“The price of apathy towards public affairs is to be ruled by evil men.” Plato

  • Daily Quote:

    "Intolerance is itself a form of violence and an obstacle to the growth of a true democratic spirit."

    Mahatma Gandh

  • Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 90 other followers

  • Subscribe

  • Advertisements

Archive for the ‘Moral Hazard’ Category

It’s Back: Risky Loans Again Growing

Posted by Steve Markowitz on July 18, 2010

It hasn’t been two years since the financial meltdown that included the Lehman Brothers’ failure and risky loans are already coming back.

It is generally agreed that the worse financial disaster since the Great Depression was caused by greed and imprudent investments, especially those related to debt financing.  Perhaps the biggest example is Wall Street’s use of collateralization to sliced and dice bad mortgages and then selling them to investors as quality investments.  This led to an overheating of the housing market, then the popping of the housing bubble, and finally the sup-prime mortgage catastrophe.  The rest is history.  The world’s financial system was in danger of a systemic breakdown, which caused governments to bail out banks and other intuitions.

While we will never know if the bailouts actually saved us from Armageddon, we do know that they saved many banks and investors from imprudent behavior.  This reality has consequences, such as damaging the “moral hazard”.  Banks and investors learned that if they bet big enough so as their failure has huge consequences to society, governments will come to their rescue.

Not surprisingly, banks are now going back to similar risky behavior that caused the original meltdown.  The Wall Street Journal has reported the following examples:

  • A 66-year-old retired phone-company worker in Brooklyn, NY is $33,000 in debt, earns $2,414 a month and filed for bankruptcy in June.  Shortly before the filing, she received an offer from Capital One for a credit card even though they sued her in 2006 to recover $4,470 she owed them on a different card.  The Capital One offer told the retiree: “At some point we lost you as a customer and we’d like to have you back.”
  • An Illinois couple received six credit card offers since emerging from bankruptcy in June even though they still $73,000 in student loans.
  • Credit-card issuers offered 84.8 million cards to subprime borrowers in the first half of 2010, almost double last year’s rate.
  • 8% of new car loans in the latest quarter were to borrowers with the lowest credit scores, up from 6.2% in the previous year.
  • AmeriCredit, a Subprime auto lender, informed investors that loan originations could be $900 million in the fourth quarter, over four-times the previous year’s volume.
  • Fannie Mae, perhaps the largest villain in the subprime mortgage meltdown, is also back at it.  Fannie was seized by the U.S. government in 2008 to avert failure.  Fannie launched an initiative in January that allows some first-time home buyers to get a mortgage with as little as $1,000 down.

While it is too early to determine if increased loan activities to those with questionable credit worthiness will lead to another meltdown, it doesn’t feel right.  The government intervened in markets and saved investors who made poor decisions from paying the bill.  Now those same people are back with similar behavior.  It doesn’t take a PhD in economics to know this is not good.

An appropriate closing paragraph to this posting is Fannie Mae’s response to questions about their $1,000 down mortgage offering.  There justification for these mortgages is that Fannie faces limited risk because these mortgages then go through state agencies that have solid histories.  This justification sounds suspiciously similar to the pitch that Wall Street gave for the collateralized mortgages that were then highly rated by bond rating agencies.


Posted in Bailouts, Fannie Mae, Moral Hazard | Tagged: , , , , , , , , , , , , , | Leave a Comment »