Part I: Who's to Blame for the Crisis, or More Briefly, Everyone

I'm pleased to present the Logician once again. To refresh your memory, I had asked him to write to help us understand certain aspects of the financial crisis. He did so HERE. This is part one, so he/we will be writing more about this in the near future.

Edit: Blogger software is mucking up formatting and failing to paste things where they belong. Apologies.

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A while ago, I promised our host the Brew Master I'd write at greater length on the economic meltdown. In short, the problem arose from decades of pride, greed, stupidity, shortsightedness, willful blindness, naivety, dishonor, selfishness, and pride. Remember the vulgarization and glorification of greed? Remember "greed is good" and "greed works"? Greed is the foundation of capitalism, they said. Of course, none of them ever bothered to read Adam Smith's classic, and they were too blinded by lust of money to acknowledge a difference between greed and self-interest. (Nice explanation, here.)

I digress. Let's go back to the beginning. Before we discuss the greedy, dishonest, stockjobbing, maneuvering, conniving, angling real estate & finance professionals, let's discuss the borrowers.

THE BORROWER

The naïve, the willfully ignorant, the dunces, the lazy, the gamblers

Sally and Bob want a house so they meet the realtor who helps them find their dream house in Los Angeles. At half a million bucks, it's a great deal, even has a porch! Bob does pretty well as a contractor, sometimes making more than six figures, and Sally pitches in. Between them they're pulling in $125,000+ a year. Sally figures she'll quit her job and become a full time mom after they qualify for the loan.

Sally and Bob have a mortgage professional working for them to get a loan, so it absolves them of all personal responsibility. Remember second grade math? Multiplication? The social program that prepares you for your responsibilities as a citizen? In today's world, remember that the borrower is always the victim. If I say I'm no good at math, it absolves me from the responsibility of doing second grade math to figure out if I can afford something.

For fun, let's do Sally and Bob's math for them. Hell, we don't even have to do the math, go here. Let's say I borrow the full amount (no shit, some of these loans were for 120% of the property value) of $500,000. In 30 years, Sally and Bob will pay $1.4M, or just under half of Bob's salary, if he can sustain his six figures. Of course he'll lose a $30K each year in taxes, if he even pays them. So taxes & payments together, Sally and Bob have $20K each year to live on in Los Angeles. It might be a tough decision, y'know? You have to hope you can maintain or increase your present salary for the next 30 years, especially if Sally plans to stop working after they qualify for the loan. It never occurs to Sally and Bob that the bank's requirement for demonstrable income is there because the bank knows that if the income isn't there, the house isn't getting paid off.

Fortunately, the housing market always goes up. Everyone knows this, it went up for over 20 years now, eh? Sally and Bob listen to a pep talk from their realtor, who tells them they can flip the house in five years to another buyer. Not only will they pay off the loan with the sale, they'll profit from the sale, maybe pull in a couple hundred thousand. You'd be a moron not to buy the house, they figure. It's not hard to find Bobs and Sallys. You can find a hundred financial exhibitionists on the internet bragging about these schemes (like here).

Alberto and Rosa wanted a house too. These poor migrant workers have a deeply moving story. Struggling as $15,000/year strawberry pickers, they pool with other migrants to qualify for a $720,000 house in San Francisco. Yes, that's right, really. Short story this time – they're victims to predatory lending. Yeah, it'd take over 48 years just to pay the principal, so long as they can pay their entire annual salary to the mortgage payments for 48 years. But this is division, it's neither fair to ask them to do their own division nor expect them to ask anyone else with a 2^nd grade education. Alberto and Rosa probably don't speak very good English, and they probably have limited education. Based on everything that happened at this time, I'd guess they were presented a SISA loan application (Stated Income/Stated Assets, or "what I write is what I make, no proof required" loan). The broker likely reported their income as $200K, told them everyone does it, it's cool, and they went ahead and signed.

Guest Writer - The Logician on the Economic Meltdown

Good morning Coffee Drinkers. I am most pleased to present to you the first ever Morning Coffee guest writer, the Logician. I've been trying to get guest writers for a long time now (yes, this is a guilt trip), but the MC doesn't pay, nor is it as prestigious as even the National Enquirer, although our journalistic integrity far exceeds that rag. Anyway, the Logician is a longtime reader and and has frequently commented on various posts. Since he has a mind for such issues, I asked him to write, in layman's terms, a bit about the economic issues that our country faces. So, please, enjoy what he hath Brewed for thee.

[Publisher's Comment: I'm not sure how the naming conventions for guest writers should work, having never had one, so mayhap this format will change.]

