Marginal Revolution: Credit Snobs II

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« Safety nets | Main | Department of Why Not »

Credit Snobs II

The volte-face in this post by Robert Reich is a real howler.

When the Fed decides to fight inflation by raising interest rates and cooling the economy, it’s the poor who are the first to be drafted into the inflation fight because their jobs are the most tenuous, and they’re the first to lose them. When the Fed decides to ease up and reduce rates, it’s the poor who are among the first to get the new jobs because employers who are most likely to hire at the start are small service businesses offering jobs at the bottom rungs of the wage scale.

I might not put it that way but nothing crazy so far. He continues:

But the Fed affects the poor in another way, too. It determines their access to credit. And here as well, the Fed's decisions can either be a great boon to poorer Americans or a huge curse, depending on how responsibly the Fed manages the credit markets.

I agree. So where do you think the argument is going from here? He's going to make the point that when the Fed reduces rates that helps the poor to get credit and a too quick tightening could increase unemployment and create a credit crunch, right? Nope.

In this respect, it’s done a lousy job in recent years. In the early 2000s, rates were so low that banks didn’t know what to do with all the extra money they had on hand. But instead of keeping an eye on bank lending standards, the Fed looked the other way. The result: Credit standards were disregarded in a tidal wave of sub-prime lending to the poor home buyers...

Ouch, that one gave me whiplash. The Fed has done the poor a disservice by looking the other way while the poor got loans at really low rates of interest. Thus, high interest rates are bad for the poor because they can't get jobs and low interest rates are bad for the poor because they borrow too much money.

Reich argues this way, of course, because he thinks that the poor can't handle their money. I'll add Reich to the list of credit snobs.

H/T to Steven Bass at Trivial Reasons.

P.S. Person 1, Dave 0.

Posted by Alex Tabarrok on March 26, 2007 at 07:17 AM in Economics | Permalink

Comments

I have some sympathy for your disdain, credit snobs, etc.

But also think I've heard this subext before ... just because a 6-year SUV loan is stupid in some cases, that doesn't mean it is stupid in all cases ... so let's let everybody off the hook (no matter how many of them are "upside down" at the moment).

What I think happened was that human beings, social creatures that we are, adopted a new and dangerous idea for what was acceptable debt management. And yes, some who didn't really understand their debt (rich _or_ poor) went along with their neighbors and piled it on. As I was told in the suburbs, "debt is good."

As economists I'm sure you can do the maths, and can make arguments for when debt is really good ... but for God's sake don't use that skill to make some sophistic argument that everyone else has done the same maths.

Posted by: odograph at Mar 26, 2007 7:59:51 AM

It is irrelevant if they have done the same maths. It is only relevent
whether they are able, given whatever criteria they find important, to
understand and subsequently enter into binding contracts. If they are,
then they're responsible for the outcome. Done. Next issue?

On a side note: I enjoy the coverage of many issues on public radio, but
if I hear one more interview on All Things Considered talking about
"predatory" lending or how the poor are taken advantage of by *banks lending
them money to buy what they want*, I think I will scream.

Posted by: hamilton at Mar 26, 2007 8:55:06 AM

It's possible that he's somehow arguing that the poor are worst hit by lowered rates because of the inevitability of the rates later rising (combined with getting ARMs). It's possible that he's just arguing that the Fed should not raise rates to try to fight inflation as much as it does, that it should let us have a bit more inflation. Given that inflation affects people with money more and the poor and debtors less, he could perhaps be making that argument. Easy money and inflation has been a policy of the Progressive Left before, certainly.

Otherwise, I could conclude that he's making a simple argument that the poor tend to be least-equipped to face any sort of disruption or hardship. But that's practically self-evidently true-- what else would being poor mean? More importantly, it hardly would argue for any sort of public policy, at least at the Fed.

Posted by: John Thacker at Mar 26, 2007 9:12:45 AM

"It is irrelevant if they have done the same maths. It is only relevent
whether they are able, given whatever criteria they find important, to
understand and subsequently enter into binding contracts."

