The New York Times had an article today on the advertising campaigns that led to the spate of subprime borrowing.

The reader comments fall into two broad categories: “Borrowers should have known what they were getting into.” and “Big, bad, evil banks.” I think both attitudes are naive.

Borrowers should have known… Really?

Borrowers should have known? How? Our high school graduation rate is only about 70% overall, and it’s hard to believe that every single high school graduate is educated in how to make good financial decisions. In fact, it’s easy to believe that many high school graduates have difficulty with so-called “word problems” in math (and taking out a mortgage, people, is the mother of giant word problems).

I have an MBA from Harvard and when considering my mortgage, found myself staring at a 90-page document full of 8-point type, written in incomprehensible legalese. I had no real choice but to go on the “plain english” explanation of my bank and mortgage broker, both of whom had likely received lots of training in how to make the sale.

Thankfully, I settled with a fixed-rate mortgage. But I found out six years later that even with my MBA, I’d misunderstood (been mis-explained to?) how the variable rate mortgage worked. It turns out the first variable reset was directly to the target interest rate of prime-plus-X%. That was news to me! I thought the first reset was capped and only slowly moved to the target.

Furthermore, people were bombarded with sound bites saying “Life richly” by companies who, frankly, they trusted. Banks have historically been trustworthy institutions. They were known as financially conservative, considered decision makers. So people may well have been inclined to trust the ads. Lacking the education to do a financial analysis, they may have thought, “if the bank says this is a safe loan, it must be. After all, they make prudent financial decisions.”

Even so, whether or not you trust the ads, whether or not you even believe the ads, advertising works! It creates behavior change. That’s why advertisers pay $1,000,000 for a 30-second spot in the Super Bowl: because a well-constructed ad can manipulate emotion and cause people to buy stuff they don’t need.

So I can’t just say “be responsible.” That’s too tall an order and obviously, it didn’t happen and isn’t likely to suddenly start happening.

(And a note to the commenter on the article who says he’s from “old money” and that the borrowers should stop waiting for “mommy and daddy” to bail them out. Are you serious? You inherited your wealth and have a problem with people being bailed out by “mommy and daddy?” Look in the mirror sometime!)

The banks shouldn’t have been so greedy. Really?

Banks shouldn’t have been so greedy. In what universe? When we deregulated them (why did we do that?), they became businesses subject to the same profit pressures as any other public businesses. Furthermore, the folks at the top had bonuses become tied to growth measures. The bonuses and stock options were relatively short-term. Bonuses were based on yearly performance, and stock options often begin vesting immediately, or at the most, have a 5-year time horizon.

This gives everyone at the bank incentive to push short-term sales and profit now. When you’re selling a 30-year loan, but your compensation structure rewards you for 5-year results, it’s makes total sense to design a product that generates a lot of sales. If it blows up in year seven, well, that’s a shame, but if we wanted accountability out seven years, we should have designed the system that way.

And before you go off saying, “well, that’s just plain WRONG,” consider that we all make this kind of decision every day. Do you eat high-fructose corn syrup? If so, you’re trading short-term sugar high for long-term health consequences. How about, say, do you drive a car? If so, you’re using a non-replaceable resource that won’t be there for your kids because you want to live in a luxurious suburb instead of an inner city where you could walk to the grocery.

The banks did exactly what they were supposed to do: produce short-term returns by persuading people to buy products that, in the short-term, were safe, affordable, and met people’s needs.

How do we avoid this again?

That’s simple: we don’t. At least, not by focusing on one half of the equation. For better or worse (I believe worse), we’ve evolved to the point where we consider business to have no binding responsibility to the community or society. Thanks to Milton Friedman, as long as business is profitable, measured solely by one-year pretax, cash income, we reward the people who run the businesses and the people who invest in the businesses.

We have an advertising industry that complements business by having a good 100+ years of learning on how to create emotional needs that don’t exist and link those to people’s purchase decisions so people actually go buy consumable stuff instead of saving their money. It works, and it isn’t going away.

We also have an educational system that apparently isn’t preparing people to make intelligent financial decisions. Given the negative savings rate and average household credit card debt, I feel pretty comfortable suggesting that even the college-educated, financially literate aren’t turning on that financial intelligence as often as they should be. Or, if I want to be extra-generous to the people, perhaps their good financial sense is still being overwhelmed by the emotion-laden ad messages.

If we want to avoid this again, we have to do something to rebalance this triumverate. We need to educate people and stop advertising so much. Or we need to link compensation and measurement to much longer-term, broader measures than short-term profit (which means you, gentle reader, will have to stop evaluating your savings and investments on one-year returns), and educate people. Or we have to tone down the emotional advertising and educate people.

Hmm. All three of my top-of-the-head solutions seem to have education as one of those components. So let’s get to it, people. The school systems aren’t doing it, so it’s up to us. If you’re financally literate, grab a friend and teach them to be, too. If you’re not, find a friend and learn something. Then practice watching commercials and rather than thinking, “Oh! I want that!” calculate exactly how many more years you’ll have to put off retirement if you decide to buy that cool, neato new widget.

Speaking of cool, neato things to buy, consider this: Your life will be much, much better if you buy my “You Are Not Your Inbox: Overcoming Email Overload” audio product. Your teeth might sparkle, you might get all the sex (men) and cuddling (women) you could ever desire. In fact, you will find that saving 30 minutes a day adds up to three weeks a year. If you make $52,000/year, that means the savings would be more than $3,000. All for the low, low price of $47. Keep me in business, people.

There, you’ve been psychologically manipulated. Go buy. And if you don’t have the cash, you can charge it on your credit card or your home equity loan. Go wild.

It’s not so easy to say “subprime borr…

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