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Good morn to you good folk of the world, you who rise with dread when the sun rises, long week after long week, with a wish for the fragrant comforts of the percolator. Heartiest salutations to you all, and contempt and curses to the rest of you! And a hex on Pyrrhic verse, and all those who force the practice on suffering young. Read on, grow wise.

Leaving behind failed poetic greetings, let me launch into the topic of the day. The current economic crisis, with increasing foreclosures, failed banks, toppled securities firms, lost investments, and a staggering economy present an ugly picture. Many are objecting to helping incompetent and failing big businesses, as witnessed by the massive public rejection of a bailout.

The Morning Coffee's reader has no doubt heard the rhetoric: regulators failed, greed caused it, the market was overpriced, predatory lenders preyed on unsavvy customers, irrational panic in the stock market, tax cuts for the wealthy, greedy investors, people overspent. There's truth to many of these charges. There's lots of blame to go around, and varying degrees of culpability. Some have intentionally gouged customers, some have been willfully negligent, others stupid, most foolishly optimistic. It's a big problem with many sides to it. Hopefully the following survey of the landscape will present a clearer picture. I hope to explain the start of the problem here. The second stage of the problem will be in a subsequent essay.

The easiest problem to understand is that people are losing homes. Who's responsible? Ultimately, the customer accepted the mortgage. In most cases, sixth grade math should have told them they wouldn't be able to pay in the long run. Mental laziness, lack of wherewithal, indifference toward personal honor and responsibility provided the stimulus to enter into a loan that the borrower could not sustain over the long haul. Mortgage brokers and lenders acted as enablers by making it easy for people to get these loans. The scale of the problem inflated when pushy real estate agents withheld business from appraisers if they failed to inflate the value of the property sufficiently.

The other side of this problem is that lenders are losing money. In many cases this threatens their ability to survive and to continue lending us the money we need for our day-to-day needs and desires. The more that banks and thrifts go under, the harder it gets to receive a loan. Under current conditions, no one wants to give a loan to anyone but those with the highest credit ratings. It's becoming more common for lenders to insist on 30% of a loan as a down payment. As noted above, lenders were frequently responsible for their own downfall because of their shortsighted focus. By failing to require a sufficient down payment, failing to verify the borrower's financial claims, and failing to even crosscheck their own records and do a proper risk assessment, they set themselves up for a big fall. Why would anyone set themselves up this way? Greed and lack of personal loyalty to their institution played a big role, from the bottom up. The mortgage officer was glad to push through a crappy mortgage; if he didn't, there was no commission. The president of the company could point to increased sales and project ballooning revenues for the next year. One needn't be concerned with the fact that these mortgages are 30 year mortgages I suppose, so long as the killer yearly bonuses keep coming.

Lenders' negligence doesn't explain all their losses. Organized criminal gangs (white collar, usually) gouged billions of dollars from lenders and stole houses outright from the owners. These types of fraud are very cost intensive to uncover in many cases. To prevent these, the level of scrutiny for loan applicants would need to increase dramatically. This measure would delay loan approvals significantly, and require substantial additional costs passed onto the borrower. Lenders have typically made business decisions that help them define an acceptable level of risk. (No one – I emphasize this point - has made a serious attempt to quantify how much fraud is involved in this mess. Nor do federal agencies appear inclined to tackle that project. It would make many agencies, fairly or not, appear grossly negligent. Even if the criticism is unjustified, it would be a brutal rhetorical blow to many. On a political note, John McCain is the only political figure that has ever pushed for a systematic investigation on the extent of mortgage fraud. Specifically, he intends to create a "9-11 Commission style" body to investigate various aspects of the mortgage crisis, including the degree of damage caused by mortgage fraud.)

Another variable causing losses for lenders is that borrowers simply stop paying. If a borrower has a $250,000 loan on a house that devalues – as in many current markets – to say, $125,000, many borrowers decide that it's foolish to keep paying and simply stop doing so. The lender may recover some of the lost money, but they can only get $125,000 from the house, minus processing fees. It might not be worth while going after the assets of a welcher who probably lives from paycheck to paycheck anyhow. People from all classes of society have done the calculations, chucked personal responsibility out the window and walked away from the mortgages.

The lending institution fails because it took out BIG loans to allow it to make the "small" loans. Now they have to pay principal on those same big loans but don't have money coming in from the small loans. The lender also gets money from the sale of business securities. But investors see the problems in the mortgages and pull their money out. Now they lender doesn't have this money either.

That's the first part of the problem. The indirect affect on the rest of the economy is the bigger issue, but this will require a follow-up essay.