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Tyler Cowen: "Predatory Borrowing The Bigger Problem"

Original title:  Tyler Cowen, Apologist for Fraud?

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Over the years, I've noted the problems I've had with Economists in general seem to fall into one of three categories:

1) They are not particularly good at their jobs -- assuming their jobs require them to review economic data and determine what it means;

2) Economists, like academics, can be "reality challenged." This typically involves a skewed conception of reality, often so divergent from the real world experience as to make their conclusions erroneous and their methodology suspect;

3) The abuse of economic data for political purposes.

Today's example is via the Economic View column in the NYT. I usually find Tyler Cowen's work at Marginal Revolution interesting and thought provoking. However, his column today is perfect fodder for our example of a "reality challenged" economic discussion (#2, above).

Cowen puts forth an argument that while "there has been plenty of talk about predatory lending, predatory borrowing” may have been the bigger problem."

How utterly silly.

This places Cowen in the role of being an apologist for the lack of lending standard's worst excesses during the credit bubble. Even worse, it reveals his complete misunderstanding of what occurs in the real world of real estate agents, banking, mortgage brokers and predatory lending.

First the excerpt:

IT’S NOT JUST THE LENDERS

"As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default.

Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers. Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation of income and assets. As long as housing prices kept rising, it didn’t seem to matter."

Anyone who works in this area knows that the reality of the situation was far more blatant. To begin with, most people are naive when it comes to any financial product. They rely on the experience of the professional they are working with, even if this person is a SALESMAN or another party in an ADVERSARIAL NEGOTIATING ROLE.

I work with many builders and mortgage lenders; I take personal responsibility for a major builder selling much of his company's stock in 2005 (more than $100 million worth). The rest of the family hated me -- for about 6 months. I know how their company works, and I know what they and others in their field do in actuality.

During the hey day of the no-income verification, "No Doc" loans, the builders finance people, as well as other mortgage brokers walked people through the application process. Mr. Cowen writes that "Too often, mortgage originators and middlemen looked the other way." That's a rather generous read on it. The reality is that THEY TOLD PEOPLE WHAT INCOME TO WRITE. They used sentences such as "Put down $150k." OTHER TIMES THEY APPLICANTS LEAVE THE INCOME SPACE BLANK; The reps later conveniently filled in the data on the own.

To claim mortgage originators and middlemen only looked the other way is putting too fine a point on it. THEY WERE ACTIVE COLLABORATORS IN ANY FRAUD.   

Oh, and, don't take my word for it -- find some people from the industry and ask them yourselves. This is a very well known fact amongst real estate agents, mortgage brokers, and builders.

If you thought the reality challenged Mr. Cowen was merely repeating the data of an industry shill, that's just the first half of it. Consider the next paragraph:

"In other words, many of the people now losing their homes committed fraud. And when a mortgage goes into default in its first year, the chance is high that there was fraud in the initial application, especially because unemployment in general has been low during the last two years."

I have noted that of the 3 million new homeowners the credit bubble created, I expect half to two thirds  to ultimately return to their prior status as renters. That's what happens when you buy a property you cannot afford. And, i don't think the government should bail these people out. However, I find it utterly contemptible to accuse these people of fraud.

Mr. Cowen should be ashamed of himself . . .

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UPDATE2 : January 14, 2008 5:22pm

To clarify one point, I specified a laundry list of who was responsible for the lending mess back in August of last year. The borrowers are near the top of list. The responsibility was widespread, with plenty of blame to spare:

• Federal Reserve (FOMC)
• Borrowers
• Mortgage brokers
• Appraisers
• Federal Government
• Fannie Mae
• Lending banks
• Wall Street firms
• CDO Managers
• Credit agencies
• Hedge funds
• Institutional Investors (pensions, insurance firms, banks, etc.)
• And back to regulatory role of the Federal Reserve

But borrowers as predatory? Give me a break.

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UPDATE: January 14, 2008 1:35pm

Professor Cowen adds the following comment:

I thank Barry for his kind words in the post but I think his criticism is a simple misunderstanding. I think the lenders are greatly at fault, as does anyone else with a fair mind. Pointing out additional faults elsewhere doesn't (and should not be understand as) subtracting from those faults. More generally, the point of my column was to point out some new information about a bunch of different economic issues, not to provide a comprehensive survey of who was at fault in the mortgage crisis. I didn't even mention the regulators but clearly they are at fault too and of course you could lengthen the list of people at fault. I think the title of this post is misleading and I would like to ask Barry to reconsider it.

