specified a laundry list of who was responsible for the lending mess back in
August of last year. The borrowers are near the top of list. The
responsibility was widespread, with plenty of blame to spare:
- Federal Reserve (FOMC)
- Borrowers
- Mortgage brokers
- Appraisers
- Federal Government
- Fannie Mae
- Lending banks
- Wall Street firms
- CDO Managers
- Credit agencies
- Hedge funds
- Institutional Investors (pensions,
insurance firms, banks, etc.) - And back to regulatory role of the
Federal Reserve
But borrowers as predatory? Give me a break.
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UPDATE: January 14, 2008 1:35pm
Professor Cowen adds the following comment:
I thank Barry for his kind words in the post but I think his criticism is a simple misunderstanding. I think the lenders are greatly
at fault, as does anyone else with a fair mind. Pointing out additional
faults elsewhere doesn’t (and should not be understand as) subtracting
from those faults. More generally, the point of my column was to point
out some new information about a bunch of different economic issues,
not to provide a comprehensive survey of who was at fault in the
mortgage crisis. I didn’t even mention the regulators but clearly they
are at fault too and of course you could lengthen the list of people at
fault. I think the title of this post is misleading and I would like to
ask Barry to reconsider it.–Posted by: Tyler Cowen | Jan 14, 2008 1:20:34 PM
I think I have been mostly offended by the following line: "there has been plenty of talk about predatory lending, predatory borrowing” may have been the bigger problem."
Either its a false but cute attempt to be clever, or, quite possibly, a case of shifting the blame from the lenders to the borrowers. Regardless, that line is misleading in extremis.
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Source:
So We Thought. But Then Again . . .
TYLER COWEN
NYT, January 13, 2008
http://www.nytimes.com/2008/01/13/business/13view.html
Both the predatory lending and borrowing arguments are valid. All parties are to blame. These borrowers understood the concept (and consequences) of an ARM especially the bait of no docs. It’s all about an absence of ethics. Everybody was wearing their Gordon Gecko suspenders.
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BR: I think you are misunderstanding the concept of what “Predatory” is — where one party with superior knowledge, resources, experience, expertise etc. uses them to take advantage of the other party.
When a borrower does what he’s told by the representative of the lender, that is not at all “predatory.” Its totally disengenous to compare the two.
That’s the idiocy of the article — putting what the borrower did — at the lender’s request! — on the same plane as true predatory lending.
Quite bluntly, its a rather despicable analogy. My opinion of Cowen went down dramatically today.
Barry:
I fail to see why you are hot and bothered by the quoted text. In my reading of it, the author is naming both parties as co-conspirators. I think that’s a totally fair charge. I agree with you that in the transaction buying a home the paperwork is easy to get lost in and I don’t fault people for not understanding every clause in the boilerplate (nor do I claim to understand it absolutely). But be realistic, if there is one thing a borrower absolutely must be responsible for it is the personal information they provide to get the loan!
If you are in a store and there is a $5,000 watch on the counter and the store owner says “Psst! Go ahead and take it! Its hot a I just want the insurance money!” are you going to bolt with the watch? HELL NO! Why not? Because you know it’s wrong! The store owner being in on it doesn’t let you off the hook.
There is plenty of blame to go around in this mess, but I see no reason to shy away from accurate, if unkind labels of the parties involved. If a person doesn’t have the intestinal fortitude to be honest on an application then god help/damn them.
Mr. Cowen should be ashamed of himself . . .
He won’t be. Most of his output is of similar quality, if not so blatantly hacktacular.
Barry,
Don’t you think the title of this blog entry is a bit harsh?
Yes, we know the brokers and the bankers were active participants in the fraud. And of course, we know the general public isn’t as informed about financial matters as they should be. But the question is–WHY?
It is because the govt. promises to “protect” the consumer, that they have lost the incentive to effectively protect themselves. Why should they, if their good old Uncle Sam or the courts promises to bail them out when they do something stupid?
The reality: all of these interventions to “protect” people ultimately end up in creating greedy, gullible people–those most easily taken advantage of. Crooks in mortgage finance couldn’t ask for better marks–I mean people.
If these “poor” consumers were half as skeptical of mortgage lenders as they were of car salesmen, this situation would never have gotten to the point it had.
If a person signs a tax return prepared by the professional, and the IRS finds that the professional had done something illegal, it is still the taxpayer who is responsible. The same principle applies here.
Of course, if the Fed hadn’t driven interest rates to historic lows, and the govt. got out of the silly business of making homes “affordable”, or encouraging those not cut out for home ownership into buying, this mispricing of risk, and the glut of housing inventory would not likely have happened.
Of course, this mortgage mess is supposed to be a “market failure” right? It reeks of govt. failure to me.
If income is overstated both parties committed fraud. Blame should also go to the lenders who gave money to people that could not afford to repay without verifying income.
Both sides were at fault, and both should be held accountable for this mess. If you treat people like innocent and clueless lemmings, then lemmings you are sure to get.
Your comments below address the issue, but I believe you are still understating the complete asymmetry of understanding that occurs when ordinary people finance homes. To most families a buying home is an emotional experience as much as a financial one.
