Upton Sinclair famously said:  “It is difficult to get a man to understand something, when his salary depends upon his not understanding it.”  Do our convictions necessarily follow our self-interest?  To me, Sinclair’s caution is to always look at the monetary incentives associated with a course of action, not just the direct ones, but those that lead to more financial success even in untraditional fields (e.g. votes, grants, favors).  We need to look at all our motivations, whatever we have to gain from a situation.  Without this kind of introspection, we are prone to act irresponsibly and make terrible errors in judgment.

I recently watched the TV movie “Too Big to Fail,” about the collapse of Lehman Brothers and the subsequent TARP bailout and cash infusion into the “big” lenders.  These events are very recent history, almost too recent to have been made into entertainment, although this movie had an info-tainment quality, like an after school special for people in the financial services industry.  Since we are all living in the post-apocalyptic world after the collapse of Lehman Brothers, introspection into its causes is warranted.

The narrative that helps most Americans sleep at night goes something like this:

Evil greedy villanous rich people on Wall Street conspired to bilk honest, hard-working Americans and take away their homes.  When they got caught, being the financial terrorists that they are, they threatened to blow up the world economy unless the government bailed them out.  Thankfully, the government (using tax money from citizens, those very same people who were also tricked and losing their homes) bailed them out, preventing even more catastrophic impacts to the economy.

The roles in this drama are pretty clear.  Protagonist:  Main Street citizens.  Rescuer:  Government.  Villian:  Big Business.  But is this the whole story or are there shades of gray being overlooked?

Government

Politicians, including both Clinton and Bush, bought the myth of home ownership as an integral part of the American dream.  They also sold this myth to the American people, a myth people are eager to buy.  Film clips in Too Big to Fail showed both of them giving speeches about the goal of home ownership being attainable for all.  Clinton no doubt saw it as an egalitarian ideal – a chicken in every pot and a car in every garage.  Bush doubtless saw it as evidence of prosperity – all boats rise with the tide of a booming economy.  Both seemed to sincerely believe their rhetoric.

Working in the financial services industry about a decade ago, I was absolutely dumbfounded at some of the governmental lending requirements.  We were forced to lend to individuals and businesses with low FICO scores (so low our systems were designed to automatically reject an approval) who would never be able to pay these loans off.  Essentially, we were writing them a check, under the Community Reinvestment Act.  As I evaluated some of these loans I had to ask myself how the government could legally bind a lending institution to loan money with the statistical certainty of default.  Basically, we were legally required to write off a certain amount of debt in bad loans that nobody could ever be expected to pay off.

Discussing the reasons for the Clinton administration’s proposal to strengthen the CRA and further reduce red-lining, Lloyd Bentsen, Secretary of the Treasury at that time, affirmed his belief that availability of credit should not depend on where a person lives, “The only thing that ought to matter on a loan application is whether or not you can pay it back, not where you live.” Bentsen said that the proposed changes would “make it easier for lenders to show how they’re complying with the Community Reinvestment Act.”

Because politicians relied on the notion that home ownership equates to prosperity and that it is something that all Americans are entitled to achieve, they sold this vision to their constituents and then had to make good on this “promise” by creating legislation that would relax lending criteria and enable people who were previously deemed not credit-worthy to obtain 30 year mortgages they eventually could not afford.

Home owners were also able to borrow against their mortgages, not as a method of reinvesting on their home, but as a way of borrowing against their future equity to reinvest in the economy now.  Who benefited?  In the short term, those responsible for a strong economy did.  And they told voters what they wanted to hear:  “You deserve that house you can’t afford.”

Lenders

Well, we all know the villainous tale of the lenders.  In order to benefit from these lopsided lending rules, lenders insured the loans they knew would fail.  By insuring the loans, they took the sting out of loaning to people who weren’t credit-worthy.  Because the lending rules had been relaxed, there was a higher percentage of bad loans.  Did lenders know it would all come crashing down?  Well, the insurance was to prevent that from causing their collapse.  Not all companies were equally irresponsible lenders, but companies are generally survivors.

Home Owners

There are also some who borrowed more money than they could afford to pay back.  When we were expecting our first child, we were living in an apartment in Rose Park.  Our neighbors neglected their children who showed up at our door looking for help.  We saw people getting arrested in our apartment complex several times.  One night it looked like an episode of Cops as policemen emerged from hiding places all over the quad and converged on one apartment. When we bought our first home, the bank was willing to loan us up to twice our annual income, which was frankly not that much at the time.  We bought a starter home under those parameters in West Valley City, in a neighborhood that a couple years later had a drive by shooting, followed by another one.  Our home was partly finished with two bedrooms and one bathroom.  By the time we moved to another part of Salt Lake a few years later, we had added another bedroom, a family room, and another bathroom.

As time passed, we continued to make more money and eventually we moved to Arizona in 2006 just after the height of the housing bubble. This time the banks were willing to loan us up to four times our annual income, which seemed incredibly risky to us at the time.  We decided to stay close to the less risky loan parameters that were offered to us in our first home, and we bought a house that cost more than twice what the house we had sold in Utah had been worth.  Housing values in Arizona were extremely inflated at the time.  We probably should have rented, but we totally bought in to the myth of home ownership.  Our home is still worth less than 2/3 of the amount we paid for it.  After six years, we owe more than the current market value of that home.

Yet we were the lucky ones.  We could afford our folly.  People who naively believed that they would not be loaned more than they could afford to pay back were quickly overextended.  Many lost their homes through foreclosure or short sale, which is one thing that devalued our home (as neighbors’ homes were sold for extremely low prices, values in the neighborhood went down overall).

A few questions to discuss:

  • Was the crash inevitable or could it have been avoided?
  • Are politicians getting a free pass in the media on this?  Is it because we prefer to believe them than to share in the blame by admitting we borrowed more than we should have been allowed?  Or are they sharing the blame proportionately?
  • Should we be busting the myth of home ownership?  Is the housing bubble just “righting” a system that was never tenable by creating more renters (who have lost their homes)?
  • Would you consider renting rather than buying next time?

Discuss.