Trust, and a Terrible Development
A new development in the housing crisis is a growing trend of homeowners who owe more on their mortgages than the house is worth simply walking away. They stop paying the mortgage and abandon the house, leaving the bank owning the property that isn't worth what the bank paid for it.
I'm of two minds about this development. The first, obviously, is that it isn't a good thing when people renege on signed contracts. Granted, these sales were stupid to begin with, and in many cases, the banks have no excuse for not realizing that a lot of folks weren't going to be able to pay them off. Still, a contract has to be worth something.
The economy only works if there is a significant amount of trust. At a certain, and fairly early, point, you have to be able to assume that your counterparty is acting in good faith. If you can't, then the economy is going to grind to a halt, because the amount of due diligence necessary before anyone is willing to enter into an agreement is crippling. So many resources get used up making sure that you don't get screwed that nothing happens. Trust is one of the lubricants necessary for the system to function.
In this case, what we have is that the mortgage lenders are going to have to stop assuming that house buyers are really committed to paying off the mortgage, even if they sign a contract saying that they are going to do so. So, they have to do more due diligence.
Of course, this is a crappy example, because anything that forces mortgage originators to do more due diligence going forward is a good thing. Aside from allowing them to avoid jingle mail, it would also mean that they'd stop making such obviously stupid loans. This is a case where some sand in the gears is actually a good idea.
In the bigger picture, though, I have a hard time castigating the folks walking away from mortgages in isolation. They are simply a part of a bigger problem. Trust of all sorts has disappeared from American society, and the economic sphere in particular. It is common to argue that the beauty of a capitalist system is that it harnesses a fundamental aspect of human nature, greed, and turns it into a force for good.
This is true, but only to a point. The folks who don't bother to stop and think this through any farther are making a horrible mistake. A system based exclusively on greed can't work. There have to be other factors at work. Broadly speaking, those factors come under the heading of "trust."
Trust means a lot more than that someone will fulfill the terms of a signed contract. In its widest sense, it means that participants in the market have to have confidence that the other participants have more than just their own selfish interests at heart. People actually have to care about how the outcome of a transaction affects the other party. Setting about maximizing one's return regardless of the consequences on the other side is something that works fine for individuals, but, when it becomes the norm, things break down. It's a giant game of Prisoners' Dilemma. (As an aside, I'd love to see an analysis of Prisoners' Dilemma played not only through multiple iterations, but with multiple simultaneous players. The payoff matrix would be fascinating.)
The Free Marketeers almost get this. They argue that a party has to keep these sorts of things in mind, or people will stop doing business with them in the long term. That's fine as far as it goes, but there is a broader issue. Quite aside from the reputation that any individual market actor has, participants have to trust each other in general. Upon dealing with someone for the first time, one has to have confidence that they are acting in good faith. If not, the approach to every transaction becomes defensive.
Anyone who has familiarity with any of my writings on William Slim has a good idea where this is headed. The switch from the concern of corporations with various stakeholders to the approach where profit maximization was the overriding, and in many cases, only, goal, did drastically increase the efficiency of the economy. It did so at a cost, however, and that cost was trust.
At its most bleeding heart, this has been a critical change in the employer/employee relationship. There are all sorts of euphemisms for it, but the idea that your boss was only going to employ you so long as he didn't have some other way to get the job done for more profit is corrosive. It eliminates the trust on the part of the employee that his employer has his interests in mind. No company has the wall space for enough of those annoying motivational posters to change that. As I've said, a lot of the people who cite Slim's managerial methods miss the point that they aren't something you can fake; you have to actually mean it.
This has the first order effect that a company that starts to treat its workforce this way is going to run into the problem of employee morale, and will find that its workers aren't loyal, either. There are second order effects, though. Once a critical mass of companies operate this way, it becomes the default assumption that all companies behave in this fashion until proven otherwise. If you want to find the wellspring of the populism that John Edwards taps into, it's right here. The sort of economic system that has developed is one in which a very large number of people feel that no one is looking out for their interests except for themselves. Not surprisingly, those who have less ability to defend their interests get disillusioned with the system.
