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I watched the candidates for Vice President debating last night. Sarah Palin said the credit problem was caused by predatory lending. In other words, the evil banks made loans to people who didn't have good credit.

This raises an interesting question: What did the lenders know about the borrowers that the borrowers did not know about themselves?

In theory, the people who got loans from the so-called predators had enough monthly income to pay the mortgage plus their other living expenses. The real risk was that the borrowers would become sick, unemployed, unlucky, or irresponsible. Apparently we expect lenders to be better judges of the strangers asking for loans than the would-be borrowers are of themselves. How did the conversation between lender and borrower go in the old days, before predatory lending?

Banker: "Well, Billy Bob, you can afford this loan now, but based on that dumbass hat you're wearing, I give you two weeks before you drink a case of beer and drive your Chevy into a silo."

If a potential borrower has the monthly income to repay a loan, how much external risk should the banker accept? I think it's somewhere in the 2% range. In other words, a good banker should turn down a loan for someone who has a 2% or greater chance of being doomed during the early years of the mortgage, before any equity has built up.

Lenders should be required to assign a doom factor to all loan applicants, like a fortune teller. It would be interesting to know, for example, that Wells Fargo has assigned a 20% doom factor to you. Then you could find out on the same day that you aren't going to own a house, and you have a 1-in-5 chance of becoming a hobo by 2010.

In one of my earlier career incarnations I was a banker. My job for a few years included reviewing and approving commercial loans for doctors and dentists. One day I declined a loan application for a dentist who, according to his recent tax returns, didn't have enough cash flow to repay the loan. My boss at the time reviewed my work and turned the decline into an approval without even looking at the financials. When I asked why, he explained that the borrower had a Chinese name. I questioned the wisdom of this lending procedure and he directed me to the files of delinquent borrowers, challenging me to find any Chinese names in there. There weren't any. I'm not judging, just telling you what happened.

 
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Oct 4, 2008
This is partially true. Problems started when many loan officers in the field offices began to fake documents - stating an applicant had a higher income or speculating on the income that other people in the household (including children) would contribute - or would change the interest rates to an escalating scale in the very fine print of a legal document.

But what really brought down the whole industry was when financial firms began buying and selling the debt on the market. Banks have always bought and sold debt (my student loans have changed hands three times and a large medical bill I was paying in agreed installments was sold to a bank) but when they began to bundle these subprime mortgages and sell them like stocks.... Anybody remember the dot com bust? Only this time, the banks or lenders that set up the original mortgages didn't have a vested interest in the original venture: they lent the money upfront and then sold the mortgages off as quickly as possible. So long as the housing market was growing through artificial inflation the scheme worked. When the economy took a hit and people were no longer able to pay, it wasn't the original lenders that were in trouble - the ones with their shady practices - but the reputable and respectable financial giants who left holding a very holey bag.

 
 
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Oct 4, 2008
I received this interesting idea in an e-mail. I'm sure it would never get past Congress, and there would probably be some unintended consequences, like inflation, but it is nice to think about:

"I'm against the $85,000,000,000.00 bailout of AIG. Instead, I'm in favor of giving $85,000,000,000 to America in
a We Deserve It Dividend. To make the math simple, let's assume there are 200,000,000 bonafide U.S. Citizens 18 .

Our population is about 301,000,000 /- counting every man, woman and child. So 200,000,000 might be a fair stab at adults 18 and up. So divide 200 million adults 18 into $85 billon that equals $425,000.00.

My plan is to give $425,000 to every person 18 as a We Deserve It Dividend. Of course, it would NOT be tax-free.

So let's assume a tax rate of 30%. Every individual 18 has to pay $127,500.00 in taxes. That sends $25,500,000, 000 right back to Uncle Sam. But it means that every adult 18 has $297,500.00 in their pocket. A husband and wife has $595,000.00.

What would you do with $297,500.00 to $595,000.00 in your family?

Pay off your mortgage - housing crisis solved.
Repay college loans - what a great boost to new grads.
Put away money for college - it'll be there.
Save in a bank - create money to loan to entrepreneurs.
Buy a new car - create jobs.
Invest in the market - capital drives growth.
Pay for your parent's medical insurance - health care improves.
Enable Deadbeat Dads to come clean - or else.

Remember this is for every adult U S Citizen 18 including the folks who lost their jobs at Lehman Brothers and every other company that is cutting back. And of course, for those serving in our Armed Forces.

If we're going to re-distribute wealth let's really do it...instead of trickling out a puny $1000.00 ( 'vote buy' ) economic incentive that is being proposed by one of our candidates for President.