--Posted by: Tyler Cowen | Jan 14, 2008 1:20:34 PM

I think I have been mostly offended by the following line:  "there has been plenty of talk about predatory lending, predatory borrowing” may have been the bigger problem."

Either its a false but cute attempt to be clever, or, quite possibly, a case of shifting the blame from the lenders to the borrowers. Regardless, that line is misleading in extremis.

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Source:
So We Thought. But Then Again . . .
TYLER COWEN
NYT, January 13, 2008
http://www.nytimes.com/2008/01/13/business/13view.html

Sunday, January 13, 2008 | 12:54 PM | Permalink | Comments (68) | TrackBack (1)
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Comments

Both the predatory lending and borrowing arguments are valid. All parties are to blame. These borrowers understood the concept (and consequences) of an ARM especially the bait of no docs. It's all about an absence of ethics. Everybody was wearing their Gordon Gecko suspenders.

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BR: I think you are misunderstanding the concept of what "Predatory" is -- where one party with superior knowledge, resources, experience, expertise etc. uses them to take advantage of the other party.

When a borrower does what he's told by the representative of the lender, that is not at all "predatory." Its totally disengenous to compare the two.

That's the idiocy of the article -- putting what the borrower did -- at the lender's request! -- on the same plane as true predatory lending.

Quite bluntly, its a rather despicable analogy. My opinion of Cowen went down dramatically today.

Posted by: Ellis | Jan 13, 2008 1:28:28 PM

Barry:

I fail to see why you are hot and bothered by the quoted text. In my reading of it, the author is naming both parties as co-conspirators. I think that's a totally fair charge. I agree with you that in the transaction buying a home the paperwork is easy to get lost in and I don't fault people for not understanding every clause in the boilerplate (nor do I claim to understand it absolutely). But be realistic, if there is one thing a borrower absolutely must be responsible for it is the personal information they provide to get the loan!

If you are in a store and there is a $5,000 watch on the counter and the store owner says "Psst! Go ahead and take it! Its hot a I just want the insurance money!" are you going to bolt with the watch? HELL NO! Why not? Because you know it's wrong! The store owner being in on it doesn't let you off the hook.

There is plenty of blame to go around in this mess, but I see no reason to shy away from accurate, if unkind labels of the parties involved. If a person doesn't have the intestinal fortitude to be honest on an application then god help/damn them.

Posted by: Mike G. | Jan 13, 2008 1:36:40 PM

Mr. Cowen should be ashamed of himself . . .

He won't be. Most of his output is of similar quality, if not so blatantly hacktacular.

Posted by: F. Frederson | Jan 13, 2008 1:39:04 PM

Barry,

Don't you think the title of this blog entry is a bit harsh?

Yes, we know the brokers and the bankers were active participants in the fraud. And of course, we know the general public isn't as informed about financial matters as they should be. But the question is--WHY?

It is because the govt. promises to "protect" the consumer, that they have lost the incentive to effectively protect themselves. Why should they, if their good old Uncle Sam or the courts promises to bail them out when they do something stupid?

The reality: all of these interventions to "protect" people ultimately end up in creating greedy, gullible people--those most easily taken advantage of. Crooks in mortgage finance couldn't ask for better marks--I mean people.

If these "poor" consumers were half as skeptical of mortgage lenders as they were of car salesmen, this situation would never have gotten to the point it had.

If a person signs a tax return prepared by the professional, and the IRS finds that the professional had done something illegal, it is still the taxpayer who is responsible. The same principle applies here.

Of course, if the Fed hadn't driven interest rates to historic lows, and the govt. got out of the silly business of making homes "affordable", or encouraging those not cut out for home ownership into buying, this mispricing of risk, and the glut of housing inventory would not likely have happened.

Of course, this mortgage mess is supposed to be a "market failure" right? It reeks of govt. failure to me.

Posted by: Double R | Jan 13, 2008 1:41:22 PM

If income is overstated both parties committed fraud. Blame should also go to the lenders who gave money to people that could not afford to repay without verifying income.

Posted by: Jon W | Jan 13, 2008 1:58:51 PM

Both sides were at fault, and both should be held accountable for this mess. If you treat people like innocent and clueless lemmings, then lemmings you are sure to get.