“Anyone who works in this area knows that the reality of the situation was far more blatant. To begin with, most people are naive when it comes to any financial product. They rely on the experience of the professional they are working with, even if this person is a SALESMAN or another party in an ADVERSARIAL NEGOTIATING ROLE.”
To show just how ridiculous the lenders are behaving, people should read this article from the NYT (Banks Plead They Can’t Follow Rules):
http://www.nytimes.com/2008/01/11/business/11norris.html
Rules in society enable people to function knowing that standards apply. This works for all fields except the money men. If everyone else can follow rules in their lives, can someone tell me why these lenders don’t deserve hard time – not country-club prisons?
I don’t see anything in Barry’s quotes that was making any excuse at all for the lenders. They were co-conspirators, plain and simple.
As another example of the dirty side of that business, I know someone who was having a $900K house built by one of the major builders. When it came time to get the loan the builder said “We have someone we prefer. You can use anyone you want, but you must get a quote from our preferred lender”. Well, he’d already lined up his loan and was happy with it. He got the other quote which wasn’t nearly as good, but the process cost him about $400! What a scam.
As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; (emphasis mine)
So a company that works for banks and lenders says provided this analysis, eh? That alone knocks the results a few bars higher on my skepticism scale. This is especially true if the study mostly blames borrowers for the fraud. That would make my skepticism meter will shoot through the roof!
I appreciate Barry’s view, to a point. However, I live in the Sunshine State and will disagree. Financial ignorance does not entitle one to a pass- if you sign a legal document, you should know WTF it states. If you don’t, a mortgage/real estate broker should not be relied on in lieu of an attorney. A majority of those being served with notices of foreclosure knew what they were signing. They expected to flip it for a quck buck. How else can one explain the dramatic increase in first payment defaults since Q4 ’05? As well, the FBI (as well as the FL Dept. of Law Enforcement) have well publicized increases in staff to deal with the rampant levels of mortgage fraud. One final note, the level of speculator homes that have been “homesteaded”, constitutes fraud on its own merit. Besides stating that this is a primary residence (nod nod, wink wink) on a mortgage app, here in FL there is a separate filing stating the same with the county. Are we to believe that brokers conned the owners into following up with the county, as well?
The average Joe knows next to nothing about finance (which, admittedly, is a problem – but not one that’s likely to be fixed any time soon). The average banker knows much, much more (or at least should know more than the average Joe). When they come to a mutual agreement, the bias for blame should automatically shift towards the bankers, since the bankers, as a group, would have consistently been in an advantageous position of better knowledge than the Joes. Of course, part of the blame falls on the Joes, but I don’t think they should share it equally with the lenders. In a perfect world, they would – But we obviously don’t have that. Yet. LOL.
There was this huge pile of money on the floor that didn’t belong to anyone. It was left by the Fed. EVERYONE tripped over each other jumping on the pile. Everyone got a little of the money but some were bruised, bleeding and had broken arms.
At least that’s how I explain it to my 4 year old grand daughter.
During the madness I had occasions to review a few loan documents for friends. These were the normal, for the times, loans that had low teaser rates. I found two things appalling.
Number 1: I don’t remember even the term ‘negative amortization’ being used. People were not told explicitly that the difference between what they were going to pay over the next five years and what a ‘normal’ mortgage would have been was going to be added to their borrowing and was not a deal for them.
Number 2: They were led to believe that when the teaser term was up that the previous five years or so of low rates (which were artificially low due to the FRB not wanting the dot com bubble to turn into a Depression) would be about they would then have to pay.
Borrowers were massively deceived by the lenders.
Predatory borrowing? Hmmm. Ask those people who spend their Christmas without a home or in fear of losing their home if their actions were predatory. While he writes in the cozy den of his nice house…..
Without reading his article, I could imagine he meant euphoric borrowers and developers who took advantage of banker’s stupidity but it is a banker’s responsibility to protect the assets of those who entrusted them with their deposits….Not the borrower. If someone gives me a free lunch, I’m going to take it. And, so would everyone else.
From where I sit in Newport Beach, CA, the editorial has it spot on. Looking through foreclosures, it’s amazing how 2 or 3 foreclosures have the same last name. From watching both the local market here, plus the market in Scottsdale, AZ, together with having some clients that are ‘in the biz’ there were more borrowers looking to benefit from the game than there were lenders getting taken advantage of. I can’t tell you how many times I’ve heard a story on the radio about predatory lending, only to have the ‘victim’ say something like ‘they already took 2 of my homes away’….2 of my homes? Nope, sorry Barry, from where I sit there was more predatory borrowing than lending.
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BR: No doubt, plenty of multi-property speculators ended up in foreclosure. But what does that have to do with the idiotic industry concept of predatory borrowing?
Do you really believe that in 70% of the loans, the poor ignorant banks were “taken advantage of” by these predatory borrowers?
[quote]
If someone gives me a free lunch, I’m going to take it. And, so would everyone else.
BDG123
[end quote]
Then you sir/madam, would be one of the unfortunate people finding out that the old adage is true: There is no such thing as a “free” lunch!
Or how about “If it looks too good to be true, it probably is”?
