An Academic Ramble
There's a reason why I have an Economics degree instead of a Finance degree.
Recent events in the financial sector create yet another layer of worry in tandem with the credit crunch. I'm referring to the fact that Lehman Brothers had to file for bankruptcy, causing other stocks to fall, and that Merrill Lynch has been taken over by Bank of America. Thousands of people are losing their homes because they can't afford to pay their mortgages, which is old news by now, as in our short national attention span it seems as though it has been going on forever. In times like these, it makes me want to call my Finance profs and simply say, "Mind answering my questions now?"
When I was an undergraduate, I entered the business school as a Finance major. It was more hands on than the other options. I basically wanted to be Suze Orman, who started off as a personal financial consultant helping people figure out their hang ups with money, what they really wanted out of life, and how much it would cost to get there. I had an internship set up withe Prudential before I abandoned Finance for Economics. And the main reason I abandoned it was because of the attitude of the profs teaching the subject.
I remember them going over the basic concept of the "utility curve"--it's a sort of a crescent diagram on an axis that is supposed to demonstrate consumer preference when spending their incomes. Let's say the vertical line is "food" and the horizontal line is "clothing". People can then be tracked on that crescent curve depending on how much more they value food over clothing--it's supposed to be a basic model for how people distribute their income among various wants and needs. But even then--and this was pre-Worldcom scandal--it just never felt "true." I remember saying that model couldn't possibly be a basic representation of what people do, because that's not how people behave. They take their income and spend it on food, and then they take their credit card and buy the clothes anyway. The basic response was, so what, everything else is based on this model, so if you don't use it, you can't work any of the rest of this stuff.
Another big gap I had in trying to study Finance was the cognitive dissonance you were supposed to apply when figuring out how to value a company. There are mathematical formulas you can apply to a company's earnings and costs to determine whether they represent a good stock buy or not, whether to loan them money or buy their bonds, whether they're risky or safe, blah, blah, blah. It's all in the math. But the math is based solely on the numbers that they provide. I got a giant lecture mid-class one day about how we should always assume the company was being truthful--it was the assumed default position. It's not like I think all businesses are by default crooked. But the basic tenet of finance is that businesses are in business to maximize profit. Not to behave ethically. At times I'm sure both things happen. But there are plenty of times when it doesn't. There are also other extraneous factors that just don't figure into the known equations. I tried to argue that the thing that makes, say, a mutual fund more successful than not was the manager who was hired to run the fund. If he had a good performance record, chances were even better that this one would, too. That is a provable fact. He was just as important (or maybe more so) than the calculation. How did the manager fit into the math? The answer is, he doesn't. And so you get things like Worldcom.
I had just switched over from Finance to Economics (and was having a much better time) when the Worldcom thing really blew up. I felt like calling up one particular Finance prof and simply saying, "I told you so." Granted, one bad company does not a pack of crooks make. But it does mean the formulas we use to calculate what's safe and not need to be reconfigured. Quite frankly, a hell of a lot more social science and philosophy needs to configure into subjects like Finance. In Econ, I got to study things like poverty and welfare, labor economics and stuff like that--where the data was applied to beliefs about the way people function, and those theories were evaluated. Being in Finance made me feel like a cog in a preprogrammed wheel. I'm glad I got out when I did. I even continued to encounter that sort of blind faith in the system attitude in my work life. Sitting through one benefits session just out of college on a government contract job, the financial rep was there explaining retirement programs and all that jazz. His company had just been in the news for having major financial improprieties back in 2003. I don't remember the name of this particular institution now, but it would be equivalent of saying "Merrill Lynch." I asked him during the Q&A about the article I'd just read about it and how that would possibly impact our investments. He got red faced, angry and without going into specifics just kept saying "That would never happen."
I'm not surprised that any of this is happening. Part of the problem stems from people taking on more house than they could afford and being unwilling to save money and work for things. Part of it is from predatory lending companies who made loans to people they knew would default three months later because a regular bank wouldn't touch them with a ten foot pole and who didn't bother to explain the fine print or even left the fine print out of the contract. Some of the blame goes to huge and supposedly safe and intelligent financial companies who bought up bundles of these shoddy mortgages because they used the out of date theory that 90% of people pay their mortgages on time--without admitting that model was based on people who had standard mortgages with good credit scores from reliable banks instead of fly-by-night lending companies who issued ARM or interest only mortgages based on lower qualifications. And part of the blame is on the people who promote blind acceptance of the way the financial markets are supposed to work--instead of explaining and exposing how they really work.
Know who agrees with me? Suze Orman.
Good job, finance companies.
-- Virgil
posted by contemplator at Tuesday, September 16, 2008
10 Comments:
"Part of it is from predatory lending companies who made loans to people they knew would default three months later because a regular bank wouldn't touch them with a ten foot pole and who didn't bother to explain the fine print or even left the fine print out of the contract."
An additional factor is the 1977 Community Reinvestment Act (CRA), which compels banks to make loans to low-income borrowers and minorities that they might not otherwise make based on purely economic criteria.