The concept of noblesse oblige originates in some assumptions about social class that modern America no longer believes in. Stripped of those connotations, though, it is crucially important. The well-off have an obligation to look out for those who are not. Personally, I think that this is a moral obligation, but it holds true even if you don't. In the big picture, the rich need the not so rich to buy into the basic idea of whatever economic system you have. They have to believe that their interests can be, and are, protected in some way.
That basic belief has broken down in America. Trickle-down economics hasn't really allowed the money to trickle down, but the attitudes sure have. No one should be surprised that there is a changing attitude towards debt, that says it is socially acceptable to simply walk away from it. Corporations have adopted that attitude, with regard to both monetary and ethical debts, over the last several decades. Now, individuals are following suit. You reap what you sow, and what has been sown is the idea of profit maximization. Well, these people are maximizing their profit, or at least minimizing their losses.
I love finance. I think that it is a fascinating subject, and I hope to get back into it. Nevertheless, it's the industry that is at the heart of this corruption of America. This is true at the macro level, in which the markets have come to reward short term earnings at the expense of all else. Executive pay structure has exploded. Within the finance industry, I don't believe that much of that explosion is even justified by efficiency at the marginal level of improvement brought by most of these executives. However, even if it were, it would be wrong. It is a stark depiction that profit maximization is the imperative for individuals as well as companies. In the end, nothing else matters. Of course the rest of the population is going to adopt the same attitude. If they didn't, all they'd be is chumps for those who do operate that way.
There's a perfect example of this, and it's even connected to the mortgage issue, though at the other end. Over the last few years, several large investment banks, especially JP Morgan, came up with the idea of selling not just the mortgage bonds that are crap, but complicated interest rate derivatives, to school districts. Many of the examples come from Pennsylvania, which change its laws to allow such investments. No one on most of these school boards has the slightest idea what an interest rate swap is, let alone how it works. They are completely at the mercy of the finance guys who are pitching these things to them. Of course, a lot of these school districts have gotten badly burned by the swaps that were sold to them as a safe investment. Worse, the banks and various middlemen disguised what they were charging in fees. It turns out that they were collecting 2-4 times the fees in these deals than they were getting in similar deals with more sophisticated customers. Hey, in a profit maximization world, you need to make as many of these deals as you possibly can. It's pretty much free money.
It's easy to say that the school boards were foolish. They should never have invested in complicated financial products that they had no hope of understanding. That's true. Nevertheless, it's indicative of a system in which everyone needs to be constantly vigilant, because anyone trying to sell them something is also looking to rip them off. Don't trust anyone. If you can't figure out which person at the table is the mark, then it's probably you.
What a horrible society to live in. Why, I wouldn't be surprised if it leads to people walking away from signed mortgage contracts.
"I used to like to go to work but they shut it down
I got a right to go to work but there's no work here to be found
yes and they say we're gonna have to pay what's owed
we're gonna have to reap from some seed that's been sowed
and the birds up on the wires and the telegraph poles
they can always fly away from this rain and this cold
you can hear them singing out their telegraph code
all the way down the telegraph road"
Mark Knopfler - Telegraph Road
" Big money goes around the world
Big money give and take
Big money done a power of good
Big money make mistakes
Big money got a heavy hand
Big money take control
Big money got a mean streak
Big money got no soul..."
Neil Peart - The Big Money
And here is the rest of it.
I'm of two minds about this development. The first, obviously, is that it isn't a good thing when people renege on signed contracts. Granted, these sales were stupid to begin with, and in many cases, the banks have no excuse for not realizing that a lot of folks weren't going to be able to pay them off. Still, a contract has to be worth something.
The economy only works if there is a significant amount of trust. At a certain, and fairly early, point, you have to be able to assume that your counterparty is acting in good faith. If you can't, then the economy is going to grind to a halt, because the amount of due diligence necessary before anyone is willing to enter into an agreement is crippling. So many resources get used up making sure that you don't get screwed that nothing happens. Trust is one of the lubricants necessary for the system to function.
In this case, what we have is that the mortgage lenders are going to have to stop assuming that house buyers are really committed to paying off the mortgage, even if they sign a contract saying that they are going to do so. So, they have to do more due diligence.