Can you really understand the contracts without the maths?

Or, in a world were economists acknowledge bounded rationality, why do they pretend evenly distributed bounds?

Posted by: odograph at Mar 26, 2007 9:36:23 AM

Alex,

There is a difference between snobbery and prudence.

The snob lender would say, 'I will not lend to this person because I do not like their footwear/taste in T-shirts/accent, etc. They are obviously not the right sort of person'.

A prudent lender would say 'I will not lend to this peson because they are looking to borrow more than they can service/they do not have a stable employment history/they cannot display a credit history'.

Reich may or may not be a credit snob, Alex (I don't think he is, as far as I can see he's only following the economist's principal duty of counselling caution); but if he's a credit snob then I hope you're happy with the appellation 'bankruptcy pimp'.

Posted by: Martin at Mar 26, 2007 9:38:49 AM

Alex, I think you're willfully misinterpreting his meaning to support your "credit snobs" theory. Yes, people got low rates at first, but later these rates rose to unmanageable levels. If you're going to start calling people credit snobs then why haven't you targeted Greenspan? He first trumpted loans with floating rates and later denigrated them. Why don't you point this out? He had a much bigger impact than the people you've singled out so far.

Posted by: eriks at Mar 26, 2007 9:59:04 AM

On this side of the ocean (I'm in Eastern Europe) there is a widespread belief that "the poor cannot cope with any sort of change". If one believes this, deducing how exactly they suffer from falling interest rates or rising interest rates becomes a purely technical task.

While that is no doubt a deductive way of reasoning, with the belief coming first, there is probably some truth to it. Were interest rates stable, handling one's money would boild down to simple math; yet in an unstable environment it requires continuous flow of information, and the poor surely consume less of WSJ per capita.

Posted by: Pretinieks at Mar 26, 2007 10:54:56 AM

The protestations of various commenters are not very convincing - Alex was on firm ground wheen he called Roubini et al, credit snobs: Snob - One who tends to patronize, rebuff, or ignore people regarded as social inferiors and imitate, admire, or seek association with people regarded as social superiors. One who affects an offensive air of self-satisfied superiority in matters of taste or intellect. Why don't you just admit that you think that these poor people need a wiser protector? In fact, most of those who got subprime loans are not behind in their payments (maybe 85%) so even this snobbery is denigrating a large group for the assumed failings of a small minority.

Posted by: Rich Berger at Mar 26, 2007 11:25:43 AM

"Hello, Mr. Poorman, I'm Robert Reich, and the government sent me here to help you. Now, interest rates are really low, but I want to warn you against borrowing any money. You see, I know you might be tempted to borrow so you can move out of your run-down apartment and become a homeowner in a better neighborhood. Less crime, better schools for your kids (by the way, you probably have too many kids, but that's another story). But you know, you're so stupid and lacking in self-discipline that you can't really be trusted to borrow anything. Why, the next thing, you'll be borrowing money to buy booze, drugs or lottery tickets. So I want to warn you against this temptation. But does this make it OK for you borrow if interest rates go up? Haha, Mr. Poorman, I think you know the answer to that one! Of course it's not OK! High interest rates make credit too expensive, and you might get in over your head! So just forget about borrowing! You're obviously a real dunce, so just stay in your rotten apartment in your crime-ridden neighborhood and forget about ever getting out. After all, I'm a card-carrying liberal, and I demonstrate my moral superiority by feigning concern for poor people while I patronize them and secretly despise them. If you doubt me, just ask Bill Clinton!"

Posted by: Ned at Mar 26, 2007 11:42:37 AM

While I appreciate the mention and stand by my posts, I'm not sure what I said that warranted a mention.

I also didn't respond to Dave's challenge, which in any case was a request to find something I didn't claim
existed. What I claimed was that liberals before said that lenders under-rated the creditworthiness of
the poor and now call lenders stupid for making such risky loans to them. No, I don't have a name list, but it
shouldn't be hard to find. Just google the terms associated with the depriving people of credit (like
"redlining") and then google "subprime". The same people should show up.

