How should we think about personal responsibility in light of the financial bailout currently being debated in Washington, D.C.? Is that value even relevant in this context? For those that think that the value of personal responsibility is an important one in this context, should we think about any of the following differently?
(1) The losses of a consumer who took out a mortgage that is more than he or she can currently afford.
(2) The losses of a mortgage lender that offered loans that turned out to be more than its applicants could afford.
(3) The losses of a investor who bought stocks in mortgage lenders that now hold bad loans.
Additionally, does the way we pay for bailout of the consumers/mortgage lenders/investors raise issues of personal responsibility, particularly given that it will almost certainly be paid for by increasing the national debt (i.e., a mortgage to be paid by future tax payers)?
Finally, if personal responsibility is important here, how should that responsibility most appropriately manifest itself given the arguments sounding from Washington that (a) causing the consumer/mortgage lender/investor to bear their respective losses will hurt the national and even the global economies and (b) given the state of the economy, the only way to finance the bailout is by increasing the national debt?
I’d add to your numbered list:
(4) The loss of a consumer who did nothing reckless but now finds that the three foreclosures on his street mean that the value of his own house has plummeted.
I’ve never seen such a massive case of fraud in my life.
And they want a bailout?
Julie – the home value of that consumer was artificially overstated by greedy market manipulators. The home value is now a bit more accurate.
Julie — I agree that you could look at this by a loss. If you did, would that raise issues of personal responsibility? If so, it what ways? I have many more questions than answers today.
Roland,
What fraud? I keep hearing that asserted but, the FBI investigation notwithstanding, I suspect little if any fraud will be discovered.
And Julie, the homeowner may be innocent but, if she holds on to the house as an investment, she is not only subject to the upside potential, but has to face the downside. If I buy a share of IBM stock, it may lose value in spite of my having done nothing wrong, but I shouldn’t be protected from that downside.
I, of course, have a dog in the game here: as someone who has been priced out of housing because of the inflated bubble values, this correction (or apocalypse or whatever) makes it more possible for me to enter the housing market (I know, I know: without cheap credit, it’s still not easy). So while the declining housing prices hurt the people in houses, they help others of us.
All,
I have no good answers here. While someone who bought a home in an overheated market perhaps should have been more careful, I am still somewhat sympathetic to their situation–at least, I am more sympathetic to it than I am to the losses listed in Brigham’s 1, 2, and 3.
Julie,
I’m not sure (in general) why (4) is more sympathetic than (1), (2), or (3). If she bought the home as an investment (i.e., with the purpose of making money on it), she has to accept the downside risk in order to get the upside potential. If there is no downside risk, there should be no significant upside.
If, on the other hand, she bought the house as a place to live, its value has little relevance (except to borrow against, which I have to confess I’m not super-sympathetic to). If she plans on being there for five or ten years, she won’t probably have lost money.
The one exception is the person who buys a house and, unexpectedly, has to move. In certain circumstances, I can be sympathetic to that (like job loss or illness or something). In others, though, I’m still not sympathetic–if she got a better job somewhere else, the value of her home should weigh into her considerations.
The problem with a house vs. stock is that we often get an emotional connection to our homes that we don’t get to IBM. But as investments, they’re really only different in terms of they type of asset and the sheer amount of money necessary to get in.
I have lousy credit. And accordingly I have a higher interest rate on my mortgage. The higher rate goes to cover the additional risk on the part of the mortage company. Now my mortgage company is in trouble because of defaulting loans and the government is being asked to pick up the slack. So where did the extra money I (and others) paid go? Does the mortgage holder get more of my money AND money from the government? And what about PMI (private mortgage insurance) I pay that too. Isn’t that supposed to cover the mortgage holder’s risk in allowing me not to have a 20% down payment? Seems to me I’m paying for the additional risk upfront as well as paying for it in taxes later.
I understand why I pay as much as I do now (personal responsibilty), but why should I pay in taxes too.
There probably isn’t much fraud at play — just irrational exuberance. Humans are poorly wired for rational risk-taking. Almost everyone gets stupid when math gets probabilistic, especially when money is involved. The guys running these companies aren’t statisticians or econometricians, they’re schmoozers.
To approach the actual question — the actual bail-out operation should ignore the humans involved. It should take a systems approach to the problem. The system of financial flows is broken and needs fixing.
As for personal responsibility, it has to remain personal. A large company is not a person. Letting a bank fail is nothing like letting an individual lose on an investment. The more appropriate parallel would be firing the bank manager–having a person lose some of their flow of income. So: buy the illiquid loan instruments, claim equity in the companies, and invalidate the management’s employment contracts. Let main street experience some shifting of assets from the unwise to the less unwise. Regulate the real estate industry at all levels in a serious way. Rinse and repeat.
