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On the economic crisis

January 2, 2010

Looking back in time again to 2008, this episode of This American Life is worth listening to again. It’s an *astonishingly* good portrait of the sub-prime mortgage crisis. I’m not sure about the accuracy of the underlying argument (that the crisis was driven by a giant pool of investor money with nowhere to go), but I suspect that there is some merit to this argument, though it is likely to be one of several factors.

Undoubtedly though, this program made the collapse of the housing market easier for me to intuitively grasp how so many people could collectively make such big (and expensive!) mistakes. Since then, there have been bigger aftershocks that deserve to be as closely examined as this particular piece of the financial crisis puzzle.

Maybe Ira Glass, Alex Blumberg and Adam Davidson will consider explaining the massive bailouts in the US and the UK.Which banks got how much and why? Take the aptly named firm of Goldman Sachs– it seems a little suspicious that they were able to make out like bandits only one year after they were poised for a meltdown like everyone else (as suggested by this Rolling Stone article)….

This American Life: The Giant Pool of Money

A special program about the housing crisis produced in a special collaboration with NPR News. We explain it all to you. What does the housing crisis have to do with the turmoil on Wall Street? Why did banks make half-million dollar loans to people without jobs or income? And why is everyone talking so much about the 1930s? It all comes back to the Giant Pool of Money.

In addition to the standard theories on the crisis being put forward by Nassim Taleb (The Black Swan) and Nouriel Roubini, let’s add a mixed-generation version of the They-didn’t-understand-derivatives theory to the mix:

“Two things happened. One is that the amount of money that could be made on Wall Street with hedge fund and private equity operations became just mind-blowing. At the same time, college was getting so expensive that people from reasonably prosperous families were graduating with huge debts. So even the smart guys went to Wall Street, maybe telling themselves that in a few years they’d have so much money they could then become professors or legal-services lawyers or whatever they’d wanted to be in the first place. That’s when you started reading stories about the percentage of the graduating class of Harvard College who planned to go into the financial industry or go to business school so they could then go into the financial industry. That’s when you started reading about these geniuses from M.I.T. and Caltech who instead of going to graduate school in physics went to Wall Street to calculate arbitrage odds.”

…“Because there is,” he said. “When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”

Now for more news on the next wave of the financial crisis, here is another warning of dire consequences resulting from credit card debt. The executive warns that we haven’t seen the worst of it yet– there is definitely more to come. And I think many of us who have lived in the US subconsciously know this– speaking for myself, I have received more offers for pre-approved credit cards and lines of credit than I know I should have been eligible for as a graduate student with negligible income. But it now looks like the chickens are coming home to roost:

Today, we are bailing out the banks because of their greedy and deceptive lending practices in the mortgage industry. But this is just the tip of the iceberg. More is coming, I’m sorry to say. Layoffs are being announced nationwide in the tens of thousands. As people begin to lose their jobs, they will not be able to pay their credit card bills either. And the banks will be back for more handouts.

Over my career, I have seen thousands of consumers that have credit card lines in excess of their annual salaries. Some are sinking under their burden. Some have been fiscally responsible and have minimal amounts outstanding. My 21-year-old daughter, who’s in college, gets pre-approved offers all the time. She has no ability to repay debt, yet the offers flow in just the same. We all know how these lines are accumulated. The banks, in their infinite stupidity, keep upping credit lines because the customer pays the minimum payments on time. My daughter’s credit line started at $1,000 and has been increased over the last two years to $4,400. She has no increased earnings to support this. But the banks do it without asking. And without being asked. The banks reel in the consumer, charge interest rates higher than those charged by the mob, increase lines without the consumer asking and without their consent, and lure them into overextending. And we can count on the banks to act surprised when they aren’t paid back. Shame on them.

As a banker, let me describe what we do wrong when we accept and review an application for a credit card. First, we don’t verify income. The first ‘C’ of credit: Capacity to repay, is completely ignored by the banks, just as it was in when they approved subprime mortgages. Then we ask for “household income” — as if other parties in the household could be held responsible for that debt. They cannot. And since we don’t ask for any proof of income, the customer can throw out any number they think will work for them. Then we ask if they rent or own and how much they pay. If their name is not on the mortgage, they can state zero. If they pay $1,000 in rent, they can say $500. (Years ago we asked for a copy of the lease to verify this number.) And finally, we don’t ask how much of a credit line the consumer is looking for. The banker can’t even put that amount into the system. There isn’t any place on the application for that information. We simply put unverified information into a mindless computer and the computer gets the person’s credit score and grants them the biggest line that score and income (ha!) qualifies for. Full story.

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