I don’t see anyone saying that the forms etc. are not complex and the brokers don’t really know it all much better than the hapless borrower, all that is true. But good God man, the borrower has to be held accountable for supplying fraudulent information!!! There was no complexity there. Either you make $150K/year or you don’t! Or is it one of those “it depends on them meaning of ‘income’ is” things?
Um, it is not “fraud” if the agent of the lender fills in your income. It is not “fraud” if the agent of the lender tells you what to fill in. Even if it is a “lie” it is not “fraud.” Nor are you “co-conspirators” The mortgage broker is the agent of the lender (as I understand the process). The lender is deceiving itself (in effect) which is precisely what happened.
But actually what was occurring is that the lender wanted to pass off the trash to someone up the line. Therefore it did not really care abut the “lie” because it was really lying to the people to whom it sold the bonds
All you “personal/moral responsibility” folks just want to blame individuals and refuse to see just how screwed up the system was. A system which was completely and totally encouraged by the people who were supposed to be regulating this stuff. Heck, they were touting this as “innovation” like investment bankers were on par with people who actually do “discover” useful things. Nothing new, just the same old games with a different name. That is the sad thing.
I am not saying that any of these people should be bailed out either. But when are all those investment bankers going to start giving back all of their bonuses? Ha!!! Never gonna happen.even if every one of those IB’s goes bankrupt. They get to keep all their loot. But let’s pile on the poor schlubs who did nothing but try to own a house because every single leader in this country from the president on down said that we were an “ownership society” and told everyone that things would be great in this wonderful country.
The apologetic tone concerning the mortgage industry espoused by some of the posters truly staggers me – but I guess it is difficult to admit systemic flaws when you sincerely believe in that system and the leaderership that approved the system.
Pointing fingers of blame does no useful duty unless it is to obfuscate truth – however, uncovering flaws is a useful venture if previous flaws are not to be repeated.
Regardless of whether mortgage writers lied or borrowers lied or some combination of both, the bottom line is that none of this would have occured had the originating lenders been required to hold the risk of their loans.
This was systemic flaw exacerbated by rising asset values, with plenty of blame to spread – from the Greenspan Fed holding interest too low for too long and encouraging securitization and exotic loan types, to lenders more interested in speed of loan turnover than quality of loan, to borrowers who believed the hype that housing values would forever rise.
Regardless of who gets the most blame, the bottom line is that the absence of r-i-s-k to the loan originator was at the monster’s heart.
The real fraud was systemic self-fraud that by slicing and dicing poor risk one could magically transform that risk into acceptible risk – kind of like saying that if you spread the e-coli colony mixed with peanut butter across enough pieces of bread that everyone might get a little sick but at least no one would die.
What the system forgot was that without being required to participate in the risk, the originators of loans had no reason to add any peanut butter at all – so instead of a slightly tainted slices of bread, they passed out toxin-loaded bread – after all, it was not the q-u-a-l-i-t-y of the sandwiches that created their fees but the q-u-a-n-t-i-t-y of sandwiches they shipped out.
It was this no-lender-risk, FICO-score-led, speed-of-turnover=fees environment that allowed the fiasco to occur.
For those who claim the borrower is at fault, it would be interesting to put them in a time machine and send them back to 1960 and let them try to buy a house – it is amazing how much hodling onto the risk of loss affects lender’s attitudes.
Really? I’m not in mensa, but when I think about someone knowingly signing a piece of paper that intentionally mis-states their income, I’m thinking it maps pretty well to this. You may feel otherwise. You may feel Elvis is alive and well!
I don’t see the blame as an either/or thing. I don’t see all us “personal/moral responsibility folks” saying let the business side off the hook. Where do you see that here?
I’d be more sympathetic if the argument was “the papers are complex and they had no idea they were providing false information” but even allowing that some might have signed blank forms, they have to be the minority, and that still doesn’t let them off the hook.
Hey, what do I know. I’m just this, I guess. :) (I do love the song – well, except the end part – and am shocked that Barry has never highlighted it!)
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BR: I have been told that this was a typical discussion:
Borrower: What is a no income check loan?
Lender: Your income doesn’t matter.
B: What shall I put down for income?
L: It doesn’t make a difference.
B: I’ll leave it blank
L: Put down $150k — just to be safe.
B: OK
How hard is it to verify income? Cash flow says either the money is there or it isn’t.
Next excuse: the butler did it.
I am humbled.
I had no idea.
It is now clear, though, that 3 million sharp-dressing slick-haired Hillary-loving Bush bashing silvery-tongued shyster-type taxi drivers took advantage of the aw shucks innocence of the poor, uneducated, trusting, honest, and hard-working bankers in a savage and purposefully coordinated fraud in order to ruin forever the enjoyment of watching Jimmy Stewart in It’s a Wonderful Life.
Bastards!
I see it this way. The three million renters who became homeowners never really had the mentality of homeowners. I see them every day in my office. The never had a plan to be able to pay the fully ammortized, fully adjusted mortgage. They just thought about how to pay the entry rate teaser mortgage.
They come to my office and say “what do I do now?” It is clear to me, the never thought deep into this mortgage and they were treating their payments like rent.
