Fungible Convictions

There’s a lot to catch me off-guard in the last year . . .

For example, there’s the hilarity of Flight of the Concords, which I totally missed by not having HBO:

There’s cancer blah blah blah . . .

And there’s how much, it turns out, I like martinis, despite growing up around and enjoying cheap beer—both amongst my parents’ friends and especially at college, when we’d drive two hours out-of-state to get a few cases of Yuengling, still the cheapest greatest beer in America.

But, in a larger context, what’s really caught me off-guard is the idiocy of leaders who weren’t caught off-guard by the current financial crisis. In 2005, when my father and I started looking for a home loan to buy the condo Lindsay and I live in now, we knew we could game one company and immediately refinance. It was pretty easy.

Those same people are the ones now wallowing in the Freddie Mac and Fannie Mae crises, companies that owe or guarantee $5.2 trillion in mortgages.

A long-term virtue in both Lindsay’s and my family is the assumption that at some point things will go wrong. (In Catholicism this is called prudence.)

How is it that lenders could have been so imprudent? The reality is that individuals in these companies had little to lose, they didn’t enjoy the right the fail as they should have: as publicly traded companies, these people could enrich themselves, but even if the stock collapses, they have their salaries and the supposition that the government would step in at the first sign of systemic failure.

So, for example, as leaders they were encouraged to go after the boom in sub-prime mortgages. Nevermind that booms are followed by busts—but who cares when your salary is guaranteed? Moreover, who cares when your company is both publicly traded and implicitly (and now explicitly) backed up by taxpayers? As the Economist writes in this week’s lead, “the profits were privatised, but the risks were socialised.”

One could argue, as I would, that this is indicative of bad government. Good government overseers would have said, “You’re welcome to fit this niche in the mortgage market”—those marginal borrowers who may have been too risky for private companies—”so long as you keep long-term stability as your key goal.” Instead, leaders at Fannie and Freddie helped design a business model that took as its key assumption that house values would continue to rise (ignore the fact that southern California’s market is down more than 25%, and that takes it merely to 2004 levels). And why wouldn’t you take that as your key assumption if the potential reward enriched you but the potential failure wasn’t your problem?

The lesson for me is the libertarian one: governments cannot be trusted to do thorough oversight of an industry over which it doesn’t have 100% discretion, because industry will always find ways to relax that oversight, usually through successful lobbying.

The other libertarian lesson is that consumers must educate themselves. Diane McLeod is just one example of a consumer who didn’t think through her purchases and is now hundreds of thousands of dollars in debt.

I’m not someone free of debt myself. I have student loans from graduate school that my father pays, and he and I, along with Lindsay, pay the mortgage on my condo, roughly a third each. I don’t underestimate my good fortune.

Then again, I’ve always paid my credit card bill in full, every month, because I’m terrified of outstripping my means.

Anyway, beyond personal responsibility is corporate responsibility. . . .

My question for lenders is simply this, which honestly I don’t think they ever consider: What do you do when you succeed?

In other words, these adjustable rate mortgages and credit card rewards programs and derivatives—what in the world did you think would happen when they did what you’d hoped? The only way they have a return for you and your company is if people take on more debt than they can truly afford, and if millions of people are doing that, then hundreds of thousands, if not these same millions, are outstripping their means, are about to default. Meaning your company implodes dramatically or gets bailed out.

In the short term it must be great to rake in that dough. But when those schemes fail, as they inevitably must when they’re premised on lending to the financially weak, why is the public the one picking up the pieces?

While Freddie and Fannie need to be bailed out in this situation to avoid catastrophe, it’s another lesson in what should be an inalienable right to fail. In order for an economy to function at its best, companies that seek rewards should bear the brunt of its failures.