Sam, your IBM example continues to make me smile because my husband works there.
Anyway, I was really focusing in on the issue of “has to move”–that is where I have the most sympathy. Especially if it isn’t to a better job, but a crummy one because she was laid off because the economy is bad.
Sam B (#7) In my last job change, I had to sell my house and move. It was a better job. But the decision to move was made before the housing market tanked. By the time it came to actually sell the house, the market had started down. But by then I had resigned from the old job. When it became clear the house would not sell, the old job had been filled and I could not go back. The timing could not have been worse. The value of the home was a consideration in the decision to take the new job, but ultimately the value changed too quickly.
Most stock, even if it is going down, has enough volume to sell at the current price. Houses are not as liquid. Selling can take months or years, not hours. The price can change quite a bit in that time.
Example of Real Estate Fraud –
A realtor, a banker, a mortgage broker, and a appraiser (who are all professionals with some certification by the state dept of Real Estate) all approve a loan deal with a a low entry level interest rate for someone who clearly lacks that capacity to keep paying when the teaser expires.
The banker then sells the loan package to a quasi-government agency called Freddie Mac or Fannie Mae.
One year later when the homeowner defaults the realtor, banker, broker and appraisor all get to keep their fees inspire of approving a bad deal?
Sounds like a first class real estate scam.
And who approved the government program to buy and/or insure all of these sub-prime mortgages?
Julie,
I’m glad I can make you smile. IBM stock seems to me to be the widget of the investment world. I agree that the has-to-move is the most sympathetic, although there is still blame to lay.
Bruce,
As a result of the downturn, the market for housing is less liquid, true. But when Worldcom tanked in, what, 2002, the market for Worldcom stock became pretty illiquid, too. My dad held it at the time and, to the extent that it wasn’t wiped out in bankruptcy, probably still does. I definitely agree that most people don’t have a good sense of the risks associated with homeownership, and don’t have any good way of figuring out if they’d be better off buying or renting or what. But most people don’t have a really good idea of the risks of stock ownership, either–until I started working where I do, I couldn’t have told you the difference between a credit default swap and a defaulted mortgage.
None of this is to say that people who got trapped, by no greed or fault of their own, are bad or immoral people. But assets can lose value, and sometimes, for reasons we can’t foresee, we’re forced to sell our assets at bad times. That doesn’t make us bad people, although it can make us poorer people. Although some people who lost money are probably bad, greedy, overextended people, not all were. And while some people who made money were bad, immoral people, not all Lehman employees (for example) were. Capitalism doesn’t much care if we’re moral or not.
Roland,
I’ll grant you that there was probably some fraud going on at the mortgage level. When you get to the level of packaging the mortgages, though, mostly two things went wrong: (1) the banks probably pressured the rating agencies to give better ratings to the securities, and (2) the people packaging the mortgages did their math wrong: they didn’t really understand the risks they were taking, and so undervalued the risks. Both are bad things, but I don’t think either rises to the level of fraud. The bankers really, sincerely believed that the top tranche of MBSs were as secure as Treasuries (or at least, as secure as GE bonds). They were wrong, and their wrongness had dire consequences, and many of them were greedy, but they were not malicious.
So yes, there was fraud at some levels, but not at the levels everybody seems to be complaining about.
Again – I insist that there is major fraud going on here.
I work for a real estate developer – we have strict rules here about who gets a mortgage. Mortgage default rates are challenge for a loan pool with good credit scores.
We are not allowed to approve one deal for anyone with a bad credit score. – Not one sub-prime type deal.
Bankers analyze the heck out of this stuff – they knew exactly what they were doing with sub-primes. As early as 2005 there were senate banking hearings to reform freddie mac and fannie mae – but they went nowhere because of sectarian politics.
As early as 2005 – a lot of financial observers were sounding the warnings. This crisis is no surprise to me!
Roland,
Not to go too much further with this, because it is at best tangential to the post, but yes, bankers knew there was something wrong with the mortgages. That’s why they bundled and sliced them. The lowest tranche was clearly junk bond-quality. The upper tranche, they believed, was AAA. It turns out, their math was wrong. From what I understand, they used historic mortgage default rates (call it 2%), and failed to take into account the lowered lending standards. If only 2% had defaulted, everything would have worked like they said. But it turned out that 4%, or 6%, or 8% were defaulting. The bankers should probably have known that the higher percentage would default. Some did. But doing your math wrong is a lot different than fraud. The bankers and investors misjudged horribly how much risk they were taking on. But, like you say, they knew they were incurring risk. They just thought that they had sold risk to people with tolerance for it, when those people were actually taking on more risk than they realized.