And that’s what is was–just rent.
No one should be surprised by the result.
The bad business practices flow rather naturally out of the easy money provided by the Fed & foreign central banks. When central banks make money incredibly cheap & you are in the mortgage business, you are strongly motivated to lend money.
Not exactly on topic, but worth the time:
http://www.washingtonpost.com/wp-dyn/content/article/2007/12/04/AR2007120402186_pf.html
Winston:
I can’t fathom why there is this cry that anyone in this thread is trying to let the lenders off the hook. There has been NO such call! NONE! Barry’s initial post strongly hinted that the rube buyer was led down the primrose path to foreclosure by evil lenders and the quoted author was nuts for having the audacity to lay at least partial blame on the lender.
You are right in that the problem is systemic, but it didn’t have to be. Collateralizing the mortgages and getting it off the books of the lender so they could lend again is a pretty good idea, IF you can accurately gauge the risk of the collateralized debt. For my money, the real failure that made it all come down were the ratings agencies. Because of their cock-up, the CDO buyers had NFI what they were buying, and the CDO themselves were too complex a beast for them to check evidently (so much for “know what you are buying”!)
But assuming that some way could have been found to accurately measure the risk so the price could be fairly set, it is kind of ingenious. You can’t blame people for thinking that spreading the risk (whatever it was) around the world in a multi-trillion dollar global economy as a good thing either. Unfortunately the leverage used to buy the CDOs tended to muck that good idea up as well.
Barry, maybe you are dissatisfied with the way Tyler represents this, but the fact is, people signed a contract which they had every opportunity to review. If you put your name to a contract with fraudulent information in it, you’ve committed fraud. I’m sure the lenders and mortgage originators helped to make this happen, and they should (and certainly have) take a hit for it. But don’t you think that anyone who signed a contract with missing or fraudulent information on it has more or less committed fraud?
Lenders are the experts in this recipe and as experts are held to a higher level of responsibility in most courts of law.
Lenders passed on their responsibility to their shareholders, because they were overwhelmed by the desire to make commissions on transactions that were ripe for the picking.
And they were in a state of denial thinking they could delay or prevent the inevitable by making more and more bad loans.
But it was a house of cards.
In that sense they are just as guilty as Mssrs. MCI and Enron who fudged their financials in hopes a recovering economy would happen before disaster caught up with them.
You have to wonder if the “common man” really stands a chance when they are given 100+ pieces of paper at closing. Within those 100+ pages are phrases that you can not expect most people to understand.
I guess it would be like having filing taxes, but without accountants, instead someone filing on commission for you with the IRS not existing.
Lenders are the experts in this recipe and as experts are held to a higher level of responsibility in most courts of law.
Lenders passed on their responsibility to their shareholders, because they were overwhelmed by the desire to make commissions on transactions that were ripe for the picking.
And they were in a state of denial thinking they could delay or prevent the inevitable by making more and more bad loans.
But it was a house of cards.
In that sense they are just as guilty as Mssrs. MCI and Enron who fudged their financials in hopes a recovering economy would happen before disaster caught up with them.
I assume you mean Bob Toll as the builder who unloaded his stock. If so why was he still bullish after the sale?
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BR: No
I’m not sure it was the credit rating agencies responsiblity to verify the income and creditworthiness data the borrowers provided in the loan documents. I’m guessing their argument is that their job was to assume the data provided them was accurate. Using that data, they could run it throught their rocket science models and create different tranches that satisfy varying degrees of risk tolerance.
But if the data they feed into their models is up to 70% fraudulent, then the predictive ability to forecast default rates is worthless. Garbage in, garbage out.
And people should be outraged at the conduct of “professional investors” who bought this stuff. It’s insane that someone I’ve entrusted my hard earned money to, or worse, someone acting on behalf of pensioners, buys investments based soley on a credit rating with no ability to independently monitor the creditworthiness of the investment over time.
“It was an incestious cabal of amiable dunces”. That pretty much sums up the decline of morality on the ‘street’ and in politics.
the FED should raise rates and banish these idiots that invested in this crap.
That way, mankind will be rid of the IQ deficient …. natural selection at work.
I think you have to remember that a lot of these young buyers had NO memory of the 80s S%L problems, being young or not even born then. The 90s dip was not so severe, and companies weren’t going bankrupt.
If “housing always goes up”, and you can sell if you get in trouble on a loan, then no problem. But when the music stopped, those left holding the houses were in trouble.
When one of the most popular TV shows is about flipping houses, you think people would have woken up and realized we were in trouble. SOme of us certainly did. That’s when rates SHOULD have gone up.
This is Greenspan’s bubble, plain and simple. Greed would not have had the opportunity it had without the Fed’s complicity.
[quote]You have to wonder if the “common man” really stands a chance when they are given 100+ pieces of paper at closing. Within those 100+ pages are phrases that you can not expect most people to understand.
