Tuesday, August 28, 2007

The Sub-Prime Summer III

It’s just another massive stock sell off on Wall Street in this subprime summer of 2007. High finance is in a mess for multiple reasons. The greed of wealthy institutions in constructing leveraged games for squeezing out profits is a huge factor, but the fashionable culprit is the irresponsibility of the larger population making and taking bad loans. Tanta at Calculated Risk has been exposing the uber-nerd details about how a breakdown in traditional mortgage lending discipline contributes to the overall mess, yet even she hesitates about laying too much blame on the borrowers.

Delusional Borrowers" and Reality Checks: I remain convinced that there's something wrong with blaming the financially inept for not realizing that they are financially inept, when those who are supposed to be financially ept--loan officers, brokers, financial counselors, advice columnists in business publications--spent the last several years refusing to tell them that they were financially inept.

Focus in on that last phrase: “refusing to tell them that they were financially inept”. Welcome to the world of unintended consequences. The Federal Trade Commission gives the basics in their consumer guide but let’s go right to the text of our Federal Law.

Equal Credit Opportunity Act: Sec. 202.5 Rules concerning taking of applications. (a) Discouraging applications. A creditor shall not make any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application.

It is highly illegal for any financial institution offering credit to discourage anyone from applying. We are talking crack cocaine illegal to even hint to an individual that they may be making a really bad financial decision. So the lenders take every application and when underwriting turns down bad risks, those risks walk over to the next lender and apply again. Over time the industry learns it is foolish to let business walk out the door in a game rigged in favor of anyone looking for money.

Let me put it this way. The industry best suited to educate the public about financial responsibility is, for all practical purposes, forbidden by Federal Law to educate the public. In our continually growing welfare state, the task of teaching belongs almost entirely to unionized public school teachers. Thousands of people act on their desire for the instant American Dream because no one adequately instructed them how to use credit, manage debt and budget for the expenses of life. Now we are all waiting for the rubble to settle and the dust to clear.