Posted by: Mike D | Jan 13, 2008 2:19:49 PM

Your comments below address the issue, but I believe you are still understating the complete asymmetry of understanding that occurs when ordinary people finance homes. To most families a buying home is an emotional experience as much as a financial one.

"Anyone who works in this area knows that the reality of the situation was far more blatant. To begin with, most people are naive when it comes to any financial product. They rely on the experience of the professional they are working with, even if this person is a SALESMAN or another party in an ADVERSARIAL NEGOTIATING ROLE."

To show just how ridiculous the lenders are behaving, people should read this article from the NYT (Banks Plead They Can't Follow Rules):

http://www.nytimes.com/2008/01/11/business/11norris.html

Rules in society enable people to function knowing that standards apply. This works for all fields except the money men. If everyone else can follow rules in their lives, can someone tell me why these lenders don't deserve hard time - not country-club prisons?

Posted by: Ed Miller | Jan 13, 2008 2:28:39 PM

I don't see anything in Barry's quotes that was making any excuse at all for the lenders. They were co-conspirators, plain and simple.

As another example of the dirty side of that business, I know someone who was having a $900K house built by one of the major builders. When it came time to get the loan the builder said "We have someone we prefer. You can use anyone you want, but you must get a quote from our preferred lender". Well, he'd already lined up his loan and was happy with it. He got the other quote which wasn't nearly as good, but the process cost him about $400! What a scam.

Posted by: Mike G. | Jan 13, 2008 2:44:15 PM

As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; (emphasis mine)

So a company that works for banks and lenders says provided this analysis, eh? That alone knocks the results a few bars higher on my skepticism scale. This is especially true if the study mostly blames borrowers for the fraud. That would make my skepticism meter will shoot through the roof!

Posted by: Josh | Jan 13, 2008 2:54:18 PM

I appreciate Barry's view, to a point. However, I live in the Sunshine State and will disagree. Financial ignorance does not entitle one to a pass- if you sign a legal document, you should know WTF it states. If you don't, a mortgage/real estate broker should not be relied on in lieu of an attorney. A majority of those being served with notices of foreclosure knew what they were signing. They expected to flip it for a quck buck. How else can one explain the dramatic increase in first payment defaults since Q4 '05? As well, the FBI (as well as the FL Dept. of Law Enforcement) have well publicized increases in staff to deal with the rampant levels of mortgage fraud. One final note, the level of speculator homes that have been "homesteaded", constitutes fraud on its own merit. Besides stating that this is a primary residence (nod nod, wink wink) on a mortgage app, here in FL there is a separate filing stating the same with the county. Are we to believe that brokers conned the owners into following up with the county, as well?

Posted by: AJF | Jan 13, 2008 2:59:21 PM

The average Joe knows next to nothing about finance (which, admittedly, is a problem - but not one that's likely to be fixed any time soon). The average banker knows much, much more (or at least should know more than the average Joe). When they come to a mutual agreement, the bias for blame should automatically shift towards the bankers, since the bankers, as a group, would have consistently been in an advantageous position of better knowledge than the Joes. Of course, part of the blame falls on the Joes, but I don't think they should share it equally with the lenders. In a perfect world, they would - But we obviously don't have that. Yet. LOL.

Posted by: Robert | Jan 13, 2008 3:02:54 PM

There was this huge pile of money on the floor that didn't belong to anyone. It was left by the Fed. EVERYONE tripped over each other jumping on the pile. Everyone got a little of the money but some were bruised, bleeding and had broken arms.

At least that's how I explain it to my 4 year old grand daughter.

Posted by: Ross | Jan 13, 2008 3:02:57 PM

During the madness I had occasions to review a few loan documents for friends. These were the normal, for the times, loans that had low teaser rates. I found two things appalling.

Number 1: I don't remember even the term 'negative amortization' being used. People were not told explicitly that the difference between what they were going to pay over the next five years and what a 'normal' mortgage would have been was going to be added to their borrowing and was not a deal for them.

Number 2: They were led to believe that when the teaser term was up that the previous five years or so of low rates (which were artificially low due to the FRB not wanting the dot com bubble to turn into a Depression) would be about they would then have to pay.

Borrowers were massively deceived by the lenders.

Posted by: Norman | Jan 13, 2008 3:40:58 PM

Predatory borrowing? Hmmm. Ask those people who spend their Christmas without a home or in fear of losing their home if their actions were predatory. While he writes in the cozy den of his nice house.....