Posted by: Joe | Jan 13, 2008 6:45:54 PM
[end quote]
I’d be in 100% agreement with you if we were talking about hidden clauses of property rights or deed oddities or something but we most definitely are not! I don’t care if you are a Wal Mart greeter who rides to work in the back of a turnip truck every day and they push you out on your pointy head at your stop. You know what you make, you know what the form says. If the # of the form is (significantly!) higher than what you actually make you are comitting FRAUD!! End of story. Go directly to jail. Don’t even think about whining to me that your fraud backfired and some cold-hearted bank is actually expecting you to pay the mortgage that YOU said you could pay! Gimme a break!
Barry, Barry, Barry
Puul-eeeze tell me your just writing this to generate responses. This rant just TOTALLY Removes personal responsibility from the mix. Real Estate (in Ca, at least)had a chain letter mentality to it! some enormous Percentage thought they could get out sooner than the other guy with a lot of dough!
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BR: Read the entire piece — As I wrote, of the 3 million new homeowners the credit bubble created, I expect half to two thirds to ultimately return to their prior status as renters. That’s what happens when you buy a property you cannot afford. And, I don’t think the government should bail these people out.
I don’t now how much clearer you can make personal responsibility than that.
~~~
P.S. I could give a rat’s ass about how many responses there are, as long as its intelligent debate . . .
I am afraid this is what you get when you have a general culture of corruption. I’m sure there were many greedy speculators bidding up the prices of houses but what about the average Joe just wanting a house to live in. The only way he could compete was to be dishonest too. You can say he should still have been honest but that isn’t reality.
Suppose you lived in a country where you had to give bribes for routine services such as electrical service. Would you stand on principle and not bribe?
Accurately assessing risk or quality of the loan agreement is the responsibility of the lender. Figuring out if a borrower is lying is part of the risk assessment process as there has and always will be people trying to cheat a transaction to their favor. That’s certainly greedy and selfish, but not unexpected in an economy fueled by encouraging endless consumption.
IMHO, we’ve trained people in this country to buy stuff at the lowest price, and so the focus has been to deliver mortgages at the lowest possible initial rate. With the federal rate so low (and without a significant change in lending regulations) , banks didn’t have as much pressure to accurately gage risk. So they got sloppy and lowered mortgage rates at the cost of reduced quality (quality being the long-term viability of the lending agreement.) “Predatory borrowing” whatever…the banks were just lazy for not putting the effort into developing a quality product and stupid for thinking sloppy work has no consequences.
Mike G,
I quite agree that the concept of securitization is good and should have spread risk as planned – but it didn’t happen that way.
What went wrong?
R-I-S-K was misplaced. There is a degree of truth in all areas of blame – some borrowers cheated, for sure – but who was dumb enough to create the no doc loan application in the first place?
And why?
There is only one reasonable explanation and that was to increase the speed of the process. And why would speed of process be so important?
To generate fees.
This is where the system broke down. If this is where it broke down, it only makes sense that this is where the repair should be made.
If originating lenders were held financially accountable for the integrity of their loans, fraud would be virtually eliminated – both lender’s fraud and borrower’s fraud.
“predatory borrowing” ?
Please.
More than a dozen states Attorney Generals are investigating enormous levels of fraud that has been perpetrated by unregulated predatory mortgage lenders and brokers, as well as realtors.
The wide-spread fraud ranges from deceptive practices, including falsifying an applicant’s income, misrepresentation to applicants about mortgage rates, and failing to disclose expensive prepayment penalties to applicants attempting to refinance, to fraudulent property appraisals, fraudulent securities ratings by ratings agencies, and misrepresentation of securitized investments.
According to one Attorney General, by his own investigation, as much as 50% of the ‘sub-prime’ foreclosures are as a result of fraud involving mortgages sold by unregulated predatory lenders or brokers.
It’s all about the Benjamins.
Barry’s point does not remove personal responsibility from the mix. He concludes:
But when you are in business, you have a target clientele and you understand that clientele. In fact businesses often understand how their customers will behave in relation to their products better than the customers themselves do. The business knows the customer’s emotional incentives and technical blindspots. In any transaction the institutional player has access to more information and expertise than the consumer. That’s all fine.
However, when you take advantage of your customers emotional and technical blindspots to sell a product that you know is not in their best interest to buy and you facilitate that purchase, because you are about to sidestep risk
. . . well, then that is on an another order of magnitude than fudging your income because you really want to buy your own home or you were coached by the mortgage broker or you didn’t fully understand what you were getting yourself into WHEN YOU SHOULD have.
The institution bears greater responsibility for the fraud inherent in the transaction. Especially if brokers were creating an environment that encouraged borrowers to lie about their income. We all know how susceptible most people are in those situations – not bad people, clinical psychology tells that they are average people – the brokers certainly knew what kind of outcome they would get by creating that environment.
But it doesn’t stop there. The institution bears greater responsibility in the individual transaction. But their responsibility is MULTIPLIED through ALL the transactions. While each individual borrower is only responsible for their part in a single transaction, the mortgage brokerage is guilty on one side of thousands of transactions.
Borrowers had no incentive for real fraud. When the teaser rates ended their real incomes were verified by their inability to pay the loan and they lost their houses. They were mostly guilty of being fools or giving into the kind of peer pressure that clinical psychology tells us over and over again that nearly everybody is susceptible to. That’s not predatory behavior and I’d be hard pressed to call it fraud.
