the economy

I highly recommend this week’s This American Life, appropriately titled Another Frightening Show about the Economy.  After listening to it, I finally feel like I have a decent idea about why the rest of the economy, not just Wall Street, is at risk, and what the heck a credit default swap is.  Enough so that I was annoyed at how bad the explanation of a CDS on Marketplace tonight was by comparison. 

The main thing I took away from it was just how massively leveraged the whole system was.  In Bonfire of the Vanities, my favorite scene is where the main character’s daughter asks him what he does.  She says that her friend’s daddy (a publisher) "makes books."  "So what do you do, daddy?"  And he tries to explain what an investment banker does, and totally confuses her.  So her mother, his wife (who despises him), jumps in and explains that what he does is like slicing up a cake, and passing it around, and whenever some crumbs fall off, he gets to keep them.  (This of course pisses him off, as he thinks he’s a Master of the Universe.)

Well, as far as I can tell, what happened is that the ibankers decided that crumbs weren’t enough, so they started passing the cake faster and faster.  And then they decided that they didn’t actually need to pass the cake, they could just promise to deliver a cake next week, and they didn’t have to own a cake, but they could get someone else to promise them a cake next week.  And they got to keep more and more crumbs.  But now someone’s actually asking for the cake, and it turns out there isn’t one.

In the comments on my last post about the meltdown, Amy and amy have been going on about how everyone who bought a house they couldn’t afford, or who financed a better life than their cashflow justified through cash-out refinancing is guilty of contributing to this mess.  And on some level, they’re right.  But if Wall Street hadn’t leveraged all this to the nth degree, it wouldn’t be threatening to take down much of our economic system.

Judith Warner had an interesting column last week on how much "regular" upper-middle-class New Yorkers, especially those who are by education upper-class, but not especially affluent, resented the huge amounts of money sloshing through Wall Street over the past decade.  And similarly, I think the people who didn’t take out huge mortgages are bitter about bailing out those who did.

There’s a good discussion going on at 11d about how much people feel like they’re personally being affected.

19 Responses to “the economy”

  1. Mamalooper Says:

    Love the cake passing analogy and the tip of the hat to Bonfire of the Vanities. That just ties is up perfectly.
    This American Life also had a great podcast on the subprime mortgage crisis and described in straightforward yet not simplistic terms how it worked between the person being loaned the money on up to the broker on Wall Street.
    Haven’t heard much yet of the contribution to this mess made by the idea that has been floating around for a while that spending is somehow a patriotic duty – that if citizens get out there and spend, then the economy keeps moving and growing.
    I’d feel more comfortable bailing out over-leveraged home owners who may have been led astray/duped by aggressive bankers than wealthy wall street firms who knew what they were doing and the risks that they were taking. Of course, that IS simplistic in that it doesn’t take into account the interconnectedness in the economy and how you can’t fence off a certain part (wall street) for hand slapping.

  2. K Says:

    Thanks for the This American Life recommendation. Every week, I seem to download 6X more podcasts than I can actually listen to. It helps to have a recommendation on which one to keep and which ones to ignore.

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  4. amy Says:

    Elizabeth, you’re right — if investors hadn’t played “invent the money” games, we’d be much more OK. But do you see how this worked? Fannie (thanks to Congress) created a market for bad debt, and everybody jumped on it. The more loans you could push at these greedy suckers — essentially pink-collar people looking for too much house or a neighborhood out of their league, a HELOC, a cruise, a kitchen remodel — the more money you could make. Next thing you know, we had mortgage party. Why? Because there were millions of greedy suckers willing to take the bait. People knew better and did it anyway.
    There’s a limit to how much bad debt even Fannie could buy, but they hire clever people on Wall Street, and so they found other markets for lousy mortgage loans, and ways to keep the SEC out of it. Hence the problem you see today. None of it could have happened without the willing — in fact eager — cooperation of the American consumer. Not citizen. Consumer.
    If you craft naive policy that depends on men to behave like angels, you have to expect it to blow up in your face. The Dems insisted on making a market, a private market, for bad loans. This is the result. And really, it was a sneaky thing to do. The public would not have support backing home mortgages to this extent for the millions who couldn’t really afford houses; that wouldn’t have passed through the front door. So this was the workaround, and now it will cost far more — both in money and public trust — than any line-item mortgage aid package would have.
    We are still not talking about the fact that we’re selling too little and buying too much from the rest of the world, and have done for decades. For now the financial crisis has run ahead of that conversation, but when the currencies and trading rules are sorted out, that hard fact will remain. What it means is that we’re poor. This will also have consequences for social policy.
    So let’s get on to the next question: Where are we competitive? In what sectors, industries, markets do we have a trade surplus, and why? What’s wrong with us in others? How do we fix it?