I suspected Ralph Nader would be one. For the "you are underrating the poor", I found this from '93:

http://topics.nytimes.com/top/reference/timestopics/subjects/l/law_and_legislation/index.html?offset=60&query=MORTGAGES&field=des&match=exact (first story -- you can't read it all without paying, but
you can see what he's arguing -- that the lenders aren't loaning to those who deserve it.)

For the "you overrated the poor, you idiots", I found this:

http://www.thestreet.com/pf/markets/activetraderupdate/10344345.html

That's not by Nader, but you can see in his bio, he's a close confidant. (Nader hasn't written anything about subprime mortgages for 5 years, it seems.) Kass says:

"Culprit #2: Irrational lenders like Novastar, New Century, Fremont General, Option One, Accredited Home, OwnIt Mortgage Solutions and others were no smarter than a sixth grader. "

Posted by: Person at Mar 26, 2007 11:57:15 AM

Great post. Reich reminds me of the old joke about the NYTimes headline: "Blackout Hits City, Jews and Blacks Suffer Most"

Posted by: Daniel Klein at Mar 26, 2007 11:59:51 AM

Well, you don't have to be a credit snob to see that sustained low interest rates can lead to credit bubbles.

And you don't have to be a credit snob to see that, when credit bubbles collapse, the poor are typically the least prepared to deal with the shock.

Posted by: Mr. Noah at Mar 26, 2007 12:11:18 PM

Reich argues this way, of course, because he thinks that the poor can't handle their money.

And what if that's true, and they can't? It's not a foregone conclusion that offering people loans is in their best interest. Rather than name-calling, how about seeking out evidence one way or the other?

Posted by: Tony at Mar 26, 2007 12:38:41 PM

credit is for the responsible and hard working people in the world. If lenders lend money to the poor for low interest rates who wouldn't be on line to get that deal, nobody wants to be poor, but only a few have the strength and vision to do what it takes to be successful in life.

Posted by: neil henry at Mar 26, 2007 12:39:33 PM

Funny that those who would most often attack political correctness practice their own form when convenient.

It does not imply policy in my mind to make the simple connection that financial skills might correlate with wealth. Though, I guess that is the fear, and the reason for the selective blindness. Do you fear that if you admit that correlation you will be endorsing a nanny?

It's laughable really, because people otherwise speak of financial best-practices must suddenly argue that wealth is random, and that the distribution of skills (in mathematics or risk assessment) is even across income levels.

Posted by: odograph at Mar 26, 2007 12:39:59 PM

What should I be called if I think that Reich is correct (at least in a large number of cases) that the poor will mis-manage their credit, but I think that this situation is preferable to the alternatives? A cold-hearted snob? An anarcho-capitalist-snob?

Posted by: Steve at Mar 26, 2007 12:41:14 PM

Oh, and another thing: isn't the fact that someone took a 10+ percent loan (in the current environment)
itself prima facia evidence of irresponsibility? How can you justify paying that high of an interest
rate on a home? Your loan rate has *beaten the S&P for the past seven years!* At that point, a home is
no longer an investment, it's consumption.

Posted by: Person at Mar 26, 2007 12:43:22 PM

Never thought I'd see the day Alex starts trolling his own blog.

Posted by: Mark at Mar 26, 2007 12:56:34 PM

"What should I be called if I think that Reich is correct (at least in a large number of cases) that the poor will mis-manage their credit, but I think that this situation is preferable to the alternatives?"

One free-market friendly alternative would have been a little more fear and a little less debt willingness.

Do economists love and encourage debt? Just enough? Or too often? To what degree did Federal economists create debt-love?

Posted by: odograph at Mar 26, 2007 1:12:19 PM

"Can you really understand the contracts without the maths?

Or, in a world were economists acknowledge bounded rationality, why do they pretend evenly distributed bounds?"

