On Laying the Blame for the Financial Chaos

I like to cut to the chase and believe, in general, that getting to the heart of the matter, in the most simplistic form, identifies the problem, which is the first step towards finding a solution.

I find what triggered the current financial crises, the subprime mortgage, to be a relatively simple issue.  Of course various factors, such as the securitization of the mortgages, complicated the issue, thus making the crises global and worse, immeasurable.  At its core, though, what drove the subprime mortgage is rather simple:  those with no income, no jobs, and no assets (so-called “NINJA”) wanted a loan, and the banks were willing to risk giving them one.

Thus, the borrowers share as much blame as the government, the banks, the lender service agencies, the analysts, and credit rating agencies for the meltdown of the market.  Of course, no politician would dare say to those who are losing their homes, “You are to blame, too.”  But the fact remains, it takes two to tango.

Take an example I personally witnessed.  During my clerkship, my judge handled half of the foreclosures in my county.  Many people came in, asking the judge to delay an imminent sheriff sale of their home after an entry of final judgment of foreclosure because they have a buyer for their home.  In these proceedings, the judge always asked the same questions, one of which was “what is the monthly mortgage payment?”  In one case, a lady was required to make nearly $4,000 in mortgage payments a month–yet she and her husband only earned $36,000 a year.  Even by putting every penny of income into paying the mortgage, this couple would have defaulted on the mortgage.

Do I feel sorry that she’s losing her home?  Of course.  Do I think she shares the blame?  Absolutely.  It’s certainly reckless to commit to a mortgage payment exceeding your annual income; it’s as reckless as lending money without doing a background check.  The lady should not have borrowed the money and the bank should not have lent it.

Whether they should have done what they did, though, is a different question of whether the government should have let them do what they did.  This is where I take a strictly laissez-faire approach.  If two parties to a transaction, fully informed and aware of the risks, choose to take it, why should the government stop it?  Let them take the risk and reap any rewards.  The borrower receives the money he/she needs and the bank earns higher interest than it otherwise could by lending to a more secure borrower.  If the gamble fails, both parties lose, with the borrower losing his/her home and the bank possessing a house it does not want.

The suggestion the government should engage in risk management is discomforting.  I recently bought a stock in a company called Companhia de Saneamento Basico do Estado de Sao Paulo.  Being a Brazilian water company, the amount of information available is limited compared to a common American publicly traded company.  Thus, the risk of investing in it is higher.  It should be left up to me to decide whether the risk is worth it, not for the government.

The argument the NINJA loan arrangement inevitably collapses does not call for government intervention.  The Internet bubble clearly could not continue; a company that’s making no money, with negative cash flow and a negative balance sheet is bound to fail.  Long-term investment in such companies inevitably leads to massive losses.  Yet no one suggests the government should have prevented the purchase of stock in these companies.

This is not to say the government has no role or that it is blameless for causing the current crises.  It appears, from what limited information I’ve gathered, the government was encouraging these subprime mortgages as a way to encourage home ownership.  Regardless of whether the home ownership goal is something that should be pursued, it’s clear the government should not have been encouraging the means any more than it should have been encouraging purchase of Internet stocks.

The far bigger fault, though, lies in the lack of government oversight.  My view is people and entities taking informed risk should be left alone.  If, as I deeply suspect, the banks and servicing agencies were lying about the loans they were giving out–say, not disclosing the adjustable interest rate may quadruples in the fourth year–the mortgagors took a risk they didn’t choose to shoulder.  Government regulation to prohibit such manipulative conduct is a necessity if free market is to function, just like government regulation is necessary to require, and set standards for, financial disclosure of companies.