  5. amy Says:

    Also, mamalooper, if you took out a mortgage in the last ten years, then surely you’re aware that before you sign, the bankers must talk to you like you’re brain-damaged about your obligations under the loan. You get an FHA sheet that looks like a middle-school handout explaining how your mortgage works. You get warned that if you were dumb enough to take an ARM for your home, your interest rate might go up considerably and cost you much more monthly. You get warned that the mortgage is not a gift, and that you must pay it back with interest, and that if you don’t you can lose your house.
    “Duped” and “led astray” I don’t see. If the mortgagees abandoned all responsibility and just sat at the table nodding and hearing Charlie-Brown wonk-wonk noises till they heard the magic words “sign here”, this is not something I’m sympathetic about.
    When I took out my mortgage, I asked the banker for a copy of it before the signing. Why? he asked. So I can read it, I said. I’m borrowing a lot of money, I want to see what I’m agreeing to. He was astonished. In over a decade of lending, he’d never had that request before. This floored me. I understand perfectly well that most people cannot read those documents. So? Find a lawyer, your own lawyer, or a trusted smart person. (If you can’t pay a lawyer $200 to read the thing for you, you can’t afford a house anyway.) If a person’s not willing to go that far to protect him or herself, I don’t want to step in on his or her behalf.

  6. Anonymous Says:

    “The Dems insisted on making a market, a private market, for bad loans.”
    It’s not as simpleas that: five members of the Securities and Exchange Commission met in a basement hearing room in 2004 to consider an urgent plea by the big investment banks:
    They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.
    So we are back to deregulation as the ultimate culprit.

  7. Mykal Says:

    I highly recommend the Plant Money Podcasts. It’s short segments every day on the economic crisis, by the same people doing the larger shows for This American Life.

  8. Jody Says:

    I think amy is spot-on about the underlying problems re: our international trade deficit. But I think I disagree with her about the information people had when they signed their loans, because I think there were multiple loan markets, and I never experienced the shady one. I say that because all of our loan documents were picked over with fine-tooth combs (we were denied a loan in 1998 by one bank because of a single 4yo late credit-card payment — although now that I write that, maybe they would have been happy to lend to us at a higher rate?) and in both 1998 and 2004, we had to provide multiple proofs of income, assets, etc. To the point where computer print-outs of brokerage statements were denied — we had to pay Fidelity to send along real copies before anyone would approve our loan.
    That was the world where all of our loan terms were explained in language a 5yo could understand, and everything was on the table.
    Because the media now reports that there were loan markets in which people were openly encouraged to falsify even their incomes, let alone all the other documentation we had to provide (three years of utility payments! not photocopies or print-outs but documents that someone believed had been issued direct by the utility companies!), I’m perfectly prepared to believe that those same markets were shady and under-handed when it came to rate and payment disclosures, too.
    My blood boils whenever I think about bailing out people who bought more house than they could afford, or who leveraged that house for a vacation we saved cash to buy. Then again, my household income is robust and I didn’t have to use credit cards to pay off the hospital bills after my 6-week hospitalization and my kids’ 17, 20, and 31 days in the NICU — because we had insurance that provide 100% coverage.
    Many, many people used credit cards to pay medical bills, and took home-equity loans to pay off the credit cards, and then used the credit cards to pay for necessities, not just large-screen TVs and venti mochas. I figure, trying to figure out who the “worthy poor” are is not only Victorian, but a fool’s game.

  9. amy Says:

    noname, note the date. 2004. That’s after the bad-debt market was already a-booming, thanks to Congress’s creation of it. You can’t exonerate consumers and put all the blame on the banks unless you’re also willing to put all the blame on Eve for the fall of man. Really, though, in the end: wellmeant liberal housing policy that ignored both human nature and predictable market behavior.
    Jody, what you’re saying may be true, but what I’ve seen with my eyes over the last 15 years leads me to believe that both outright fraud and the medical-poverty/HELOC/bankruptcy story account for no more than a small percentage of mortgage loans made. If you’re in hock to your eyeballs with big med debt, you spend down any savings, and then you try to save your home. You do that with bankruptcy, not a HELOC.
    I would bet much more of the HELOC story has to do with consumer goods and home improvement, and I’d want to see some pretty solid reporting before I believed otherwise.

