If what we want to do is point fingers, there’s plenty of blame to go around. At the end of the day, though, I hold the creators of the securities as being far more responsible than the home buyers.
Professionals should be held to higher standards
First off, the financial companies are supposedly professionals. That means they understand far more about how all this works. Bluntly, I hold them to a higher standard. If they’re going to take home billions in pay, I expected them to think through their investing decisions and security formation very, very carefully.
The financial community has gone wild in abstracting away risk and reward from underlying securities. And they’ve gotten very, very rich from that. But they’re professionals. If they buy a mortgage-backed security and are surprised that people can default on the mortgage, then they need to take full responsibility for that. Period.
Stocks and bonds and mortgages all represent actual entities in the world who are actually doing stuff. If you remember this, you can make intelligent decisions. Warren Buffett became the richest man in the world by doing this intelligently and sharing with everyone who cares to listen how he does it. When others in the finance community choose to ignore that underlying reality because it’s convenient, I can’t have much sympathy when the house of cards collapses.
(Upcoming crisis: if they buy a credit swap from someone who can’t actually guarantee the underlying loan, then again, they absolutely deserve whatever they get. Especially if they’re the ones who lobbied for non-regulation in the credit swap market!
My solution involves using eminent domain to reclaim every penny and every asset paid to every employee of the i-banks who created, traded, and sold these entities. then the taxpayers pay for the remainder of the bailout. Aren’t you happy I’m not in charge?)
Selling a financial product to numerically illiterate customers is bad business
Second, innumeracy. You can say all you like that it’s the dumb mortgage holders who bought dumb mortgages. And I agree. Only they weren’t dumb; they were simply ignorant. We don’t teach people anything about financial literacy in school. Even when I got my MBA, it took quite a while for the group of very bright (but non mathematical) students in the room to understand how to calculate simple financial concepts like “net present value.”
Most people don’t really understand the math of a variable rate mortgage, and certainly aren’t good enough at budgeting and forecasting future scenarios to realize what is and isn’t a good financial decision.
Again, the mortgage underwriters were professionals. For them to say, “we sold these to people who couldn’t pay, it’s their fault,” is simply absurd.
If you’re in the business of making loans and then carrying those loans on your books, it’s YOUR responsibility to make sure the loans can be paid off! Not because you owe the customers anything, but because Accounting 101 GAAP rules say that you don’t count on an asset’s value unless you’re highly certain it’s going to be worth that much.
If a bank writes a mortgage and chooses to relax its standards under the theory that it can sell the mortgage before the borrower defaults, then the bank is being irresponsible (not to mention implicitly defrauding the folks it sells the mortgage to).
The “2nd tier” buyers can also be smart about what they’re buying
The 2nd-tier people buying that mortgage from the bank are buying an asset they don’t understand. They’re free to ask for a payment guarantee from the bank to accompany the mortgage. They didn’t, and are then surprised that the default rates were higher. (These people clearly missed the whole Junk Bond crisis that had all these same elements.) If I have to buy insurance on my house in case there’s a fire, then the 2nd-tier buyers should also be smart enough to demand the bank guarantee the default rate that they claim their mortgages will produce. Or if the banks won’t do that, then the 2nd-tier buyers should at least look at the mortgages to make sure they’re as high-quality as the bank believes them to be.
Rating agencies don’t exempt finance professionals from due diligence
“But the rating agencies…” you begin to cry. Screw the rating agencies, people. If a buyer of a mortgage-backed security decides to trust a rating agency’s evaluation of a security that everyone admits is hard to value, then again, you’re consciously deciding to allow your business’s integrity to reside in the hands of the rating agency.
You could take a random statistically valid sample of mortgages and hire a bunch of interns to re-run credit and income checks to make sure the mortgages are sound. You could further ask whether you believe the borrowers can still repay after rates increase. It’s called “due diligence” but it requires admitting that there’s a physical reality that might get in the way of your free money-printing machine. It also requires doing legwork in the physical world, which the finance people were understandably loathe to do.
It wasn’t the consumers who came up with the idea that these mortgages were affordable
And lastly, the marketing of these mortgages were designed to persuade people to take them out. Well, it worked. And for banks and lenders to be shocked that their marketing worked, and then further shocked that their own lax standards put them in a position where their borrowers couldn’t repay is just hubris beyond belief.
So yeah, many consumers should have made better decisions. But they’re not professionals, they’re not financially literate, and they’re being subjected to $100,000,000 of marketing and sales tactics.
The mortgage writers and derivative creators are financially literate professionals who chose to ignore their own historical underwriting standards and sell mortgages that couldn’t be repaid. They then took these bad mortgages, repackaged and resold them to other institutions that didn’t bother to do real due diligence.
To me, the case is clear: if I have to blame someone, I’ll blame the industry of “professionals” who ignored the financial realities of their customers, invested in bad quality securities, eschewed due diligence, and generally took the profits when times were good and are now trying to shove away responsibility for their own decisions now that times are bad.