The lenders took this into account and knowingly sold them loan products that they knew were essentially flawed. That’s where their responsibilty lies. It’s predatory and it’s fraud.
Most of the borrowers of these loans shouldn’t be bailed out. They should be held responsible as adults who defaulted on their mortgage. But the lenders definitely shouldn’t be bailed. But they will be. They should be facing consequences. But they won’t. So much for personal responibility.
[quote]
Borrowers had no incentive for real fraud. When the teaser rates ended their real incomes were verified by their inability to pay the loan and they lost their houses. They were mostly guilty of being fools or giving into the kind of peer pressure that clinical psychology tells us over and over again that nearly everybody is susceptible to. That’s not predatory behavior and I’d be hard pressed to call it fraud.
[end quote]
Tough to say, even tougher to generalize I suppose. If we wanted to be kind, we could say that they were both guilty of being overly optimistic. Guilty of thinking that the teaser rate didn’t matter because by the time they needed to refinance the house would be worth 10-20% more and refinancing would be a snap. If we wanted to be kind. (!)
Securitization 101: abdication of accountability by the lender. Fluff that part off to the ultimate bagholder. Now bagholders are crying foul over being forced to prove ownership… tsk tsk.
really, it’s all about your distance from the bankers or borrowers in the monkeysphere. i my monkeysphere, i think i am closer to the borrowers. so those bankers should go pound sand, i don’t care what tyler says.
I find I am in agreement. Especially considering Barry has berated Best Buy a couple of times over a simple error in their weekly circular. If an economist can’t rationally deal with that simple issue – how can an average joe work through a 100 page mortgage document and a purchase of a house?
Three parties were to blame for this fiasco:
1)The lenders, who were predatory at the worst and naive at the best. But, where was all this anguish about predatory lending before the housing bubble burst? Had those poor victims, who borrowed “too much”, flipped their house and made a tidy profit, would anyone here be arguing that they should return the profit to the bank? So why the hell should the bank be forced to take a negative profit (loss)when it has no rights when the profits were positive?
2)The borrowers. Fraudulent at worst, naive at best. What the hell is adult responsibility? It means wearing your mistakes. The whole borrowers were victims mentality, assumes that borrowers are imbeciles, which in a large degree is probably true. But here is something to think about; if a man can’t understand a mortgage, should he be given a say in the choice of government he lives under? Should he be allowed to vote?
3)The regulators. A dumber bunch of bastards I have never seen, all unlikely to cop as much of a smack on the wrist. I suppose they were victims too.
I think your average new homeowner thinks of only one thing: the monthly payment.
As for punishing well-meaning honest but not-too-sophisticated borrowers: What are people advocating here? Debtor’s prison? Broken kneecaps?
Well, I read Tyler’s piece first, answered him on his blog, and then saw your piece a day (two?) later.
I enjoyed your answer. It was more aggressive than mine, but yeah, maybe some of that is called for.
Some economists have been boosters for debt, and when debt hits the fan, they have trouble adapting. Google “credit snob.”
Barry, just following-up on your response to my comment. I agree with you regarding Mr. Cowen. Having participated in both residential/commercial real estate debt/equity transactions, I know what constitutes predatory lending. I was merely commenting that these borrowers should have walked away from the lending table. Semantics regarding “predatory” aside, my sentiments are simply that these borrowers knew exactly what they were getting into. I find it hard to believe their intuition did not kick-in when valid proof of income was tossed out the window. As I have stated before, all parties are blameworthy (especially the Fed).
The term ‘predatory’ seems to be deliberately appended as an adverb to make an emotive point against the borrowers; it seems that when parsed down to details, what is meant by ‘predatory’ is ‘collusive’. Turn it around – what does ‘predatory lending’ mean? Seems to me that’s something a lot different from ‘predatory borrowing’ with the role of lender and borrower swapped.
Another point: I don’t mean to toot my own horn, but I teach mathematics at a land grant university, everything from statistics to abstract and linear algebra to calculus to differential equations. I may not be the sharpest pencil in the lot, but I think I fall somewhat above the line when it comes to competence in evaluating the risk of assuming a mortgage.
I tell you what, sitting down and going through those papers was confusing. I certainly didn’t get it all on the first or even the third pass. We ended up bringing in a third party to help us decipher the legalese and the sub-sub-sub clauses. Which turned out to be a good thing.
My point is this: if certain people want the average borrower – the person who’s actually going to make their acquisition a home rather than a speculative property – to ‘take responsibility’ then they should be complaining about the opacity of the process . Why, I’d almost think that at least part of that confusing mass of details was deliberate, to give the seller an advantage. No, that couldn’t be right. Our heroic entrepreneurs, exalted businessmen one and all, would never do anything like that just to gain an advantage, right?
I thank Barry for his kind words in the post but I think his criticism is a simple misunderstanding. I think the lenders are greatly at fault, as does anyone else with a fair mind. Pointing out additional faults elsewhere doesn’t (and should not be understand as) subtracting from those faults. More generally, the point of my column was to point out some new information about a bunch of different economic issues, not to provide a comprehensive survey of who was at fault in the mortgage crisis. I didn’t even mention the regulators but clearly they are at fault too and of course you could lengthen the list of people at fault. I think the title of this post is misleading and I would like to ask Barry to reconsider it.