I'll answer the first one: sure. Without any maths whatsoever, one may understand what is meant by a variable-rate mortgage. It means the rates vary. Does that mean you understand whether interest rates will go up or down in the next few months? The next few years? No. Even if you do have a strong mathematical background, you might get that wrong. I know I would. The question is whether you understand that there is risk involved, and you might not pay off your loan, and as a result you will lose your house. If you understand all that, then great. Sign on the dotted line if you wish. Otherwise, don't.

I do not have a significant amount of sympathy for the position that we should limit what people do because they might choose poorly. Yep, they might. People start "too many" restaurants; many restaurants fail. And some people borrow more money than they might reasonably pay back. The fact that people do not anticipate their inability to pay is a problem to be addressed only by the borrower and the lender. And nobody else.

Posted by: hamilton at Mar 26, 2007 1:52:43 PM

Nicely put, Hamilton.

Posted by: Bernard Guerrero at Mar 26, 2007 2:07:50 PM

"The fact that people do not anticipate their inability to pay is a problem to be addressed only by the borrower and the lender. And nobody else."

That's not really the theory of banking regulations is it? The theory is that the good actors could be protected from the bad, yes? Are savings and loan failures between the borrower and the lender? And nobody else?

Posted by: odograph at Mar 26, 2007 2:10:33 PM

Rich,

For your position to be reasonable, the average mortgage delinquency rate must be 15% at all times and under all circumstances.

Is it? Or is a 15% default rate a disease of easy money? To my eyes that does not look a healthy number...

Ned,

Your contention is a fallacy. That money is cheap does not mean it should be borrowed for its own sake.

Posted by: Martin at Mar 26, 2007 3:09:28 PM

"That's not really the theory of banking regulations is it? The theory is that the good actors could be protected from the bad, yes? Are savings and loan failures between the borrower and the lender? And nobody else?"

We might go so far to say this:

The theory of regulation is that no transaction between two consenting parties is ever really between two consenting parties. We all have a stake in what consenting parties do, and therefore we may be involved through government action.

I think that is a fair representation of the idea of regulation generally. It seems to me that it is, in fact, reasonable in lots of cases. In those cases, there is usually a party to the transaction, and that party is usually not consenting (I buy gasoline for my car; Exxon and I are consenting, but odograph has to breathe in the particulates). I'm all about making the involuntary party a part of the transaction, so that they do not take it in the teeth, as it were.

But in the example you indicate, yes, I do believe that the problem is merely between borrower and lender. I hire out the process of lending my money to a financial intermediary. I am the lender; it's the borrower. We have a contract for what it will pay me; it may choose to insure my loan (I may also choose to do so). The intermediary in turn lends that money to others; now it is the lender, others are the borrow. No matter how you slice it, what we have is a series of borrower-lender relationships, all of which may be governed by contract, all of which concern only the borrower and the lender. And nobody else.

I hate that there are a bunch of people who are losing houses they purchased. They had to save to get down payments in a lot of cases, and that's hard work lost. And all the former homeowners, even those whose purchase was 100% borrowed, lost the really cool feeling of owning their own home. But the fact that people make mistakes in judging whether a deal (on a car, on a house, or on the loan to finance either) is good for them is not a sufficient justification for interfering between consenting adults.

I often recognize "opportunities" for profit that do not exist. But I do not need others to protect me; I need to learn how to protect me from my own poor judgement. And I learn that best by bearing the costs of my mistakes.

Posted by: hamilton at Mar 26, 2007 3:12:52 PM

I leave some money at CountryWide Bank, only because they assure me (they jump out of their chair to assure me!) that they are FDIC insured. Unintended consequences?

Posted by: odograph at Mar 26, 2007 3:50:32 PM

Martin-

Perhaps you should read my post again, with more care. I said 15% fell behind in payments (I think the number was actually 13%). I would expect the default rate to be lower, as not all who fall behind will default. Furthermore I expressed no opinion about what the appropriate default rate should be (I know it will never be zero). I do believe that all the handwringing about whether subprime borrowers should have been allowed to borrow at the offered terms ignores the fact that the overwhelming majority have not fallen behind.