Just want to thank everyone. I feel like I’ve learned a lot about the whole situation reading these comments.
Roland, I don’t think you understand how this all happened. This crisis does not exist because of fraud. Nobody was deceived and nobody was lying.
Where’s the personal responsibility for the guy who didn’t buy a house, doesn’t own the stock, and still gets stuck with the taxes?
Steve:
I have a questiong re: the fraud statements. I have been told that the investors for subprime leanding securities were relying on data put forth by some third party group employed by the bank to valuate the securities. Not fraud per se, but doesn’t this create a natural conflict of interest for the third party group, if they are being paid by the bank to price the deals which they are selling?
I’m not aware of the whole situation, but I thought I’d put out there. Isn’t this one of the arguements for better oversight in the future?
The very phrase “personal responsibility” sets off alarms for me, implying as it does that there is any other kind. The current mess is a fair illustration of what happens when people are allowed to believe that they, personally, don’t need to be responsible.
Only persons have consciences.
I feel more sympathy for (a) than (b) or (c). Yes, home buyers should have known better, but if you go back in your time machine to 2004, everyone was buying homes. If you didn’t buy then you would never be able to, people thought. The lending standards changed, and people with authority said that consumers could afford to take out a lot more mortgage than people could in the past. Wouldn’t the banks know what they can afford? They are the experts, after all. The banks should have the greater knowledge, so they should bear the greater responsibility.
What do we do from here? It’s going to be nasty, no matter what. Our country borrowed money to consume, not to invest. We can’t pay it back. That means either massive tax increases or massive inflation is in our future. Our best bet is to take our medicine now and get it over with. If we keep trying to kick this problem down the road, it’s just going to get worse.
“The home value is now [as a result of a large number of foreclosures and the corresponding drop in the perceived value of the home] a bit more accurate.”
If we assume that the loan amount was therefore boosted partially as the result of fraud on the part of the mortgage industry, would it not also be a demonstration of responsibility on the part of the lender to renegotiate (downward, of course) the terms of the loan, including the amount of principal owed on the home?
What really bothers me is that again the people who made the most money from the bubble are not liable for the losses. Think about the mortgage brokers, who were incentivized to get people to sign on ARM’s that would get them into trouble; or who didn’t even make a token effort to check if people were lying in their applications – some of them made very good money. Think about the managers of the investment banks and hedge funds, who drew hundreds of millions a year by leveraging the assets of their companies to invest in the riskiest and most complicated schemes available (it’s possible that there’s nobody around able to calculate the “real” value of some credit default swaps or the like). True, for a time it looked like they had invented perpetual motion, but it was an illusion. Think about the people who rated the mortgage-backed securities so that they appeared to be as secure as T-bills or at least premium corporate bonds.
Why are they now bailed out? Why not let those people take a hit who were compensated so well for taking the risks? The answer is, of course, that so much of the money that was injected into U.S. economy was Chinese (SE Asian)- and if their investments were perceived to be in jeopardy, they might cut their losses and start converting their dollar positions to other currencies, including the Euro (overvalued as it is already). That would have been a disaster for both sides of the Atlantic, and it would have destroyed the trust that the Asians have in U.S. markets. Plus, by destroying the purchasing power of the American consumer, it would have given a very painful jolt to the SE Asian economies, too.
I forgot one thing. Remember Enron and others back in 2002. There was a cry for accountability. What happened? Some very powerful people who stood to be held accountable got in touch with the White House (they had, after all, donated handsomely) and pres. Bush turned down the heat. The result was Sarbanes-Oxley, that didn’t solve the issues, but created more of mindless bureaucracy. It really is hard to get the bigwigs to answer for what they do.
I can envision people who couldn\’t afford any mortgage in the first place driving around with bumper stickers saying:
\”DON\’T BLAME ME–I RENT\”
#18–\”Nobody was deceived and nobody was lying.\”
That\’s a bit of a stretch–many of the troubled mortgages were called \’liar loans\’. Home buyers streched the truth about their incomes. There were predatory lenders. Investors buying the mortgage backed securities were \’deceived\’ (perhaps due to their own lack of due diligence) into thinking that the investments were more secure than they really were. Maybe there wasn\’t a lot of nice clean fraud, but there was a lot of stretching of the truth.
