If you're new here, you may want to subscribe to my RSS feed. Thanks for visiting!
It is pretty well established that the housing market crash was the event that precipitated the financial system collapse and recession we are now struggling through. That’s not to say there weren’t scores of other causes, but the drop in housing prices, which turned into a death-spiral, is roughly equivalent to the assassination of Grand Duke Franz Ferdinand in Sarajevo in 1914, which set off a succession of events that turned into World War I.
I heard on the radio the other day an interview with Clarence Nathan, a man who could be a poster child for the housing and mortgage crisis, except he is refreshingly short on self-pity http://www.onpointradio.org/2009/06/planet-money. Earning $45,000 a year, he had borrowed $540,000 in what was called a “no-income verification loan,” popularly termed a liar’s loan. In Mr. Nathan’s own words, “I wouldn’t have loaned me the money and nobody I know would have loaned me the money. I know guys who are criminals that wouldn’t have loaned me the money, and they break your kneecaps. I don’t know why the bank did it…loaning $540,000 to someone with bad credit.”
When it comes to assigning blame, there is a clear split of opinion. Many people – let’s call them Republicans – blame the borrowers for taking out loans they knew they couldn’t afford, and consider them slothful, greedy, and dishonest souls who should be left to live with the consequences of their poor decisions. Others – let’s call them Democrats – put the blame squarely on the banks and mortgage brokers, who they say peddled a bunch of very risky and poorly explained mortgage products to uninformed borrowers, figuring that the huge profits on the performing loans would more than compensate for any defaults (as long as housing prices continued to rise, which of course they did not). These predatory lenders, they say, should be severely punished, while their victims, the hapless borrowers, should be bailed out by the government.
It is easy to single out the lenders as the culprits. Those slimy ads on TV urging people to take out home equity loans, in addition to incomprehensible loan documents, make it hard to sympathize with them. I refinanced my house last year with a straight fixed-term mortgage and couldn’t make sense of the numbers, and I have a degree in finance.
The truth is more nuanced. In Clarence Nathan’s words, “I didn’t cheat the bank, and the bank didn’t cheat me. We joined together to cheat ourselves.”
This is an idea that could be useful in thinking about solutions to the huge sovereign debt of many poor countries. The tussle over blame for the poor country debt crisis closely mirrors that for the mortgage and housing crisis.
Critics of the notion of debt forgiveness tend to blame the borrowers. It is no secret that many highly indebted poor countries (HIPCs, in the jargon) are fairly rife with corruption, and have spent a lot of their loans and grants on wars and weapons and palaces on the Côte d’Azur, so why should the multilateral financial institutions (MFIs) like the World Bank, the IMF, the African Development Bank, etc. bail them out now? Also, there is moral hazard. What will be the effect of debt forgiveness on a country’s future behavior, if not to encourage the same kind of behavior that got it into trouble in the first place? The same argument has been raised with respect to bail-outs of Citibank, AIG, and other financial institutions.
On the other side of the argument, it is the MFIs that receive the lion’s share of the blame. Just as unscrupulous mortgage lenders did, they foisted loans on borrowers who lacked the knowledge and sophistication to understand the fine print, who at the same time were desperate for cash to pay the salaries of teachers, doctors, and civil servants and to import essential commodities. Also, many of the projects funded with MFI loans, such as dams and power plants, are said to have done little to help the poor, while causing enormous environmental damage. World Bank loan officers, like their private sector counterparts, were rewarded for making loans, while issues of non-performance usually wouldn’t surface for several years, by which time the originating officer had moved on to other departments and other countries.
The pop singer Bono has been a vocal and ubiquitous advocate for this view, and has militated for debt cancellation rather than the more limited debt forgiveness offered by the MFIs’ “HIPC Initiative” to countries that meet certain conditions with respect to public finance reform and economic liberalization. Bono, and those who buy into his argument, tend to think that the conditions imposed by the HIPC initiative are an unacceptable infringement on the borrowers’ sovereignty.
Clarence Nathan’s words seem particularly apt. The MFIs and the HIPCs joined together to cheat themselves. There is enough blame for everyone to receive an appropriate share, just as there is in the mortgage crisis. As for a solution, helping one side at the expense of the other seems terribly unfair.
Poor countries and low-income mortgage borrowers are very different. A country can, if it chooses, repudiate its debt and refuse to repay it. This gives creditors an incentive to negotiate a settlement. This is not an option for individuals, so there are limits to the applicability of a HIPC-style remedy to the mortgage crisis. Still, a solution that apportions blame, and the cost of the cleanup, more or less equally to both sides, seems the best option. Provided, of course, that the taxpayer does not end up footing the entire bill.
{ 0 comments… add one now }