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The Credit Snobs
I rather like the title "voodoo priest of free market economics" so I am happy to take the blame for the sub-prime mortgage defaults and at the same time stick a few pins in Nouriel Roubini.
Roubini and others generating hysteria about defaults in the mortgage market are credit snobs - they think credit is something that only the rich can handle. Just look at the language that Roubini uses to analogize borrowers - they are "reckless patients" who "spent the last few years on a diet of booze, drugs and artery clogging junk food." Similarly, the Washington Post tells us that it's the end of the "borrowing binge."
Yeah, we get it. Credit is ok for us, the "sober" borrowers but poor people can't handle credit. Too much credit among the poor generates decay and social pathology. Credit must be regulated. We can't, for example, have credit stores in poor neighborhoods. Don't you know that credit is bad for people without self-discipline? Let the poor buy on installment credit? That's unconscionable. Today's furor over sub-prime mortgages is the same old story.
Basic economics says that people should borrow so that they can consume based upon their permanent income. Modern day financial markets are finally making this possibility a reality. Combine financial innovation, strong US economic performance and a global savings glut and it makes sense that credit should become easier to obtain. We see the benefits of financial innovation in bringing credit to the poor not just in the United States but around the world. Will Roubini next be calling for the retraction of Muhammad Yunus's Nobel Prize?
The fact that there are defaults is partly a learning process in response to financial innovation, and thus evolution, but also partly a simple matter of risk. Defaults are to be expected. I see no reason to expect contagion. All lending statistics must now be marked to the global financial market which means that diversification is now more extensive than ever before and thus net risk is lower. Moreover, the whole point of recent financial innovation (and reformed bankruptcy law) has been to reallocate risk way from borrowers and towards those lenders in the world wide market for capital who are in the best position to handle the risk.
The democratization of credit worries the credit snobs. The credit snobs fear that capitalism isn't just for the rich.
Posted by Alex Tabarrok on March 21, 2007 at 07:21 AM in Economics | Permalink
Comments
Excellent post!
It does appear that the left wing of modern politics who the most prescriptive. The mummy knows best nanny state.
Posted by: Stuart at Mar 21, 2007 7:38:57 AM
Is it not odd that those who favor legislation limiting the ability of the poor to borrow, on the ground that poor people are too dumb to figure out what's best for them, never advocate property qualifications for voting?
Posted by: Alan Gunn at Mar 21, 2007 7:39:27 AM
Egg-cellent post. Except you forgot to mention that you are also "toxic waste."
Posted by: Tyler Cowen at Mar 21, 2007 7:43:07 AM
It's a lot worse than being a credit snob and absurdly blaming the sub-prime mortgage lenders, who are just responding to market signals, distorted though they are.
And who's the Big Distorter, who goes unmentioned by Roubini? That would be Easy Al Greenspan, just named Stocks, Futures and Options magaine's "2007 American Hero." Easy Al's two-step monetary binges of the second half of 1999 (to head of the pseudo-Y2K problem), and post-9/11 should get him a long jail stretch at the very least.
Posted by: Bill Stepp at Mar 21, 2007 7:48:00 AM
What a strange post... I suppose I am a credit snob. I disagree with the idea of pink slip loans and paycheck loans because I've seen how they devastate a community and hurt the very people we pro-free market people are trying to help--those with the goals and means to pull themselves up the ses ladder. Would sub-prime have been as big a problem if the marketing of such loans hadn't been as facile, rooted in floating interest loans, etc?
Surely you're smart enough to see that people see the (pre-crash) effects of easy credit and leap to the conclusion that the way to prevent the effects is to remove the cause. Why on earth would you resort to ad hominem instead of using your usual analytic and normative talents?
Posted by: tsoodonym at Mar 21, 2007 8:23:13 AM
"I've seen how they devastate a community and hurt the very people we pro-free market people are trying to help--those with the goals and means to pull themselves up the ses ladder."
They have the goals and the means, but apparently not the financial acumen? Wouldn't this be like any other "protect them from themselves" situation where education, not legislation, is the answer? The sad fact is that our public schools and colleges are failing miserably at financial education, and this is simply just one more symptom of that failing.
Posted by: Brian at Mar 21, 2007 8:45:30 AM
It's easy to caricature this sort of thing, but it's not really particularly helpful. I think the following are both relatively uncontentious:
(1) There is some subset of the poor whose situation is in part caused/perpetuated by poor decision-making, including poor credit decisions.
(2) Poverty tends to make the consequences of poor decision-making more difficult to deal with. Rich people make bad decisions too; it's just that the consequences aren't necessarily as bad.
The issue is whether the costs of tying to solve these problems (including possibly making credit more difficult to come by for those who will make good decisions - although regulation need not entail that) are worth bearing. Calling people credit snobs doesn't seem to me to advance that debate much.