Posted by: Rich Berger at Mar 26, 2007 4:19:45 PM

Reich is wrong about the cyclicality of demand for low-skilled labor. When the Fed raises rates, the sectors that are hurt the most, and also the earliest, are residential construction and manufacturing of business capital goods. Both of these sectors pay above-average wages. The sectors that pay below-average wages, retailing and consumer services, tend to be more stable. (That's not to say that the low-skilled are immune to harm from cycles, just that they are not the most sensitive to cycles.)

Posted by: Bill Conerly at Mar 26, 2007 4:53:21 PM

I bought a house three years ago. I got a 30 year fixed mortgage because, though the lower monthly payment of an ARM was tempting, simple common sense told me that, as rates were as low as they'd been in a long time, they had no where to go but up, so it would be foolish to get an ARM. It isn't rocket science, it isn't like it wasn't in the newspapers all the time that rates were lower than they'd been in decades.

And so you lose your home; it isn't the end of the world. You sign your house over to the bank and move somewhere cheaper (i.e., a rental). Sure, banks will be reluctant to lend to you again, but you've just proved you have poor judgement and are more likely to default.

Posted by: bob montgomery at Mar 26, 2007 5:07:26 PM

Ned @ 11:42 am -- That was really funny! Thanks for the laugh.

Posted by: jp at Mar 26, 2007 6:10:27 PM

So no matter what the Fed does, the poor are going to be affected by their decision. If interest rates rise the poor are the first to get laid off, if interest rates drop then the poor are going to borrow to much money. I would like to see the fed raise rates because I rather not see the banks engage in subprime lending, which has been proven to raise the banks account for bad loans. They make up the for the loan losses by coming up with new fees, which are rapidly becoming banks main source of income.

Posted by: Jessica at Mar 26, 2007 11:39:06 PM

Sucks to be poor. . .

Earlier today, attempting to boil down to a bite sized nugget what it is that made a person "Left" or "Right" it seemed to settle on one thinks a governing body has a right and a need to "assist" or interfere - depending on one's perspective - in the lives of individuals. Whereas the other side says, to varying degrees, mind your own business.

While the none of your business crowd may be derided as selfish, at least they're not screamingly arrogant. And besides, that kind of selfishness also gives rise to philanthropy, kinder religions and subsequent charities. (The bothersome religions are ran by the arrogant types.)

Posted by: Ray G at Mar 27, 2007 12:13:19 AM

Rich,

OK, let's frame the argument in those terms.

Would you consider 13-15% of mortgage payments to be, for want of a better word, 'normal'?

Posted by: Martin at Mar 27, 2007 1:37:30 AM

Almost all surveys in OECD countries show that the level of financial education among the public is quite low. On the other hand, households are confronted with increasingly broader and more demanding financial choices. One needs not to be a credit snob to think that there might be potential for suboptimal outcome here. Enhancing financial literacy should be a government priority.

Posted by: vic at Mar 27, 2007 8:22:34 AM

You can hardly blame the guy. So-called "Harvard Economist Robert Reich" (as he was incessantly touted in the Clinton years) is a lawyer, with no econ training that I know of. I'd be surprised if he could pass intermediate micro.

Posted by: ModalHubby at Mar 27, 2007 8:44:29 AM

Martin-

The subprime market is only a small part of the overall market (I think it was around 7%) so that 13% being behind in payment is approximately 1% of the total market. Given the consequences for subprime lenders who are poor underwriters - disappearance - I expect that the market will correct most of the mistakes that were made. The market is a great mass of experiments and ventures that are constantly being refined and corrected.

Let's not forget the other 87% of subprime borrowers (about 6% of the total market) who are not behind in payments and certainly benefited from the availability of credit. So much of the negative portrayal of the subprime situation is based on the supposed bad outcomes and ignored the other much larger and positive side of the ledger. But then, isn't that how most government regulation gets its start?

