Pointing the Finger of Blame in Mortgages

Alan Blinder points in six directions as he attributes blame in the mortgage mess:

Six Fingers of Blame in the Mortgage Mess: Finger-pointing is often decried both as mean-spirited and as a distraction from the more important task of finding remedies. I beg to differ. Until we diagnose what went wrong with subprime, we cannot even begin to devise policy changes that might protect us from a repeat....

The first finger points at households who borrowed recklessly to buy homes, often saddling themselves with mortgages that were all too likely to default. They should have known better. But what can we do...? Not much, I’m afraid.... Greater financial literacy might help, but I’m dubious about our ability to deliver it.... Fewer words, and in plainer English, might help.... But... people don’t read those documents anyway.

It seems more promising to point a finger directly at lenders. Some lenders sold mortgage products that were plainly inappropriate.... Under current law, a stockbroker who persuades Granny to use her last $5,000 to buy a speculative stock on margin is in legal peril because the investment is “unsuitable” for her (though perfectly suitable for Warren Buffett). Knowing that, the broker usually doesn’t do it. But who will create and enforce such a standard for mortgages?... We should place all mortgage lenders under federal regulation.

That said, bank regulators deserve the next finger of blame... the regulators know they underperformed....

Securitization is a marvelous thing.... But securitization sharply reduces the originator’s incentive to scrutinize the creditworthiness of borrowers.... Don’t the ultimate investors have every incentive to scrutinize the credits? If they buy riskier mortgage-backed securities in search of higher yields, isn’t that their business? The answer is yes — which leads me to point a fourth finger of blame. By now, it is abundantly clear that many investors, swept up in the euphoria of the moment, failed to pay close attention to what they were buying... a fifth finger, this one at the investment bankers who dreamed them up and marketed them aggressively. Another part of the answer merits a sixth finger of blame. Investors placed too much faith in the rating agencies — which, to put it mildly, failed to get it right.... Under the current system, the rating agencies are hired and paid by the issuers... an obvious potential conflict of interest....

SO that’s my list of men (and a few women) behaving badly. But as we point all these fingers, let’s remember the sage advice of the late and dearly missed Ned Gramlich, the former Fed governor who saw the emerging subprime problems sooner and clearer than anyone. Yes, the subprime market failed us. But before it blew up, it placed a few million families of modest means in homes they otherwise could not have financed. That accomplishment is worth something — in fact, quite a lot.

We don’t have to destroy the subprime market in order to save it.

Comments

[Slocum]

"The first finger points at households who borrowed recklessly to buy homes, often saddling themselves with mortgages that were all too likely to default. They should have known better. But what can we do...? Not much, I’m afraid...."

I disagree strongly. One of the things we could do would be to ban below-market 'teaser rates'. I believe that even unsophisticated borrowers would make much better decisions if they had to make the full payment from month one.

Or even better, let's legally mandate that every mortgage must be repayable early without penalty. If we did that, we wouldn't have to ban teaser rates -- they'd die of their own accord.

[Aaron]

There have been dozens of housing-bubble blogs out there for years. YEARS. It's been obvious to me (and to plenty of writers, bloggers, newspaper journalists, etc.) that something was going horribly wrong in housing for YEARS.

Why not point the finger of blame at the media who failed to point out the disaster in the making? At people who didn't call David Leareah on his lies? (Just like you, Brad, call out the journamalists who fail to call Bush on his lies?)

[gordon]

Aaron, back on 7 Sept. Mark Thoma posted a useful list of previous posts at Economist's View which raised the spectre of the housing bubble bursting. The earliest was May 2005.

http://economistsview.typepad.com/economistsview/2007/09/what-did-we-kno.html

[Ponzi Q. Globalization]

"Ned Gramlich, the former Fed governor who saw the emerging subprime problems sooner and clearer than anyone."

Dean Baker points out that this is a crock on his blog.

"Yes, the subprime market failed us. But before it blew up, it placed a few million families of modest means in homes they otherwise could not have financed. That accomplishment is worth something — in fact, quite a lot."

What's Blinder been smoking? Isn't it possible for one to be happy if one does not own* a super duper big home? Is maximizing super duper big home ownership* the most important thing that policy should be aimed at? Regardless of all else?

I love Blinder because he has made clear that neoliberal globalization is gonna be a clustereff for most Americans. I hate Blinder because he is unwilling to propose anything meaningful to stop the clustereff and instead proposes ineffective bromides that do nothing but calm the nerves of the ignorant.

Anyway, what happened with housing, mortgages, and securitization was nothing but a big swindle. A swindle that has made its dishonest perpetrators rich and which will go unpunished.

Jesus Q. Christ! I wish I was smart enough and sleazy enough to be an executive at an investment bank or other big financial entity. I could be like Robert Rubin and whore for Enron and shill for a 'free-trade' that renders labor impotent and puts America in debt to the rest of the world and *still* have all the important people think I was fighting for the good of the American hoi polloi. Oh, well. One must face one's limitations. In both intelligence and sleaziness.

* - By own I mean make a mortgage payment to a bank every month for 15, 30, or infinity years or be booted out.

[glenn]

Warren Buffett invests ALOT more like Granny (should invest) than Blinder realizes. WB never stoops to speculating.

[Emma]

I am a successful professional with a master's degree, speak several languages, and I am widely read and traveled. I read every freaking word of my mortgage papers and half the stuff could not be understood. Not to mention that you don't really see the actual documents until you are signing them.

After going through the experience it is my firm belief that they are kept as unreadable as possible on purpose. Not having the paranoid gene, I couldn't say why.