If we're going to do an $85 billion bailout, let's bail out every adult U S Citizen 18 ! As for AIG - liquidate it. Sell off its parts. Let American General go back to being American General. Sell off the real estate. Let the private sector bargain hunters cut it up and clean it up.

Here's my rationale. We deserve it and AIG doesn't.

Sure it's a crazy idea that can 'never work.' But can you imagine the Coast-To-Coast Block Party! How do you spell Economic Boom? I trust my fellow adult Americans to know how to use the $85 Billion We Deserve It Dividend more than I do the geniuses at AIG or in Washington DC. And remember, The Family plan only really costs $59.5 Billion because $25.5 Billion is returned instantly in taxes to Uncle Sam."
 
 
Oct 4, 2008
The current spin is that those lenders were FORCED
by the Clinton Admin changes to make those loans.

Very good interview between Bill Moyers & Emma Coleman Jordan last night.

http://www.pbs.org/moyers/journal/10032008/watch2.html


There is plenty of blame to go around on all fronts, but
some will exploit this into an anti-poor/racist issue.
 
 
Oct 4, 2008
Very interesting article. Thank you
 
 
Oct 4, 2008
The problem with assessing risk is that there is always the possibility of a Black Swan event. That is an unforeseen event that negates all the assumptions made. Economists and bankers would do well to take the message of Nassim Nicholas Taleb to heart.

http://www.amazon.com/Black-Swan-Impact-Highly-Improbable/dp/1400063515/ref=pd_bbs_sr_1?ie=UTF8&s=books&qid=1223146171&sr=8-1
 
 
Oct 4, 2008
TOTALLY UNRELATED TO THIS SUBJECT..... There are a couple of problems with the new "Cow Supervisor" in my newspaper comic strip. To begin with "Cow" is a female cattle term, and the lower half of the character is undoubtedly female,... but the top half wears a shirt and necktie like a man. Shouldn't this be a "Bull Supervisor" ? Then it would have no teats protruding from the lower half, (and you could put pants on it to eliminate drawing that other detail) and what it supervises is already stated. The pointy haired boss ships a lot of bull anyway. It could have Steer-age problems if it has been neutered. Does it have problems with its calves? Assuming that it is a bull, does the wife think she should be treated as a heifer ? If she comes from a good bloodline she might be a heifer princess.
You really should think these things through before jumping into them.
 
 
Oct 4, 2008
WOO-HOO!

You are on the cover of Costco Connection!
 
 
Oct 4, 2008
I think you'll find that's true of other Asian names as well (like Japanese). Your previous banker boss may seem like he's treating people unfairly, judging them by their race, but if it's backed up by statistics isn't it an intelligent way to accompany the decision-making process?

You failed to finish the story and mention if your boss was eventually proved correct?
 
 
+1 Rank Up Rank Down
Oct 4, 2008
<In theory, the people who got loans from the so-called predators had enough monthly income to pay the mortgage plus their other living expenses. The real risk was that the borrowers would become sick, unemployed, unlucky, or irresponsible>

Scott, this is factually inaccurate. There's a great story on what was happening: http://www.cbc.ca/sunday/2008/09/091408_1.html. You can skip the second half (when they start talking about ABCP) if you like.

In short, the people who got loans from the so-called predators DID NOT HAVE enough monthly income to pay the mortgage plus their other living expenses. They were given low introductory rates with the banks telling them they they could just refinance in a couple of years. When housing markets dropped, they could not afford the refinancing and lost their houses. So what happened is that people were told that they could afford a more expensive house than they actually could.

Basically, the banks decided to try to cash in on the increasing housing markets by offering mortgages to people who couldn't afford them. Anyone who's taken Economics 101 could tell you that this model is not sustainable and must inevitably collapse. Unfortunately, the borrowers probably never took Economics 101 - they assumed that the lenders had. The responsibility is on the banks, and the bankers should be going to jail for grand theft.
 
 
Oct 4, 2008
One reason to emigrate to another country is that some of your relatives are already there and can help you get started. They also can lend you money if you are short and know you'll pay it back, because family ties are strong in source countries. At least that's what happened when my Swedish grandparents arrived in the late 19th century. In areas where the immigrants remain concentrated (Chinatown in San Francisco, the Somali community in Minneapolis) this extended-family-finance system can stay in place for a generation or more.

But as immigrants become more Americanized and mobile, that system is bound to break down as our group motto becomes "every man for himself" (to quote the blues trio Koerner, Ray & Glover). I bet an inspection of defaults would now turn up some Chinese names.