Of course, this is a crappy example, because anything that forces mortgage originators to do more due diligence going forward is a good thing. Aside from allowing them to avoid jingle mail, it would also mean that they'd stop making such obviously stupid loans. This is a case where some sand in the gears is actually a good idea.
In the bigger picture, though, I have a hard time castigating the folks walking away from mortgages in isolation. They are simply a part of a bigger problem. Trust of all sorts has disappeared from American society, and the economic sphere in particular. It is common to argue that the beauty of a capitalist system is that it harnesses a fundamental aspect of human nature, greed, and turns it into a force for good.
This is true, but only to a point. The folks who don't bother to stop and think this through any farther are making a horrible mistake. A system based exclusively on greed can't work. There have to be other factors at work. Broadly speaking, those factors come under the heading of "trust."
Trust means a lot more than that someone will fulfill the terms of a signed contract. In its widest sense, it means that participants in the market have to have confidence that the other participants have more than just their own selfish interests at heart. People actually have to care about how the outcome of a transaction affects the other party. Setting about maximizing one's return regardless of the consequences on the other side is something that works fine for individuals, but, when it becomes the norm, things break down. It's a giant game of Prisoners' Dilemma. (As an aside, I'd love to see an analysis of Prisoners' Dilemma played not only through multiple iterations, but with multiple simultaneous players. The payoff matrix would be fascinating.)
The Free Marketeers almost get this. They argue that a party has to keep these sorts of things in mind, or people will stop doing business with them in the long term. That's fine as far as it goes, but there is a broader issue. Quite aside from the reputation that any individual market actor has, participants have to trust each other in general. Upon dealing with someone for the first time, one has to have confidence that they are acting in good faith. If not, the approach to every transaction becomes defensive.
Anyone who has familiarity with any of my writings on William Slim has a good idea where this is headed. The switch from the concern of corporations with various stakeholders to the approach where profit maximization was the overriding, and in many cases, only, goal, did drastically increase the efficiency of the economy. It did so at a cost, however, and that cost was trust.
At its most bleeding heart, this has been a critical change in the employer/employee relationship. There are all sorts of euphemisms for it, but the idea that your boss was only going to employ you so long as he didn't have some other way to get the job done for more profit is corrosive. It eliminates the trust on the part of the employee that his employer has his interests in mind. No company has the wall space for enough of those annoying motivational posters to change that. As I've said, a lot of the people who cite Slim's managerial methods miss the point that they aren't something you can fake; you have to actually mean it.
This has the first order effect that a company that starts to treat its workforce this way is going to run into the problem of employee morale, and will find that its workers aren't loyal, either. There are second order effects, though. Once a critical mass of companies operate this way, it becomes the default assumption that all companies behave in this fashion until proven otherwise. If you want to find the wellspring of the populism that John Edwards taps into, it's right here. The sort of economic system that has developed is one in which a very large number of people feel that no one is looking out for their interests except for themselves. Not surprisingly, those who have less ability to defend their interests get disillusioned with the system.
The concept of noblesse oblige originates in some assumptions about social class that modern America no longer believes in. Stripped of those connotations, though, it is crucially important. The well-off have an obligation to look out for those who are not. Personally, I think that this is a moral obligation, but it holds true even if you don't. In the big picture, the rich need the not so rich to buy into the basic idea of whatever economic system you have. They have to believe that their interests can be, and are, protected in some way.
That basic belief has broken down in America. Trickle-down economics hasn't really allowed the money to trickle down, but the attitudes sure have. No one should be surprised that there is a changing attitude towards debt, that says it is socially acceptable to simply walk away from it. Corporations have adopted that attitude, with regard to both monetary and ethical debts, over the last several decades. Now, individuals are following suit. You reap what you sow, and what has been sown is the idea of profit maximization. Well, these people are maximizing their profit, or at least minimizing their losses.
I love finance. I think that it is a fascinating subject, and I hope to get back into it. Nevertheless, it's the industry that is at the heart of this corruption of America. This is true at the macro level, in which the markets have come to reward short term earnings at the expense of all else. Executive pay structure has exploded. Within the finance industry, I don't believe that much of that explosion is even justified by efficiency at the marginal level of improvement brought by most of these executives. However, even if it were, it would be wrong. It is a stark depiction that profit maximization is the imperative for individuals as well as companies. In the end, nothing else matters. Of course the rest of the population is going to adopt the same attitude. If they didn't, all they'd be is chumps for those who do operate that way.