Bill,
The point is, investors buyng the MBSs weren’t deceived because of the quality of the underlying mortgages. I would be absolutely shocked to learn that there was a single investor who hadn’t heard of the liar’s loans. They were deceived because the math was done wrong: in calculating the amount of risk that the MBSs represented, the issuers and the ratings agencies assumed the wrong rate of mortgage defaults. Yes, there were lies at the mortgage level, and people were undoubtedly pressured to buy what they couldn’t afford to buy. But the failure of the securities has much more to do with mispriced risk than it does anyone’s lies. There was no fraud because, at very least, no investor was deceived by anybody’s lie.
We read the newspapers or watch the news and see Republicans blaming Democrats and Democrats blaming Republicans over this mess. We the people are the ones who are truly responsible because we allowed greed to get the best of us. Flipping houses, re-financing, etc. were easy ways to get more money. Greed and land speculation were also some of the sins many of the saints had in the early days of the church and the Lord expressed His displeasure. Can Latter-day Saints today escape the same sins? No.
We must be prepared to suffer the consequences of our choices. Like repentance, there must be some suffering before deliverance. Government, stepping when it has no authority to do so, is trying to circumvent our suffering while slowly sapping personal economic liberty. Forty-five years ago Ezra Taft Benson was warning us of government slowly removing liberty to the point where we wouldn’t be able to get it back. With government taking over much of the private sector, his words have come to pass.
mlu (#21) To paraphrase Ambrose Bierce, You have hit upon the definition of a corporation. “An ingenious device for obtaining [personal] profit with [personal] responsibility.”
I think true conservatives hate the idea of the government removing the consequences of bad lending, purchasing, and other practices.
If this bailout must occur, and even as a staunch conservative, the money must be repaid in equal measure from thsoe who made money on the causes for the failure.
I think true republicans want to force Wallstreet to buy the debt. That sounds the most fair.
How many true conservatives are really left though? Most Republicans I know are socially conservative Bush Republicans, they don’t really seem to care much about their party other than it’s anti gay marriage, anti abortion and pro Iraq war.
Nobody was deceived and nobody was lying is flat out false in my experience. When we refinanced to get a lower interest rate, our mortgage lady and the guy appraising our house both told us they could make sure we got whatever value we needed if we were interested in taking out a large chunk of money on top of what we needed for the mortgage. They made it very clear that if we wanted to take $20,000 extra, that our house would appraise for $20,000 more than what we owed. It didn’t matter that a few people in our neighborhood were having problems selling similar homes for the appraised value, we were being offered up to $50,000 above that value.
Everyone in the process we were involved with was willing to lie so they could all make a little extra money, even though it would have very obviously taken our payments above what we could afford to repay.
All this opportunity for greedy capitalists was made mandatory back in 1995, wasn\’t it, when Clinton and Janet Reno mandated sub-prime mortgages. Was it not exascerbated by the refusal of Congress to regulate Fannie Mae and Freddie Mac in 2005? Was there not some additional influence thrown out by the SEC and others? Just asking.
When the gov\’t regulates, and lays down the rules, are there not those who try to take advantage of it? Are there not those who suffer from it . . . always?
Warren Buffet seemed smart enough to see what was happening. But then, he doesn\’t follow the crowd.
I wonder if we should stop subsidizing the buying of homes through the home mortgage interest deduction. I understand the value of helping people get into their own house — the first time they buy. What I don\’t understand is why we should subsidize the second house, the third house etc. until we are subsidizing million dollar homes for people who don\’t need any taxpayer help at all.
I also wonder what our wonderful LDS get rich gurus have to say — the ones who tell us how to get rich buying real estate with no money down.
Being irresponsible always seems to be someone else\’s problem.
Re #34: Ken, I agree with you. One possible solution would be to disallow the mortgage interest deduction for dwellings larger than 2,000 square feet. That approach would help prevent the unintended consequences of the subsidy.
34. Is it true that the tax code allows a mortgage interest deduction on second and third homes? Was I under the mistaken impression that it applied to principal residence?
34. Is it true that the tax code allows a mortgage interest deduction on second and third homes? Was I under the mistaken impression that it applied to principal residence?
“One possible solution would be to disallow the mortgage interest deduction for dwellings larger than 2,000 square feet.”
That’s a bit too intelligent for a government that does things like this
The problem is not the people with low credit scores. The people with low credit scores got this way because the government allowed the banks to charge outragious interest rates knowing these people were having a hard time so they took even more away while promising to be helping them build or rebuild their credit. Now that they have ruined the credit score of millions of people and bankrupted the economy the low credit score people are suddnely the reason our country is bankrupt. Come on… how much can we believe?