Without reading his article, I could imagine he meant euphoric borrowers and developers who took advantage of banker's stupidity but it is a banker's responsibility to protect the assets of those who entrusted them with their deposits....Not the borrower. If someone gives me a free lunch, I'm going to take it. And, so would everyone else.

Posted by: BDG123 | Jan 13, 2008 3:42:16 PM

From where I sit in Newport Beach, CA, the editorial has it spot on. Looking through foreclosures, it's amazing how 2 or 3 foreclosures have the same last name. From watching both the local market here, plus the market in Scottsdale, AZ, together with having some clients that are 'in the biz' there were more borrowers looking to benefit from the game than there were lenders getting taken advantage of. I can't tell you how many times I've heard a story on the radio about predatory lending, only to have the 'victim' say something like 'they already took 2 of my homes away'....2 of my homes? Nope, sorry Barry, from where I sit there was more predatory borrowing than lending.

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BR: No doubt, plenty of multi-property speculators ended up in foreclosure. But what does that have to do with the idiotic industry concept of predatory borrowing?

Do you really believe that in 70% of the loans, the poor ignorant banks were "taken advantage of" by these predatory borrowers?

Posted by: tim | Jan 13, 2008 3:47:21 PM

[quote]
If someone gives me a free lunch, I'm going to take it. And, so would everyone else.
BDG123
[end quote]

Then you sir/madam, would be one of the unfortunate people finding out that the old adage is true: There is no such thing as a "free" lunch!

Or how about "If it looks too good to be true, it probably is"?

I don't see anyone saying that the forms etc. are not complex and the brokers don't really know it all much better than the hapless borrower, all that is true. But good God man, the borrower has to be held accountable for supplying fraudulent information!!! There was no complexity there. Either you make $150K/year or you don't! Or is it one of those "it depends on them meaning of 'income' is" things?

Posted by: Mike G. | Jan 13, 2008 4:00:44 PM

Um, it is not "fraud" if the agent of the lender fills in your income. It is not "fraud" if the agent of the lender tells you what to fill in. Even if it is a "lie" it is not "fraud." Nor are you "co-conspirators" The mortgage broker is the agent of the lender (as I understand the process). The lender is deceiving itself (in effect) which is precisely what happened.

But actually what was occurring is that the lender wanted to pass off the trash to someone up the line. Therefore it did not really care abut the "lie" because it was really lying to the people to whom it sold the bonds

All you "personal/moral responsibility" folks just want to blame individuals and refuse to see just how screwed up the system was. A system which was completely and totally encouraged by the people who were supposed to be regulating this stuff. Heck, they were touting this as "innovation" like investment bankers were on par with people who actually do "discover" useful things. Nothing new, just the same old games with a different name. That is the sad thing.

I am not saying that any of these people should be bailed out either. But when are all those investment bankers going to start giving back all of their bonuses? Ha!!! Never gonna happen.even if every one of those IB's goes bankrupt. They get to keep all their loot. But let's pile on the poor schlubs who did nothing but try to own a house because every single leader in this country from the president on down said that we were an "ownership society" and told everyone that things would be great in this wonderful country.

Posted by: GeorgeNYC | Jan 13, 2008 4:26:43 PM

The apologetic tone concerning the mortgage industry espoused by some of the posters truly staggers me - but I guess it is difficult to admit systemic flaws when you sincerely believe in that system and the leaderership that approved the system.

Pointing fingers of blame does no useful duty unless it is to obfuscate truth - however, uncovering flaws is a useful venture if previous flaws are not to be repeated.

Regardless of whether mortgage writers lied or borrowers lied or some combination of both, the bottom line is that none of this would have occured had the originating lenders been required to hold the risk of their loans.

This was systemic flaw exacerbated by rising asset values, with plenty of blame to spread - from the Greenspan Fed holding interest too low for too long and encouraging securitization and exotic loan types, to lenders more interested in speed of loan turnover than quality of loan, to borrowers who believed the hype that housing values would forever rise.

Regardless of who gets the most blame, the bottom line is that the absence of r-i-s-k to the loan originator was at the monster's heart.

The real fraud was systemic self-fraud that by slicing and dicing poor risk one could magically transform that risk into acceptible risk - kind of like saying that if you spread the e-coli colony mixed with peanut butter across enough pieces of bread that everyone might get a little sick but at least no one would die.