If your explanation of that act is correct (which it isn't), that would mean there would be no need for the kinds of quicky financial loan services that have popped up over the last decade or so. If regular banks were compelled to loan to anyone and everyone regardless of financial solvency, there would be no market for those other financial centers. Banks do not have to loan to people who don't meet their criteria. But people who were financially insolvent wanted those loans anyway, so there was a lot of demand--but no *supply*, i.e., regular banks wouldn't do it. So these high interest, bizarre loan companies popped up all over the place. Then the supposedly more solvent and trustworth banks and financial product services companies (like Merrill Lynch) stupidly bought up bundles of those crappy mortgages thinking that they could get away with it before it bit them in the ass. Now we're all suffering for it.
Some references
God, honey, would you even try to read the whole thing for once instead of cherry-picking what you like out of it? From your own references:
Defenders of CRA disagree, pointing out that half of all subprime loans were made by institutions that are not subject to CRA and another substantial share of subprime loans were made by subsidiaries of banks that do not fully come under CRA. They estimate that the substantial number of riskier loans banks were forced to accept by CRA were not enough to be a problem.
Banks were required by that law to market to underserved populations, not to give out loans regardless of who asked for them. The government tied that requirement to banks who wanted to be federally ensured--a bank could have opted out, although I suppose you could argue they were strong armed into accepting it. But it doesn't require them to stamp "approved" on any and every loan. That's just plain wrong.
Your own source says that the likely result is because of other lenders who were not subject to covering lending to less than ideal consumers by making them tie their loan to savings deposits and other financial products, like traditional banks chose to do.
There are plenty of institutions willing to give credit to people whom they know will default within the first three to six months. There was no Act of the government that made them take advantage of that. No matter how much gov't conspiracy theorists would like to think so.
Further, the links to your own sources say that a full 75-80% of subprime loans were made by institutions NOT required to do so by the CRA. They also point out that subprime lending by traditional banks has dropped significantly since the quarter century or so since the Act came out, while independent lenders who again are *not* subject to CRA lend subprime loans at twice the rate traditional banks do.
That's not the government's fault. That's greed.
My own source? From that one link, there were multiple references. I never said that they would necessarily agree with each other. I do not see anything wrong with providing multiple sides of a debate. I thought that doing such a thing meant that one is fair minded.
Second, I am quite aware of lenders who take advantage of poor people, who had no relevant mandate from government to do so.
However, if you feel that when these kind of lending practices (which had no government involvement) done by organizations like Merril Lynch are to be looked down upon, why do you feel that the government should be encouraging it through acts like the CRA?
I did not blame everything on the government. I only said that the government was a factor. I do not think that this makes someone a conspiracy theorist.
Have a nice day.
Virgil, Anon is just begging to be totally owned. Please do not disappoint. :)
My knowledge of money extends to "I don't have any" so I have no background in any of this.
Le sigh. OK, Anon, in the simplest language possible, I will try to explain it to you. You came on here originally saying the 1977 CRA compelled banks to make loans, and this was part of the financial crisis we were experiencing now. After being accused of misunderstand how the Act worked, you then posted a Wiki source. Your Wiki source not only verified the fact that you were misapplying the Act, it also referenced articles explaining with hard data how the CRA did NOT contribute to the current financial mess we find ourselves in. Don't cry about your sources when they prove you to be ignorant on the subject you're trying to argue about.
You posted it--but you should've read it first. Your link does have multiple sides, some more credible than others. However the *hard data* that those links provide demonstrate that you are in error. Accept that, and do a better job of reading, instead of doing a drive-by Google search, as you are wont to do. (I see some things never change.)
I never said that I encouraged the CRA--no where will you find that in my posts. I was telling you how the CRA really worked. It did not force banks to approve loans. It tied their federally guaranteed insurance funding (something I assume you would be against anyway) to proof that they were to open operations in typically underserved areas. Your own Wiki link explains how there were reforms made under the Clinton administration because he listened to the concerns of the people it applied to.
Regardless, the economic data gives the lie to your assertion that the CRA played a roll in the current mess. How difficult is it for you to admit that? And even if you count the tiny margin of loans that perhaps the government was indirectly responsible for screwing up--how is that worse than financial organizations who should have known better risking everybody's trust by buying these bundled mortgages they knew were basically a sparkling roman candle? This is not about the government's fuck up--but that's all you chose to focus on.
I would have to conclude that you are either narrowminded (which is proven out by your inability to puzzle out your own links) and set in your ways, and/or obsessed with any impropriety of the government while turning a blind eye to the market, because after all, that's not what you've been trained to do. You've been trained to just swallow it down whole in terms of the "invisible hand" of the marketplace.
Unfortunately, it's attitudes like that which are every bit as much to blame as any government screw up is.
I love the market. If people would just work hard and believe in the market, we would never have any problems!
MARKET YAY! GOVERNMENT BOO!
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