Posted by: conchis at Mar 21, 2007 8:56:02 AM
The critical question for me is how much pain the subprime loans really cause their borrowers. Yes, some people will end up homeless and with their savings wiped out, and their suffering will be severe. But many people will end up in rental housing (i.e. where they would have been all along if subprime lending was not available), and not all will lose their houses. And many people with ARMS and low initial rates are significantly better off than they would be if they had chosen traditional fixed-rate loans, especially young families who intended from the beginning to move when their 5 year locked rate expired.
Posted by: DK at Mar 21, 2007 8:57:22 AM
If poor people aren't worse at making financial decisions, then why are they poor?
Posted by: Anderson at Mar 21, 2007 9:11:02 AM
I'd second conchis' comment. One part of the cause of many people being in poverty is bad decisionmaking, which is presumably driven by a combination of not having been taught how to manage finances by their parents or the schools, low IQ, little education, low literacy, few obvious examples in their lives of good money management, etc.
It's also possible that poor people serviced by microcredit in very poor countries are drawn from a pretty different population in terms of abilities than poor people in first-world countries. All you need is an assumption that the better/freer your economy, the larger fraction of poor people are poor partly because of bad decisionmaking. Then, you might expect making credit available to the very poor to have a radically different result in Bangladesh than in East St. Louis.
Posted by: albatross at Mar 21, 2007 9:22:23 AM
Alex needs to post more.
Posted by: eddie at Mar 21, 2007 9:57:32 AM
Roubini may sound increasingly shrill, but he's not talking about individuals in the text you quote. There's plenty there to criticize without being inflammatory.
Posted by: tucker at Mar 21, 2007 9:59:10 AM
AT's post, caricatured though it may be, matches my experience. Before, people were like,
"OMG! Why won't you lend to the poor? You jerks! Don't you understand that they need access
to credit in order to advance? Here, let's throw up a bunch of regulations so that you have
to rigorously document why you denied someone a loan."
Now that lenders did that, it has become:
"You idiots! What were you thinking? Don't you understand these people can't pay you back?"
Posted by: Person at Mar 21, 2007 10:02:09 AM
I think Alex is misidentifying Roubini's outrage. See, he's not angry at poor borrowers. That wouldn't be liberal. No, he's angry at middle-class and wealthy borrowers who borrow too much. They're a much more appropriate target for self-righteous leftist scorn: "yuppie", "consumerist", "entitled", "privileged". Don't forget "soccer mom", "SUV-driving planet haters", and, of course, "mom" and "dad". The idea that these people are selfishly destroying the global economy by borrowing too much and then defaulting is very attractive to people like Roubini. Of course, the people that are lending to them are simply conspirators in this orgy of economic ruin. Presumably everyone should have known that offering and accepting these kinds of loans would lead to default, so presumably now that they have we can lay the blame squarely on those who lent and borrowed, making them morally responsible for the horrible consequences, namely... um.... something.
You see, the poor are victims here, not the guilty parties. Because the uppity middle class arrogantly borrowed as much as they wanted to from people who were willing to lend it to them, the lower class was hoodwinked into doing the same thing. And now they're having to pay the price for middle-class wrongdoing. Namely they're going to have to move out of houses that they can't afford, after having lived in them for several years paying less in interest payments than they would have spent on rent.
Posted by: eddie at Mar 21, 2007 10:17:31 AM
Alex,
I'm afraid there's a whopping fallacy in your argument at least a mile wide and just as deep.
You cite the example of Mohammed Yunus, yet you fail (perhaps egregiously, perhaps not) to cite the critical difference between the microfinance his bank provides and tens of millions in dud mortgages written by Joe's Loans For Bums, Inc.
The Gramman Bank demands collateral.
Not financial collateral, for sure - but social collateral. If Gramman borrowers don't repay their loans, Yunus tells their neighbours and friends. It's a pretty good way of keeping the loan book healthy.
Does that make Yunus a 'credit snob'? Maybe yes, maybe no - but it means his bank specialising in $25 loans holds more true to basic banking principles than any number of bum outfits selling 'new' and /or 'creative' products.
Maybe he should be appointed to the Fed. Or the SEC.
Or George Mason University.
Incidentally, radicals like you always, always put the cart before the horse. If credit is easy, what incentive is there to save? And thus to work?
I mean, I'm no economist, but is that point so simple it doesn't need to be said?
Posted by: Martin at Mar 21, 2007 10:18:58 AM
I think there are two things going on here.
The first is the one "Person" hit on with the outrage of not lending to "poor" people. I put poor into quotes because its not necessiarly "poor" but "poor credit" worthy individuals. Individuals like Roubini don't want change, they want more regulation, they want to take money from business and give it away. They probably are credit snobs from the standpoint that that they want to make the "rich" pay and just give the truly poor the money.