  10. Jody Says:

    amy,
    my cousin bought a home in small-town Minnesota five years ago and was given a loan to make necessary improvements, few of which folks in older suburbs would consider extravagant (there were no solid-surface counters, tiled floors, or other fancy amenities, but there was a second bathroom and a third bedroom). When he lost his local job three years ago and had to move again, the improved home turned out to be worth less than the combined mortgages, and they had to work out a short-sale with the bank and walk away with nothing.
    After the fact, it seems clear that my cousin should have found a poorer-quality home (he has four kids, by the way, hence the third bedroom) and that the bank shouldn’t have been deluded into thinking the market would rise forever. In general, I blame the bank more, on the theory that they know more about the local market than any individual buyer. In any case, they both found a market solution and moved on. My cousin, to a rental property.
    When I think about worst-case scenarios, I tend to think about various relatives, and figure, well, they survived that, so I could, too.

  11. amy Says:

    Jody, it’s unkind, but poor is poor. If the public does not want a social democracy, them’s the breaks.
    When my ex and I bought this place, I wanted to put in a wood floor. I’d just installed one myself in the place I’d left, and I didn’t want to go back to carpet. So I went shopping. The wood-floor-place lady told me it’d be about $7K to do the upstairs, and was all ready with various HELOC and roll-it-into-your-mortgage schemes. I was kind of freaked out, and said no, thanks, I’ll wait till we have the money saved; I wasn’t crazy about our floor, but it worked. She leaned in and almost whispered that that was very smart.
    Memories of farm foreclosures are still a very tangible, and painful, thing here; Iowa isn’t famous for financial recklessness. I asked her if a lot of people took out mortgages for wood flooring, and she said almost everyone who bought did that. I’m very glad now that I didn’t borrow — apart from the lunacy of paying that much interest on a wood floor, I don’t want to pay any more on a mortgage than I pay today.
    Four is a lot of kids, and you have to think about the expenses when you choose to have that many. I have some good friends with four; he’s a tenured professor, she’s a stay-home doctorate till the kids are bigger. Even so they’re very very careful with the money. Three of the kids share a room, which is something that used to be ordinary. My grandfather had two siblings, and they shared a bed. They weren’t poor, either. But we didn’t used to expect that children would have so much real estate in the house.
    I cannot fault the bank in your cousin’s case. We work here on a principle of caveat emptor. It is the responsibility of the buyer to investigate the property and its value before buying, and make sure he really wants what he’s buying before he puts his money down. I did not, for instance, look at the City’s plans for the empty lot across the street from me when we built; I assumed more single-family homes would go in. Wrong. It was already bought and approved for an assisted-living facility, so my front window looks out on their parking lot, and we essentially have no real neighbors across the street. (Luckily, it’s a tidy place and they’re considerate noisewise.) Also, had I checked, I’d have seen that my street would become a collector street for a main drag, and would become much busier. Also that a farm across the way would eventually be developed with, likely, low-income housing.
    All these things affect the property value and the quality of life here. Whose fault is it that I didn’t know? The bank’s? The city’s? No: it was mine. Next time I’ll do better homework.

  12. amy Says:

    (whoops, sorry — “when we bought”, not “when we built”. House was newish, but already here.)

  13. amy Says:

    One more — it occurs to me, Jody, that competitiveness and willingness to accept responsibility for making one’s way, despite the harshness of capitalism, are two sides of the same coin. If we have a culture so ready to blame “people in charge”, for things we had control over, I don’t see how we get sharp enough to be seriously competitive again.
    I don’t think, by the way, that we’re likely to see the towering dominance we had after WWII again, not unless the rest of the world tears itself apart again while we stand aside. But I bet that if I went back and looked at our turn-of-the-century circumstances, we didn’t run trade deficits like we’ve seen for the last little while.

  14. Jackie Says:

    Amy, I would strongly disagree, partly because my city (Baltimore) is one of several jurisdictions around the country that has brought suit against major financial institutions (like Wells Fargo) for predatory lending of unprecendented levels. You can read a short piece I did for ColorLines magazine* about these efforts for more evidence, but I think it’s naive to think that predatory lending didn’t play a big part in this crisis, and I think it’s irresponsible to blame the victims of that predation, rather than the perpetrators.
    * I’m putting the link here because HTML is not allowed:
    http://www.thefreelibrary.com/Another+chapter+in+the+foreclosure+crisis%3a+cities+start+fighting+the…-a0181434530

  15. amy Says:

