Saturday, July 16, 2011

It’s My Party, And I’ll Cry If I Want To

It’s sad

An interesting observation is: one can track traffic on a website. The Hedged Economist website gets more traffic when it’s about policy, especially blame, than when it’s about how to make oneself robust against the inevitable fact of uncertainty. That’s sad. Policy and uncertainty aren’t under one’s own control. Theoretically, each of us should have some control over our own behavior. That was the thinking behind “Whose Future Is It?” and the reason for the multiple postings On Investing. For most people, the biggest influence on their future is their own behavior.

Yet, policy does peak people’s interest, and the blame game is fun. It’s a win-win-win game since bubbles and crashes are mass phenomena where almost everyone is to blame. It’s mass participation (either as players, cheerleaders, or fans) that defines a bubble or a crash. So, everybody gets to blame someone, and they’re all correct.

It’s unfortunate that people seem to forget the management saying: “Don’t fix the blame; fix the problem.” They divert valuable resources from the search for solutions to the search for whom to blame. (They ignore those pesky opportunity costs economists are so fond of). With that in mind, The Hedged Economist put most of the post, “Whose Future Is It?” in a comment on the website referenced in the posting. That elicited an interesting response. The response is reproduced below.

“Why reproduce it?” you ask. Well, bingo, we’ve got a winner. It presents an accurate description of how consumer loans are done complete with editorial reaction.

KNOW10, JULY 4TH, 2011 AT 4:07 PM

@The Hedged Economist: “It seems more constructive to focus on the fact that transactions take two willing parties”
In the housing bubble, it seems more constructive to focus on the middleman. At root, there are two transactions involved: (1) The initial loan and (2) the selling off of the loan. Only one party is involved in both transactions, and it’s the party with the least risk because they take their profit up front in fees at (1) and offload the risk as soon as they can at (2). That middleman is the loan originator. As the Opinion Piece implied, we should focus on “Loan Origination Fraud.”

@The Hedged Economist: “It is not lender’s responsibility to ‘determine who is creditworthy’”
Yes it is. That’s why we have companies like TransUnion, Experian and Equifax — to try to quantify risk to the lender. It is the borrower’s responsibility to present their situation honestly, and it is the lender’s responsibility to make a profitable loan, or make no loan at all, given their best estimate of the risk involved.

But if there is a middle man who can bleed fees off the transaction with little risk — encouraging borrowers to borrow beyond their means (by putting off costs and downplaying long-term risks to the borrower of exotic loan instruments,) and who then can offload the debt to investors by hiding that same risk (perhaps through complex collateralized debt-based derivatives) — well, that smells like “loan origination fraud” to me.
In the end, many of the unwise investors got something of a bailout. Most of the unwise borrowers are pretty much on their own. And the loan originators — well, they took their profits up front, so they’re sitting pretty. That’s where I place the lion’s share of the blame.


Regarding your first point, all that is accurate, but my point is that borrowers can put a stop to it when it’s not in their interest to borrow. There is no reason a person has to take every loan offered. Further, it makes no sense to be surprised to discover that organizations don’t lend because the loan is in the borrower’s interest. They lend because it is in their interest. A borrower shouldn’t rely on lender to act in his or her interest as a borrower.

I would be, and have been, quick to point out there are “agent” problems throughout. The only place where they don’t exist is at the borrower level when the borrower retains the obligation to pay.

Regarding your second point, we could get into a lengthy discussion of credit rating agencies and what they do, but that would be a distraction. Your final paragraph makes a point I’ve stated differently: “The borrower is betting his or her future. The lender is just betting someone else’s money.”

In the case of Greece, which was what Barry was addressing, there are agent problems on both sides of the transaction.


Again, bingo, we’ve got a winner. An opinion piece from the WALL STREET JOURNAL “Government-Sponsored Meltdown,” presents an accurate description of some more people to blame. Copyright restrictions preclude my including the piece, but this quote should present the flavor. The book and the entire opinion piece present the details.

“With the publication of "Reckless Endangerment," a new book about the causes of the crisis, this story is beginning to unravel. The authors, Gretchen Morgenson, a business reporter and commentator for the NEW YORK TIMES, and Josh Rosner, a financial analyst, make clear that it was Fannie Mae and the government housing policies it supported, pursued and exploited that brought the financial system to a halt in 2008.”

Whenever blame is the focus, the discussion gets indeterminate. People tend to look for one cause to blame, but our economy is far too big and complex for any one party, even government, to have other than a marginal impact. So, my reaction to this piece from the WALL STREET JOURNAL is the same as my reaction to the blame-the-lender-or-the-originator argument.


Unfortunately, the email has long since been deleted. But, again, bingo, we have a winner. The exchange occurred back in 2009. Basically, the idea that borrowers could be the key to avoiding liquidity bubbles was greeted with an immediate assumption that the borrowers were being blamed. That brought forth a tirade about greedy bankers, loose monetary policy, greedy bankers, federal deficits, greedy bankers, Fannie / Freddie, deregulation, greedy bankers, media touts, rating agencies, global capital markets, greedy bankers, hedge funds, politicians, voters, securitization, and, did I mention, bankers. All guilty as charged.

The idea that any participant in a bubble could stop the madness, as they say, just didn’t compute. It seems foolish to accept the “government / Wall Street view that the populous is an ignorant vessel that can only just accept whatever is poured in it.” But, some people go beyond passive vessels and firmly believe consumers should borrow any money offered. It doesn’t seem to occur to them that the populous has to be the source of capital. If the populous should never say no to borrowing, where is the capital supposed to come from? Granted, if consumers should always borrow, they are off the hook, but bubbles can’t occur because there’s no capital. No capital sounds a lot like broke.

Since a bubble did occur, and lenders are paid to lend, borrowers seem like a good candidate for stopping the madness. Why consumers rather than other participants? Well, many of the other participants are paid to play, cheerlead, or be a fan. The consumer, on the other hand, is betting his or her future. They’ve got skin in the game, as politicians like to say, and no matter how one slices and dices it, everyone else is playing with other people’s money. It matters only marginally whether it’s investors, depositors, stock owners, or taxpayers who foot the bill; it’s other people’s money.

The July 4th posting closed with “Now watch the fireworks.” Next posting will be more fireworks. Blame is so much fun. It’s better than fireworks.

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