The second point is that it the subprime market is a combination of government intervention into the market. The Fed being the most problematic with its Easy money policies of the early 21st century (sorry just had to do it) and the government backing of FreddieMac and the sub prime market. From a business stand point, why should I give a rat's rearend if I can loan to Joe down the street at 130% of LTV and then turn to sell it to the government entity that doesn't have a problem accepting risk.
For Roubini-if the government did it wrong its not because it did it wrong, but because the market "failed". If only the market had done what it was "suppose" to do!?!? When in fact the market failure is exactly the right thing for the market to do. It reigned in the malinvestment created by the easy money policy and government supported sub prime market.
Posted by: Matt C. at Mar 21, 2007 10:25:49 AM
At least some thought should be aimed at the public costs of this fallout, which, I suspect, are really behind the current push for so-called 'predatory lending' regulations. There are three kinds of neighborhoods in our cities. Uniformly rich, Uniformly poor, and Mixed Middle-Class. As those who have borrowed heavily from sub-prime lenders (ARMS, with no money down, etc.) to move into the Mixed Middle Class from their poor neighborhood default, a flood of houses in these neighborhoods pushes down the value of every other house in them. Also, there is always a welfare cost to government when these things happen, and more people apply for state assistance. Most state and federal government budgets are pretty thin, and not really ready to handle a flood of people into bankruptcy and welfare programs. I agree with Tyler, and am myself, a credit snob. However, the evolution of society towards a more enlightened credit-consuming state is not going to be easy.
Posted by: Darin London at Mar 21, 2007 10:28:50 AM
That brief of the Walker-Thomas case wasn't very good. The unconscionable term in the contract in that case was the cross-default with all of the other merchandise that the person had bought from the store. The remedy would be to strike the cross-default, not to declare the entire contract unconscionable. Any decent discussion would have brought that out...
Posted by: John Jenkins at Mar 21, 2007 10:43:10 AM
eddie No, he's angry at middle-class and wealthy borrowers who borrow too much.
That sums it up. From the screech:
First, distinguish between true victims of predatory lending and deadbeat borrowers who were into early strategic default.
That is one angry dude.
What really annoys me is the world that Roubini's setting up: lenders have to worry how they are going to be judged for a making or not making a loan based on emotions disguised as economic science (is borrowing allowed for a house at 2.2 or 3.8 times income this year?) and borrowers can pray that Roubini gifts them with absolving their economic sins if he feels like it.
Posted by: BlogReader at Mar 21, 2007 10:47:48 AM
Alex, I think you most definitely get to the implications of the people who originate and perpetuate this meme, but to the run of the mill liberal on the street, this subprime mortgage thing is a condemnation of irrational actors in the free market... An example of why heavy regulation of (name your activity) would be better than a free market. I will have to try this line of argument with some liberal friends and see how it rings!
Posted by: Brad Hutchings at Mar 21, 2007 10:49:30 AM
General statements and arguments about motivation seem beside the point when looking at upcoming ARM resets or the rate of foreclosures.
ARM resets:
http://www.autodogmatic.com/forum/viewtopic.php?p=1226#1226
Foreclosures 2006Q4 look to be at the historical average rate of 1%, but have been increasing quickly since 2005Q1.
Posted by: lw at Mar 21, 2007 11:00:25 AM
"Basic economics says that people should borrow so that they can consume based upon their permanent income."
I'm not sure what permament income is? People lose jobs, people anticipate higher future income, others have a much more variable estimation of income (bonuses). Does 'easy credit' include people who lie about income and mortgage brokers who fail to check it? This isn't the black and white situation Alex makes it out to be.
Markets are interconnected and large enough market failures in one area spillover into other well-managed financial sectors. There is a real role for government regulation and intervention here. Countrywide's terrible oversight policies are going to affect more than just Countrywide.
Posted by: Mark at Mar 21, 2007 11:42:31 AM
Roubini is making a subjective judgement rather than an objective one, even if he is correct in assessing the economic situation. The Fed created an easy money scenario, and the Federal government through tax policy and Bush's subsidies for first time home buyers (remember he made it a point to boost home ownership) virtually guaranteed the home bubble. Instead of staying objective, however, Roubini complains about the idiotic people who used MEW to buy snowmobiles, flat-screen TVs, and trips to Disneyworld. To that I say, maybe he is the idiot for not borrowing at a real rate of around 1.5-2.5%. If there is a credit crunch, and mortagage rates are up around 7-8% and CDs are yielding 6-7%, who is the idiot: the guy who didn't borrow "recklessly", or the guy who is paying off a 5% mortgage?
Posted by: Another Matt C at Mar 21, 2007 11:44:50 AM
Congress needs to institute a regulatory requirement for brain size measurements as a precursor to accessing credit ;-)
Posted by: brianS at Mar 21, 2007 11:46:57 AM
Good post. And yet, even while the left wants credit regulated, they would claim that people are poor because of external oppressions (racism, underfunded schools) and not their behavior.
Posted by: Justin at Mar 21, 2007 12:22:11 PM