I bought my current house in 1986, near the peak of a housing boom in Northeast NJ. After 1986, prices actually declined for a few years and then began a slow increase into the late 1990s. Only in the last 5-6 years has appreciation quickened. I think the peak was hit in 2005-06. Based on other sales in my area, I suspect the potential sales price of my house is 10-15% below what it would have sold for at the peak. So what? I estimate that the appreciation rate of my house over the 20-year period is about 4-4.5% per year, through boom or bust. A little better than inflation.

Posted by: Rich Berger at Mar 27, 2007 8:46:45 AM

AT's Loan Shark's post not open to comments. The trolling hits a new low. I wish there was an option that allowed me to only view TC's posts.

Posted by: Mark at Mar 27, 2007 9:24:48 AM

My economic knowledge is pretty rudimentary, and I considered my string of posts here yesterday to be an infrequent lapse. I figured it was justified by my low posting history, and my plan to fade away again ....

But LOL Mark, with respect to "Loan Sharks," if those definitions make it to top-level, why not "bankruptcy pimp?"

Posted by: odograph at Mar 27, 2007 9:58:49 AM

There is a prediction implicit in this post. Please be clear about it, and blog about this prediction. Then, in two years, we will be able to evaluate that prediction.

Posted by: mickslam at Mar 27, 2007 10:01:28 AM

When I read Reich I hear voices. Actually, just a voice - his. And that's annoying.

Posted by: John B. Chilton at Mar 27, 2007 2:14:08 PM

Odograph, I'm in the same boat - long time lurker/(mostly) first time poster. I was hesitant to call AT's blogs 'trolls' until he cited 'Person 1 Dave 0', ignoring all the excellent and articulate posts by Dave. His 'whiplash' caused by his own misinterpretation that 'credit standards' are 'poor got loans at really low rates of interest' in this post and locking his Loan Shark post is just a new low. Next step is him adding Dave onto his evil "Credit Snobs" list. I'm an economist at a major Canadian bank and I guess everyone at the bank who decided that subprime lending was a terrible business and not to engage in it are "Credit Snobs". Asanine.

I guess I can't expect much more from a dude who fist pumps 'YEAAA' to Red Dawn.

Posted by: Mark at Mar 27, 2007 2:46:11 PM

So it sounds like Mr Reich would agree with Mr Rothbard that the Fed can only do harm and should be abolished ASAP. I didn't think converting him over to the Austrian bandwagon would have been nearly that easy.

Posted by: chanceH at Mar 27, 2007 4:28:35 PM

Rich,

That was an interesting and very pertinent comment. Thanks.

Hopefully inflation will stay down long enough to enable your house to appreciate more - we shall see. In the meantime, I sleep slightly better knowing I'm fixed rate.

There is an aspect of this argument which puzzles me, and which hasn't really been addresssed. That is the increased spread of the risk involved in greater subprime, or perhaps just greater, mortgage lending.

It would seem to be the case, to my uneconomically educated mind at least, that the creation of ever more novel lending vehicles combined with low interest rates, lax credit requirements and high liquidity has the effect of spreading, if not in fact socialising, mortgage risk away from the individual borrower towards greater numbers of borrowers.

When I took on my mortgage it was calculated on the basis of my ability to pay and my willingness to assume the obligation to pay it - politically, the most conservative of arrangements.

However, one cannot help but wonder just how much analysis of their existing loan books the banks did before setting out to increase their subprime exposure. Did they factor in that 70%/80%/90% of their lenders were rock solid, like you and me, and that those lenders would keep paying even when they had to increase rates to cover increased defaults?

If they did, and one would hope they did, reasonable interpretations of that state of affairs might be either that the banks involved had absolutely no regard for their relationships with their core customers, in which case they should be allowed to go under for no reason other than their greed; or that the lenders have forced the existing borrowers, more likely than not those on variable rate mortgages, to assume the liability for their reckless lending.

So while although Tabarrok's definition of 'credit snobbery' might exist in theory, bankers' mortgage lending habits make it an impossibility in practice; if only because the bankers' have helped turn their borrowers into members of two classes - bankrupts and bankruptcy pimps.

Posted by: Martin at Mar 28, 2007 2:42:42 AM

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