Housing bubble analogy

OK, I’ve heard enough of this crap about “those thieving, lying borrowers” – as though there is no blame to the lenders.  Let’s use an analogy, ok?

You are the owner of a liquor store.  Your clerks are all on commission.  You discover that some of them – the ones with MASSIVE sales rates – are using “stated age” before selling alcohol to the individual on the other side of the bar.  A couple of your clerks (stodgy types, to be sure) insist on asking for ID — and needless to say are NOT doing as well.  Having discovered this, you decide to say, “It’s OK to use stated ID.”

Then it turns out that minor are buying alcohol at your store.  Now…

Who, exactly, is at fault here — and just how much “fault” is involved?  The minors who knew they weren’t supposed to get it – and who lied about their age?  (Yes.  But they won’t spend time in jail.)  The clerks who accepted “stated age”?  (Yes.  And they’ll serve time and pay fines.)  You, who knew of and allowed “stated age” to be used?  (Yes.  You’ll serve time, pay fines, lose your license to sell and so lose your business.)

Now admittedly, selling a mortgage to someone without the means to pay isn’t going to put you in prison.  Other than that, the analogy is quite solid.  Well, not completely.  We haven’t included the clerks who made sure kids leaving school knew they were selling booze with “we take stated income”.  We haven’t included the clerks who saw the id (underage) but called it legal stated age anyway.  These, however, are shading into the predatory and fraudulent – I’m just hammering the “who is stupid and deserves what’s happening” issue.

“These kids lied to me about their age and got drunk, send THEM to prison instead of me.”   “What ID did you use?”  “I asked them their age.  I never expected they’d lie.”

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5 thoughts on “Housing bubble analogy

  1. Nice analogy. It’s too bad that the responsible ones will end up paying, instead of those who lied or approved the lie.

    Am I mistaken in thinking that the government forced(or encouraged) lenders to approve sub-prime loans? I seem to remember reading about some sort of legislation to that effect.

    Dax

  2. Dax,

    Yeah, except… ok, I need to add one more line to the analogy, and then ramble a bit further.

    Extension of the analogy. In some states it’s legal to have some forms of alcohol when you’re 18, in others it’s 21 period. So let’s add one group of kids – ages 19-20 – who came in to get some alcohol, IDs at the ready. The clerks said, “never mind, you’re old enough.” These were getting alcohol in total ignorance – they expected the pro – the clerk – to know whether they were legal or not and do whatever due diligence was necessary.

    Yeah, “How couldn’t they know?” And “What reasonable person could POSSIBLY think they could afford that much on such a small salary.” And the answer is – lots of reasonable people. Mortgage financing is complex even when it’s a ‘simple’ fixed interest 30 year mortgage. The hardest thing to swallow is what makes everything else easy — you are buying something that in lump payment form is more than at least two times your annual income. At that point the “boggle” factor kicks in. You are paying in nibbles to get it. So the only REAL question you have is whether you can afford the monthly nibbles.

    And a retail front lender says, “sure, we just use an ARM.” And if you read the fine print you see that after XX years the rate will adjust to reflect whatever is current, but since that can’t be predicted there is nothing in the form – NOTHING – to tell you what the actual payment per month will become. You have to have intuition that says – in the middle of at least 20 pages of legal documentation, “Hey, waitaminute, this could go to five, six, even ten times what I’m paying right now.” And if you do, then you hit the second thing the retail front lender will – or used to – tell you: The value of real estate always increases. So… “Hey, 5 year ARM, the payments adjust in 5 years. But by then the VALUE of your house is so much more, even if you’re not making enough you can sell for massive profit OR you can refinance using the equity for your balance and get another 5 year ARM.”

    And why do you trust this person? Because you believe that he’s lending you his money – that he’s going to tell you, “you can’t do that because we don’t think you’re going to be able to make the jump.” But… he’s not. As soon as he gets the mortgage signed, he’s going to sell that to someone else. And they are going to take it and use it for more money fun and games. So he’s not lending you money, he’s selling you a product.