While I agree this article is standard “Who, me?” shill material, I disagree on the responsibility that those who signed a legal document bear.
The field with “income” is not financial mumbo jumbo. Someone who cannot understand the term “annual income” should not be allowed to own a house. Here’s the Merriam-Webster definition of fraud:
“a: intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right b: an act of deceiving or misrepresenting”
Last I checked, anybody who signs a contract – borrower, lender and everyone in between – is responsible for the veracity of the contents. Borrowers moved into million dollar homes and are now weeping bitter tears because they allegedly “didn’t know what they were signing”, even though the act of “signing” a contract is in fact a written declaration that you do know what you are signing and are as of the date of the signature confirming the contents and your agreement to abide by the terms of the contract.
You argue that lenders and brokers did not look the other why, but were active participants. I agree 100%, no exceptions. But borrowers were also active participants. There is no buying a house by proxy. You either signed the loan docs or you didn’t. And if the financials were significantly different than your reality…
You. Committed. Fraud.
Of course, you sign a legal document, you are responsible.
However, it is absurd to say “There has been plenty of talk about “predatory lending,” but “predatory borrowing” may have been the bigger problem.”
That’s the line that set me off . . .
Its the first time i heard of predatory borrowing. But I agree that there were unscrupulous borrowers who intentionally decieved lenders into getting qualified to borrow than what they can afford. It will be interesting to hear how the presidential canidates will tackle the housing chrisis.
I looked at who to blame some time ago — and the borrowers were at the top of the list:
Regardless of how low rates are, the simple fact remains that many borrowers recklessly took out mortgages regardless of their ability to pay the monthly carrying charges. This was simply reckless behavior, and should be appropriately recognized as such. I was surprised to learn that PIMCO’s fund manager Bill Gross was calling for a bailout. This makes me feel foolish for taking out a mortgage I could actually afford. Had I suspected a bailout of reckless behavior was forthcoming, I would have taken out a $10 million mortgage and gotten a much nicer house . . .
The Ongoing Impact of the Housing Sector
This old, stale news.I posted on this 5 months including to a FBI report that supports what Tyler Cowen is saying.
http://www.aleablog.com/%e2%80%9cfraud-for-purchase%e2%80%9d/
Re “Predatory borrowing”:
OK, I give. I guess I just flew over the phrase because I really couldn’t imagine what it could mean. I mean, how does a borrower force a lender to loan? How does a average borrower snooker the pro? I merely took the phrase to mean “aggressive”, “over-reaching” and in hindsight perhaps I was being too kind to the author.
I’m still not sure I fully understand it, but I can see now where Barry might have been particularly perturbed by that particular phrase. I am assuming that it was a cute turn of a phrase on the author’s part and unfortunately one that implied things he didn’t wish to imply.
If you’re going to call something “predatory” you better have more than “there’s a hell of a lot of blame to be spread around in this housing mess.” This is the equivalent of that scene of Carville’s in THE WAR ROOM: “If they say 2+ 2 is 400 and we say 2 + 2 is 5, the press claims that both sides are lying.”
And Cowen doesn’t just say, there’s blame: he says MORE of it may have been caused by Borrowers.
That, to be subtle, is h*rs*sh*t, and Yves and Brad DeLong, to name two, called him on it as well.
If you really want to claim that CFC or BofA or JPMC or WaMu have too few resources to detect when a borrower is buying three houses, or hasn’t earned anything in the past six months, or is claiming $450K in income this year when last year’s tax return showed an EITC refund, then I have a few Worldcom and ENE bonds with your name on them.
This is Levitt-reasoning at its worst. Let’s be clear: mortgage documents are complex. Errors get made; most of them are non-material. In the grand tradition of the CA health issuer who found mis-statements on applications, but only pursued the ones that made claims, no one WHOSE JOB IT IS TO MAKE CERTAIN THAT THE BANK’S CAPITAL IS ALLOCATED PROPERLY appears to have been able to find these “frauds” until the property was already -15%.
If you want to argue that banks don’t know how to do their jobs, you might have a point. But calling the borrowers “predatory” is like claiming those illegals working for Wal-Mart were “too clever” for a firm whose IT is supposedly head and shoulders above the rest.
Cowen is taking a page from Levitt’s book: never ascribe to inexperience (how many mortgage applications do most people fill out?) what you can blame on malice and fraud. (h/t Daniel Davies) And his definition of “predatory” is so devoid of reality that Barry R’s response is, if anything, UNDERstated.
“The practice of a lender deceptively convincing borrowers to agree to unfair and abusive loan terms, or systematically violating those terms in ways that make it difficult for the borrower to defend against.”
Other types of lending sometimes also referred to as predatory include payday loans, credit cards or other forms of consumer debt, and overdraft loans, when the interest rates are considered unreasonably high.