What the system forgot was that without being required to participate in the risk, the originators of loans had no reason to add any peanut butter at all - so instead of a slightly tainted slices of bread, they passed out toxin-loaded bread - after all, it was not the q-u-a-l-i-t-y of the sandwiches that created their fees but the q-u-a-n-t-i-t-y of sandwiches they shipped out.

It was this no-lender-risk, FICO-score-led, speed-of-turnover=fees environment that allowed the fiasco to occur.

For those who claim the borrower is at fault, it would be interesting to put them in a time machine and send them back to 1960 and let them try to buy a house - it is amazing how much hodling onto the risk of loss affects lender's attitudes.

Posted by: Winston Munn | Jan 13, 2008 4:45:38 PM

Really? I'm not in mensa, but when I think about someone knowingly signing a piece of paper that intentionally mis-states their income, I'm thinking it maps pretty well to this. You may feel otherwise. You may feel Elvis is alive and well!

I don't see the blame as an either/or thing. I don't see all us "personal/moral responsibility folks" saying let the business side off the hook. Where do you see that here?

I'd be more sympathetic if the argument was "the papers are complex and they had no idea they were providing false information" but even allowing that some might have signed blank forms, they have to be the minority, and that still doesn't let them off the hook.

Hey, what do I know. I'm just this, I guess. :) (I do love the song - well, except the end part - and am shocked that Barry has never highlighted it!)

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BR: I have been told that this was a typical discussion:

Borrower: What is a no income check loan?
Lender: Your income doesn't matter.
B: What shall I put down for income?
L: It doesn't make a difference.
B: I'll leave it blank
L: Put down $150k -- just to be safe.
B: OK

Posted by: Mike G. | Jan 13, 2008 4:54:30 PM

How hard is it to verify income? Cash flow says either the money is there or it isn't.

Next excuse: the butler did it.

Posted by: FT Woods | Jan 13, 2008 5:24:25 PM

I am humbled.
I had no idea.

It is now clear, though, that 3 million sharp-dressing slick-haired Hillary-loving Bush bashing silvery-tongued shyster-type taxi drivers took advantage of the aw shucks innocence of the poor, uneducated, trusting, honest, and hard-working bankers in a savage and purposefully coordinated fraud in order to ruin forever the enjoyment of watching Jimmy Stewart in It's a Wonderful Life.

Bastards!

Posted by: Winston Munn | Jan 13, 2008 5:45:55 PM

I see it this way. The three million renters who became homeowners never really had the mentality of homeowners. I see them every day in my office. The never had a plan to be able to pay the fully ammortized, fully adjusted mortgage. They just thought about how to pay the entry rate teaser mortgage.

They come to my office and say "what do I do now?" It is clear to me, the never thought deep into this mortgage and they were treating their payments like rent.

And that's what is was--just rent.

No one should be surprised by the result.

Posted by: k2613 | Jan 13, 2008 5:52:11 PM

The bad business practices flow rather naturally out of the easy money provided by the Fed & foreign central banks. When central banks make money incredibly cheap & you are in the mortgage business, you are strongly motivated to lend money.

Posted by: algernon | Jan 13, 2008 6:06:16 PM

Not exactly on topic, but worth the time:

http://www.washingtonpost.com/wp-dyn/content/article/2007/12/04/AR2007120402186_pf.html

Posted by: Winston Munn | Jan 13, 2008 6:12:23 PM

Winston:

I can't fathom why there is this cry that anyone in this thread is trying to let the lenders off the hook. There has been NO such call! NONE! Barry's initial post strongly hinted that the rube buyer was led down the primrose path to foreclosure by evil lenders and the quoted author was nuts for having the audacity to lay at least partial blame on the lender.

You are right in that the problem is systemic, but it didn't have to be. Collateralizing the mortgages and getting it off the books of the lender so they could lend again is a pretty good idea, IF you can accurately gauge the risk of the collateralized debt. For my money, the real failure that made it all come down were the ratings agencies. Because of their cock-up, the CDO buyers had NFI what they were buying, and the CDO themselves were too complex a beast for them to check evidently (so much for "know what you are buying"!)

But assuming that some way could have been found to accurately measure the risk so the price could be fairly set, it is kind of ingenious. You can't blame people for thinking that spreading the risk (whatever it was) around the world in a multi-trillion dollar global economy as a good thing either. Unfortunately the leverage used to buy the CDOs tended to muck that good idea up as well.

Posted by: Mike G. | Jan 13, 2008 6:34:43 PM

December 2008

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