    If you, the new home buyer, realized he was selling a product your defenses would be higher – the “show-me” factor would kick in a bit stronger. As it is, however… You’re screwed.

    So we’re not just going to pay for the liars and those who approved the lie. We’re also going to pay for the people who took the deals IN GOOD FAITH.

    Why? Why not make them all pay the penalty of their stupidity and blindness?

    Because we’re going to pay either way due to the fact there are so many of them. And our choice is pay it now or pay it later — and “now” is always cheaper in the long run.

    Oh, when we find the liars, let’s hammer them. But let me give two things to consider for why we need to be careful. Mass foreclosures and bank runs.

    In the early 1980s there was an oil slump – the price of oil plummeted (largely due to everyone in the 1970s getting a lot more efficient in response to OPECs oil piracy in the 1970s.) It caused a lot of foreclosures in places where oil was a big deal – either immediately (like Houston Texas for example) or speculatively (the “Front Range” in Colorado where Shale Oil was the thing being developed). Now, one foreclosure in a neighborhood is a nuisance but survivable. But when as much as 5% – much less 10, 20, or 50 percent – of the neighborhood is foreclosed, it’s ruinous. Those houses sitting empty and unsold push down the value of all the other houses in the neighborhood. They’re targets for squatters and thieves (wire and pipes and parts) and vandals – which further depress the neighborhood property values. They’re also drains on the tax base of the city or county – both due to the drop in property tax revenues AND the costs of processing foreclosures. Not to mention the often coincident bankruptcy. Oh – and if a neighborhood goes bad, it tends to affect the adjacent neighborhoods. Now ponder for a moment the city in which you live. Consider which neighborhoods have had lots of house sales over the past five years or so. THOSE are the ones that are facing the mass foreclosure window. That’s not to say the traditional ‘lower class neighborhoods’ won’t have their problems. But when Snob Hill is getting hit…. Cities are evaluated and considered on averages and medians. If the top is dropping, the whole thing is affected more than if the bottom is dropping.

    Then there are the bank runs. Whether we like it or not, banks are probably THE critical infrastructure to our society. We don’t have to haul around huge quantities of cash because we trust that we can safely store it. And we trust that the piece of paper – check, credit/debit slip, whatever – that we hand over or receive will be adequately matched — that the only person we have to worry about is the person handing it to us, not the organization that’s supposed to be keeping it safe. Bank runs and closings shatter the trust. And that makes it harder to do a lot of things – trades, expansions… A huge number of foreclosures means the banks don’t have enough money – it’s all tied up in that property and so not available for, well, cashing your check.

    There are more potential problems, but those two should be sufficient to show why pay now (bailout of sorts) is better than pay later.

    Let me address your last point. The answer is sort of. Not forced or encouraged, but allowed. Quite simply, we went through financial hell in the 1930s, and put in place a crap-load of regulations – limits and oversight – to prevent it from happening again. And in the interest of “business is more efficient than government” and “why should government interfere with profit and wealth for everybody” those regulations have been gradually pared back. We had a brief return when the small hit from the Savings and Loan scandal came about, but because it was “only” S&Ls, the “business beats government” folk only had to restore S&L limits – banks and other financial organizations were allowed to go unfettered.

    Bluntly, we discovered (again) almost a century ago that banks weren’t altruistic, but were rather oriented on immediate profit regardless of the future, damn the consequences to anyone else. And in the intervening 80 years we’ve forgotten — or rather, allowed them to persuade us that they’ve reformed and would never, ever do such a thing again. And besides, YOU can have some of the money TOO.

    Not forced. Not encouraged. Allowed, and anybody who asked, “What about the 1930s” were told, “This time it’s different.”

  3. I heard on NPR that the SEC is starting an investigation.

    I nearly blew a vien shouting that the top levels of the SEC should all be in jail for dereliction of duty and defrauding the public. (I pay them a salary to stop this sort of thing, they didn’t stop it, QED, they stole their salary from me)

  4. Bleh,

    My boy just dropped out of the race.

    I might as well vote for Bush for a 3rd term now. Better the Dictator we know…..

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