Lyle
 
 
Oct 4, 2008
Dude, watch the new Zeitgeist Addendum:

http://video.google.com/videoplay?docid=7065205277695921912
 
 
Oct 4, 2008
Scott

One small feedback for your graphic designers: In the comments section, the string "User Name" is unnecessarily bold and the font is very big. One can't help but see a lot of "User Name"s while scrolling the comments. Really bad design. Instead of writing "User Name", why not write the "actual user name" in black and bold and the same big font size? I tried it locally on my system, it looks great, my post will look like...

poojac20 [in bold and span class CMT_User, let it be an alink in that font, its ok, say underline on hover] followed by the date in the current fonts.
<my post>

People will automatically understand poojac20 is my username. Some usability experts may insist that they will mistake it for the answer to life, universe and everything but most users are smarter than usability experts.

Please insist on this - that bold list of "User Name"s is not letting me read the comments as I like to. If you do, thanks a million.

Regards
--- Pooja.
PS: To be honest, I won't be surprised if this is how the original designers intended it, and the software developers mistook "User Name" for the string "User Name" instead of the actual username.
 
 
Oct 4, 2008
Scott,
In some parts of Europe, you can usually not lend more than in repayments is 30% of your salary. Of course some morgage brokers 'fudge' the figures by not asking for proof and 'advising' their customers to put a higher figure. So noone is safe.

I heard a joke about the buyback: you're a student away from home, so you try drugs, skip your classes, get you girlfriend pregenant and than at the weekend phone your parents asking for $700 BN as you're a bit short.

FredB2009
 
 
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Oct 3, 2008
Scott, There are actually 3 C's typically used in evaluating whether a person is worthy of a loan. One is character (or credit worthiness). Another is collateral. Traditionally, people put 20% down on their mortgage loans, and this usually protects the lender from the borrower ending up upside-down in the property, where it becomes economical for the borrower to walk away rather than sell the asset and repay the loan. Off the top of my head, I cannot remember the third C. It wasn't "Chinese". But is is in a podcast with economist Arnold Kling, who is uniquely qualified to offered an opinion on this whole mess, having gone to school with Bernanke and worked at Freddie Mac back in the day.

http://bloggingheads.tv/diavlogs/14744
 
 
Oct 3, 2008
It's an easy question: have you paid your bills in the past?

I'm not saying that everyone with bad credit is a bad person, or even irresponsible. But they all have a history of not paying bills.

Once a person gets some history of paying bills on time, they should be able to get a home loan.

While I've never been on the banker end, I'm on the other end of the equation. It sucks, but I know it's my personal history that caused the issue. Despite all the reasons my credit is bad, it is my responsibility.

If our whole culture thought that way, we wouldn't be in this mess.
 
 
Oct 3, 2008
Scott,

In unrelated, related news, the Economist has done a survey of economists as well and here are the results:
http://www.economist.com/world/unitedstates/displaystory.cfm?story_id=12342127

The results are more or less the same as yours, though the timing is more recent.
 
 
Oct 3, 2008
maybe it's just the fact that i'm in a very northern state, but i haven't seen anyone mention the possibility that paying 1200 dollars a month for oil during the winter months might put you a little behind on your mortgage payments. hmmm. pay the mortgage bill? or keep from freezing to death, pipes bursting, etc.
 
 
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Oct 3, 2008
The last point is fairly interesting. It is both prejudiced and makes perfect sense.

There was apparently a clear correlation between people with Chinese names, and being good with credit. This will inevitably lead to a bias towards those with Chinese names, and, assuming correlation between having a Chinese name and being Chinese, a prejudice towards Chinese clients.

Is prejudice still prejudice when it's backed up by statistics? Is it still a bad thing?
 
 
Oct 3, 2008
The current problems are not so much the mortgages themselves, as what was done with those mortgages after the fact. Fannie & Freddie bought up most of these mortgages, so it was no longer the bank's problem. Others were bundled & sold by the investment banks & insured by the likes of AIG. Then they all leveraged these "assets" to an absurd degree.

By everyone making these mortgages someone else's problem, they all thought they were all safe. But it didn't take too many defaults to create blowback throughout the system.

The amazing aspect to me is that many savvy MBA's could convince themselves that everything was fine, since the were all currently making tons of money. Like it is said, there is no one more susceptible to a sales pitch than a salesman. When an individual & company are making a lot of money they become Greed Simple.
 
 
Oct 3, 2008
Interesting. I'll be sure to keep my Chinese name in all my financial documents.
 
 
 
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