[Paul J. Reber]

I read this last night and my first reaction was: "wait a minute, why are we pointing fingers at all?"

There has been a distinct upside of the housing boom/subprime mortgage market development:
* Some people got houses who would not otherwise have been able to afford then (note @Ponzi, I'm thinking of people who didn't have a house at all, not people who upgraded their McMansion -- "subprime" really means people with poor credit, prior homeowning will mostly take you out of that segment). The people who got and continue to hold their houses have gotten real benefit.

* New securitization of RMBS seems to have filled a need for additional low-risk illiquid securities (when properly rated/valued). Increasing the effectiveness of capital markets is generally a good thing.

* Job creation in the housing/sales/mortgage markets during the course of the bubble.

A few of the bad things that happened don't seem worth worrying about:
* Some people gambled on houses they couldn't afford and have to foreclose now. This seems to be between them and their banks and if everybody priced their risks fairly is a natural course of the housing market.

* Some hedge funds mis-rated (or overly trusted the agencies) the RMBS securities and took a bath because of their error. Again, this is a natural outcome of risk-seeking, which in general leads to growth (even if a few people lose along the way). I don't think the instrument complexity is to blame. If you don't understand what it is you are trading, you ought to get weeded out of the trading pool by people who do.

* Loss of those construction/sales/brokerage jobs now that the bubble has burst. It's better to have worked well for a few years than not at all, right? It's not like the economy was creating jobs in other sectors for the past 8 years.

To me, the things to worry about are:
* Predatory financial practices by brokers who used the subprime industry to fleece people. This is a kind of theft that I would also like to see attacked aggressively, but it's not just in mortgages. Financial service related theft happens in the insurance industry (check the numbers on a "permanent life insurance" policy sometime, I can't believe they're even legal), usurious credit card rates, car/furniture financing, title loans, check-cashing/payday loans. If the subprime meltdown is an excuse to tackle some/all of these, great. But I suspect mortgage fraud isn't even the biggest problem in that bunch.

* Systemic shocks that disrupt the economy beyond the big funds that got pounded in the meltdown. The Fed seems to be coping with the liquidity & economy stimulation the situation requires. The failing funds appear to be in process of being bought up by the more solid funds. Maybe it's unwinding ok?

But today I see Citigroup reporting a 60% (!!) drop in profits. Swiss UBS is reporting $4bln losses in RMBS. Those seem like very big numbers. So maybe some finger pointing is in order after all. When it's said and done, though, I hope we'll still have more ways to get poor(er) people into home ownership with fairly constructed instruments.

[JonF]

Re: note @Ponzi, I'm thinking of people who didn't have a house at all, not people who upgraded their McMansion -- "subprime" really means people with poor credit, prior homeowning will mostly take you out of that segment

Not true. Subprime borrowers included a lot of house speculators: people buying homes they intended to flip after a year or two and hence were balse about ARM rate resets since they never planned on paying the higher rate. Moreover at least some non-trivial fraction of home-owners do have bad credit (though they did not when they bought their homes). Stuff happens after all, and we went through a recession a few years which tipped many people (notably in IT and other tech careers) into insolvency and bankruptcy. They may have saved their homes, but defaulted on other debts and may have a fat Chapter 13 on their credit record now.

Re: It's not like the economy was creating jobs in other sectors for the past 8 years.

Which is a problem. Where are all those unemployed construction and mortgage industry workers going to go? One could have said the same thing about the tech workers in 2001. Having a lot of unemployed people dumped on a job market that has no other booming sectors is a recipe for recession.

[j]

Sir, We the lemmings have an unfortunate tendency to periodically jump en masse into the ocean (we dont swim). We are also unable to resist "free" mortgages. Knowing that, we elected a government of the soberest lemmings to keep us safe from ourselves. Our government failed to stop us, although later threw us paper to keep us afloat. Then I have to disagree with your finger pointing: we lemmings are built in such a way that not one of our twenty fingers can point toward ourselves. We, Sir, are innocent.

[dobedo]

Before accepting that, "Yes, the subprime market failed us. But before it blew up, it placed a few million families of modest means in homes they otherwise could not have financed. That accomplishment is worth something — in fact, quite a lot.", it's worth looking at the Center for Responsible Lending's paper on this subject at http://www.responsiblelending.org/page.jsp?itemID=32032031

According to CRL:

[A] new CRL analysis shows that while the subprime market has produced more than $2 trillion in home loans over the past nine years, these loans have led or will lead to a net LOSS of homeownership for almost 1 million families.

The reason for this net loss? From 1998-2006, only 9% of subprime loans went to first-time homebuyers, but over 15% of subprime loans ended (or will end) with borrowers losing their homes through foreclosure.

[kharris]

Is it possible that financial innovation is always a problem? That the innovators don't understand what they have done and regulators don't understand what needs to be done to keep risk manageable until after conditions change and put the new instruments under stress?

If so, then rather than surveying the damage and its sources only in the present case, would it not be possible to improve our understanding of the general case? Could we not figure out how to reduce the risk of financial innovation in general and instruct regulators and institutions how to go about it? Once the first round of trouble (which will show up anyway, but perhaps on a smaller scale if we get our regulatory stuff right) has passed, the specifics of the innovation could be addressed.

Simply assigning a higher risk rating to instruments that have not been all the way through a credit cycle or the relevant industrial cycle might help. Recognizing that new instruments are sometimes created merely as a way to get around regulatory limits would also be a reasonable first step. We either think regulation helps, or we don't. We should not on the one hand regulate and on the other applaud innovation that is nothing more than an effort to skitter away from regulation.