    Jackie, your article says nothing at all about what Wells Fargo actually offered these people and how they allegedly preyed on them. The fact that Baltimore is suing doesn’t mean that there was actual fraud or predation; it means that Baltimore recognizes that there’s a giant liability staring it in the face, and will take whatever road it can to recoup losses.
    About once a week I get offers for payday-loan-style borrowing. I get ‘free cash’ offers that come with entirely legible fine print outlining the terrible deal. I’ve seen credit card offers with top interest rates of upwards of 30% over prime. And I don’t take the loans because I’d have to be a moron to do it. I say “moron” advisedly. I’ve gotten some of these offers while living in poverty in crummy neighborhoods, in need of asthma medication that I couldn’t afford. No, I didn’t take the money so I could run out and buy corticosteroids. I banged on doctors’ doors instead and got samples and eventually found a way to get free meds from the drug companies.
    Every single one of those people, if raised in America, had the opportunity to learn to do arithmetic with percentages. Every one. And the opportunities don’t end when you leave school. There is no shortage of information out there telling you what the numbers mean. Unless you’re an illiterate immigrant or you’re brain damaged or mentally retarded or are otherwise actually incapable of figuring out what the paper says and how to do the math, I don’t want to hear about the dumb thing you did in signing something you shouldn’t have.
    I hear about crooks preying on old people with Alzheimers and the mentally retarded. This is genuine predation. These people cannot, really cannot, fend for themselves. If that’s what WF was doing, fine, I take it all back. But the preventing predation is not about protecting you from your own foolishness or lack of care in looking out for yourself.
    One more manifestation of “Someone should make the world 100% safe for me.” Once again, this is no way to get competitive.

  16. Jackie Says:

    What Wells Fargo did was reverse redlining, which is explained in the article, Amy. It’s been identified all over the country, and Wells Fargo has been the subject of predatory lending lawsuits under the Fair Housing Act for decades. A minor amount of Googling would have found that information.
    There have also been documented cases of immigrants who were not literate in English signing loans that were not what they believed, especially in California, which non-coincidentally is one of the areas hit hardest in the crisis.
    I know there is not an anecdote in this post, nor am I proclaiming how smart I am and how idiotic other people are, but oddly enough, that’s not how I prefer to deliberate questions of national crises. It’s really starting to seem like the greedy homeowner with the HELOC, Lexus and granite countertops is the new “welfare queen” of this era.

  17. amy Says:

    Jackie, “reverse redlining” is not descriptive of how WF reps preyed on anyone. At the moment of each signing, there was a WF rep and a person, or a couple, who chose to sign. WF is certainly not afraid of breaking contracts and laws and waiting for people to sue them — in fact I may have the opportunity to sue them myself in a few months. But unless the people signing those mortgage loans were in some way mentally incompetent or incapable of understanding what they were doing, all WF did there was to go find a bunch of ignorant, but sane and able, people who did nothing to remedy their own ignorance before signing.
    Baltimore, I take it, has television stations, public schools, and branch libraries. I bet that throughout the 90s it had adult literacy volunteers, too. If you wanted to learn how mortgages work before indebting yourself to a ridiculous degree, the information was out there for you to go and get.
    Locally, we have a small population of recently arrived immigrants from non-Spanish-speaking region of Mexico; they are illiterate in their own language, speak no English, and clearly come from another world entirely. If some bank person here showed up looking official and gave them to understand they would get a house if they made a mark on this paper, and that this was how it was done here, I would call that predatory. These people have no way of knowing up from down in this place, and have no cultural framework whatsoever for our legal constructs.
    Someone who grew up here, someone who came here from another place where pieces of paper are meaningful, someone who can read and add or had every chance to learn — that’s a very different story. That’s foolishness, not victimhood. I’d bet that among the victims of redlining you describe are some pretty good amateur lawyers.
    As for non-English-speakers, no, they are not the cause of California’s mortgage problems. California’s housing bubble is the cause of California’s mortgage problems. For that matter, if you’re in this country long enough to get legal and old enough to take out a mortgage loan, and you’re sane, you have no excuse for not knowing that legal documents are meaningful here. And if you can’t read the mortgage papers? Few can, whatever language they speak. Doesn’t matter. Find a trusted lawyer or smart friend to translate, and don’t sign unless you’re willing to bet that you understand those words.
    No one ever found a welfare queen, by the way. But I can show you some very pretty mortgage-funded countertops.

  18. Amy P Says:

    To add to what the other Amy was saying, real estate agents and mortgage brokers have been very prominent in news stories among the bubble victims. (There was a story recently featuring a 20-something mortgage broker who used to get biweekly paychecks for $20k, has now lost everything, and thinks of herself as a “victim.”) If anybody could have known better, it should have been them.

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