A friend of mine told me that when she purchased her house a year ago, her real estate agent arranged for a home equity loan at with a mortgage broker — at the same time as the first mortgage — so that her first mortgage would look like she’d put 20% down.
In the S and L days, it was called a daisy chain, no? Except in this case, people who couldn’t afford houses – for instance, myself – were first bombarded with advertisements that this didn’t matter. Myself, I ignored those advertisements, but I don’t think borrowers were pooling money to bombard lenders, which would properly be predatory borrowing. Then, those borrowers – people who have probably been made aware that credit services look out for your every move and that you have no financial privacy – are told, oh, put down that you have some radically big income. This should set off alarm bells, it is true – when someone you don’t know asks you to do something dishonest, buyer beware signs should flash in your head. On the other hand, greed is what every confidence man depends on – and we don’t say, about confidence men, that they were ‘preyed upon’ by their victims. In this case, the confidence game was to keep passing that mortgage on through the system. So, the lender doesn’t have the ‘resources’ to see if the income statement is right. Hmm, if this is true, why weren’t lenders ‘preyed’ upon a long time ago? Why didn’t the housing market freeze up in, say, 1991 and never return, due to the problem in determining whether the buyers had income?
I’m guessing that… the lenders didn’t care! It was somebody else’s problem. That’s how a daisy chain works. Cowen should have written about the culpability that comes with promoting the idea that we are in a ‘new economic era’ – in which case he and hundreds of those eco talking heads should ask what they were doing. Because the old story was, who needs regulation? who needs a welfare state? the private sector is really finding homes for the homeless, and it is up and up in Bush’s America!
Tyler,
Upon the supposition: “Predatory borrowing existed and was widespread.”
Let us define that in order to be proven true the supposition must hold in two parts: 1)- That borrowers can effect predatory actions on lenders, and that 2)- Predatory borrowing was widespread.
Were you to take the position of affirming the supposition and I the position of refuting it, you could not assemble an unbiased jury even from your peers at the Times and win a written debate with me.
Want to try me?
Ask your editor to assemble the jury and we’ll have a go in writing here on TBP.
You might carry the supposition on any number of different intentionally fraudulent actions of borrowers, but you could never carry it on the basis of predation.
It’s like Barringo said. The key item lacking in support of that supposition is the element of “borrower’s superior knowledge.” A commonly observed principle of law is that it assigns the greater guilt when judging two contributing parties to the party with the greater knowledge. That was unequivocally the domain of the lenders. They were the only predators.
First, borrower predation did not exist except in some isolated and exotic particular cases, but in no event could such predation by borrowers have been deemed widespread, certainly not enough to warrant your characterization of it, that it “may have been the bigger problem.” The borrowers you referenced have raised children that can’t find Kansas on a map. No predators, they, whether actively or passively guilty of fraudulent misrepresentation. At worst they were attempting opportunistic free-riding.
The key and by far greatest and most widespread predatory element was the lenders’ mad dash for pro-forma EBITDA earnings for the purpose of meeting or beating the earnings estimates of financial analysts and driving their stock prices higher and higher.
They did this in two ways. They strove for leveraged earnings from fees associated with the ordinary conduct of their origination business, but that wasn’t enough to get the real launch on EBITDA earnings. In order for that they also induced borrowers in every active and passive marginally or directly fraudulent means available to them to get them qualified and on the books… on their own books, that is… the books of secondary investment portfolio holdings that they held for their own accounts. That gave them an extra shot of adrenaline-laced earnings for the quarterly meet-or-beat orgies.
But even that wasn’t the end of their predatory practices. Their coup de grâce delivered to the public trust was the establishing of vast derivatives-based hedging strategies to protect those secondary portfolios. That tactic put the very source of their bread and butter – their good faith providers of capital, the buyers of their securities – on a roller coaster ride of volatility and conflict of interest, and if that were not enough, now, they’ve threatened us all with the prospects for a collapsed financial system.
And the second order derivative of that malignant calculus was the equally predatory derivatives-squared market that DID almost lock up the financial system last August and might yet do so now, even in the face of extraordinary and unprecedented tactics for avoiding it presently being conducted by Dr. Benber N. Anke and his happy crew of Deus ex-Machinators.
gentlemen:
this is my first glimpse of your discussion/debate and i have to say, it looks really heated. i am a criminologist working on my dissertation (5th year ph.d student) on fraud and the mtg. subprime crisis…you guys may wonder about the criminological perspective of the situation and where the blame lies…look forward to it….Tom
p.s. i also have my mortgage brokers license and was in the industry for two years.
I am working on my dissertation
It’s the bank’s job to protect their business and their depositors assets. If they don’t it’s irrespeonsible. If they don’t do this on purpose and lie about it, it’s called a crime and everyone who participated should go to jail including the CEO. Why do we pay CEOs like owners these days if not for this responsibility and risk.
It is the borrowers job not to lie. If they do, they should go to jail. There are laws for this. It’s called theft and fraud.
Middlemen along the way are called aiders and abetters or conspirators if they assist in the fraud. They too go to jail.
Why is this all so complicated.
Last time I checked we could bail out the national debt if we fined all these people and sold the assets off to people who really need homes and put the rest of these folks in “the big house”