There's a perfect example of this, and it's even connected to the mortgage issue, though at the other end. Over the last few years, several large investment banks, especially JP Morgan, came up with the idea of selling not just the mortgage bonds that are crap, but complicated interest rate derivatives, to school districts. Many of the examples come from Pennsylvania, which change its laws to allow such investments. No one on most of these school boards has the slightest idea what an interest rate swap is, let alone how it works. They are completely at the mercy of the finance guys who are pitching these things to them. Of course, a lot of these school districts have gotten badly burned by the swaps that were sold to them as a safe investment. Worse, the banks and various middlemen disguised what they were charging in fees. It turns out that they were collecting 2-4 times the fees in these deals than they were getting in similar deals with more sophisticated customers. Hey, in a profit maximization world, you need to make as many of these deals as you possibly can. It's pretty much free money.
It's easy to say that the school boards were foolish. They should never have invested in complicated financial products that they had no hope of understanding. That's true. Nevertheless, it's indicative of a system in which everyone needs to be constantly vigilant, because anyone trying to sell them something is also looking to rip them off. Don't trust anyone. If you can't figure out which person at the table is the mark, then it's probably you.
What a horrible society to live in. Why, I wouldn't be surprised if it leads to people walking away from signed mortgage contracts.
"I used to like to go to work but they shut it down
I got a right to go to work but there's no work here to be found
yes and they say we're gonna have to pay what's owed
we're gonna have to reap from some seed that's been sowed
and the birds up on the wires and the telegraph poles
they can always fly away from this rain and this cold
you can hear them singing out their telegraph code
all the way down the telegraph road"
Mark Knopfler - Telegraph Road
" Big money goes around the world
Big money give and take
Big money done a power of good
Big money make mistakes
Big money got a heavy hand
Big money take control
Big money got a mean streak
Big money got no soul..."
Neil Peart - The Big Money
And here is the rest of it.
posted by Comrade J. Michael Neal at 5:30 PM
4 Comments:
Found my way here through your CR comment. I'm glad I made the trip.
I, too, prefer to think of my fellow man as worthy of my trust, and I usually do. But you can see the fear in the elderly, parents of young (and not so young) children, residents of gated communities and neighborhoods with private armed patrols so the trend isn't good.
Recall the Cold War line: "trust but verify." I do fall back on that when I feel the need, but normally try to live by the rule of WYSIWYG.
Thanks.
It seems to me that businesses are themselves largely responsible for the ship having sailed on the "moral" side of things.
But in any case, "trust" is nonsensical. If the bank trusted me in the first place, they would not ask for collateral.
Since trust doesn't really come into it anyway, financial institutions should simply be up front about who holds which options in the financial contract, and they should be explicitly priced in the contract. So if I as the customer get an option on the debt (the opportunity to refinance if rates go way down or to walk away if prices go down too far are both options), I should of course pay for those options, but I should also see what I am being charged for them.
Banks and other home lenders should be reasonably sophisticated financial institutions - if there are options in a contract you should lay them out clearly for everyone to see. If you don't want that option to be there, figure out a way to avoid it being an option.
But you don't get to whine if the other guy exercised an option when you'd have exercised your own options had you had the opportunity.
Since in an earlier comment I was discussing the Australian situation, I figured I'd point to
John Quiggin's comment on the housing situation here.
http://johnquiggin.com/index.php/archives/2008/02/02/the-great-australian-dream/
I was thinking about your comments about the workplace and it reminded me of the story (I can't remember where I read it now, so it might be apocryphal) about companies that, as a matter of policy, fire the "weakest" 5% of the workforce every year, and use recommendations from other workers to indentify the so-called "weakest". I can't think of a more hellish environment in which to work; it will be dog-eat-dog, and it's seems calculated to ensure there can never be any kind of trust.
The only sort of person that would thrive in such an organisation is an out-and-out sociopath.
Mark Rosenfelder claims that the problem with a lot of business is that too many sociopaths have risen too high, and that sort of business model is the only one they understand.
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