Apportioning blame for the housing bubble has become a polarized political issue. The Left wants to portray the evil banks as taking advantage of hapless borrowers thus entitling these borrowers mortgage relief or absolution for strategic default. The Right points out the responsibility borrowers have for their own behavior and wants to bail out the banks for completely self-serving reasons. As with most political issues, the polarized and generally self-serving positions of each side fail to capture the truth of the matter.
Nobody wants to admit or take responsibility. Politicians are masters of deflecting responsibility, and now borrowers are deflecting responsibility in unprecedented numbers. Behaving like children who get to play but refuse to do their homework, borrowers are throwing payment tantrums. When children misbehave, how much responsibility for the child’s behavior belongs with the parent? How do you apportion blame between parent and child? You should apportion blame between lender and borrower the same way because the relationship between lender and borrower is very similar to the relationship between parent and child.
Many of my posts are critical of the behavior of borrowers because their behavior has been atrocious, but like children who are spoiled by entitlement, borrowers are enabled by their lender parents. Today, I am going to explore the similarities between the parent-child relationship and the lender-borrower relationship and affix blame where blame is due.
Who is to Blame?
In 2007 I posted, Who is responsible for this mess? Much of that text is in the Great Housing Bubble:
“Who is responsible for the Great Housing Bubble? It is one thing to identify who or what caused the bubble, but it is another to assign responsibility and blame. Borrowers, lenders, investors, and the FED are all responsible; it is only a matter of degree. Irresponsible borrowers are like children, if you offer them something they want, no matter the terms, they will take it. The federal government realized this basic fact years ago when they passed predatory lending laws. This does not make the borrower any less responsible, but by definition, subprime borrowers are irresponsible. If they took responsibility for their debts, they would not be subprime. [ii] So if a large amount of money is lent to the most irresponsible among us, it is reasonable to expect them to spend it irresponsibly and not worry about paying it back. In this case, past performance is an indicator of future performance. It should come as no surprise that the subprime experiment ended badly.
Despite the low expectation of subprime performance, people need to be held accountable for their actions….
The borrowers are certainly at fault; if for no other reason than they signed the papers and took the money. The lenders are also at fault because they should have known better than to give borrowers loans they could not afford, provide loans with no income documentation, and ignore proven guidelines for loan-to-value and debt-to-income.”
“Regardless of how low rates got, the fact remains that many borrowers took out mortgages regardless of their own ability to repay the monthly principal and interest. This was simply reckless behavior, and should be recognized as such. Innumeracy is no excuse.
Ultimately, banks have a fiduciary responsibility to their shareholders and depositors to lend money only to qualified borrowers. Hence, they have a greater liability in the lending crisis. This is especially true of the “lend to securitize” originators who knew they would be causing future foreclosures.
However, the lenders’ irresponsible behavior does not exonerate those people who failed to do basic math. It is incumbent upon borrowers to know what they can afford each month–and to not get themselves into financial trouble. Perhaps it is time to teach basic financial theory in public schools.”
Although these issues are complex, Barry and I agree that both parties bear responsibility, but the scales of justice tilt toward blaming lenders more than borrowers. If you listen to community activists trying to prevent foreclosures, you would think lenders are 100% responsible and borrowers are blameless. People who are really upset by HELOC abuse want to make the borrower 100% responsible because the conduct is so reprehensible. The truth is somewhere in between.
A discipline in psychology called Transactional Analysis provides a useful tool for assigning blame.
Transactional analysis involves looking at the roles people assume when they communicate. The balance of power in a conversation or relationship changes depending on the roles of the parties. The parent-child interactions are useful to understand because the relationship of lender to borrower closely matches the relationship between parent and child.
In the parent-child relationship, the parent has greater power and with it a greater responsibility. Children want things, and parents must decide yes or no. The parent must exercise judgment to make sure the object of the child’s desire is good for them or appropriate, and it is the parent who makes the decision and bears much of the responsibility for the outcome. How is lending any different?
Borrowers want money, and lenders must decide yes or no. The lender must exercise judgment to make sure the borrower will pay them back, and it is the lender who bears much of the responsibility for the outcome of the loan. The parent-child relationship is the lender borrower relationship.
If the borrower-lender relationship is like the parent-child relationship, there is much we can learn about how lenders and borrowers should relate to one another. From Wikipedia,
“Life is subdivided into Five Relationships:
- Father to Son – There should be kindness in the father, and filial piety in the son.
- Elder Brother to Younger Brother – There should be gentility (politeness) in the elder brother, and humility in the younger.
- Husband to Wife – There should be righteous behavior in the husband and obedience in the wife.
- Elder to Junior – There should be consideration among the elders and deference among the juniors.
- Ruler to Subject – There should be benevolence among the rulers and loyalty among the subjects.
All of these practices are the physical, or outward, expression of Confucian ideals. These are the observable behaviors of the members of society. Confucius; however, believed that in order for society to truly follow li, one must also adhere to and internalize these practices. The mentality involved in performing these rituals in society must not exist only there, it must be a part of the private life of the person. This is known as rén.
Rén is not a concept that is learned; it is innate, that is to say, everyone is born with the sense of rén. Confucius believed that the key to long-lasting integrity was to constantly think, since the world is continually changing at a rapid pace.”
In each of these imbalanced power relationships, there is a series of reciprocal duties. Confucius didn’t start with the idea that all are created equal, he explored the reality of our daily lives and came up with a series of rules and precepts for accepting and living within the power imbalances in our lives.
Candy Store Analogy
To illustrate the power imbalance, imagine yourself taking children to a candy store, and you are the only person there with money. What would happen? The children would quickly scoop up candy and present it to you for purchase; you would be responsible for saying yes and no by providing the money. This classic parent-child interaction when shared in a group is what lenders face all day — a steady stream of borrowers wanting money for whatever, and lenders having to determine who gets what. Most borrowers, like most children, will take whatever is give to them whether it is good for them or not.
Similar Relationship Imbalances
There are other relationships between parties that closely resemble the lender-borrower dynamic; (1) dealer-addict and (2) landlord-tenant.
How is the dealer-addict relationship similar? Addicts want drugs like borrowers want money. Dealers strike a bargain with addicts that look like normal transactions except that addicts will do nearly anything to get their drugs so the balance of power is certainly not 50/50. Dealers get to decide who gets what drugs based on whatever criteria they choose (usually money, but not always). I don’t know if there is a point to this other than you know the regard I hold lenders who created a society of HELOC addicts.
The landlord-tenant relationship is the closest to the lender borrower relationship. Landlords control whether or not a tenant gets to live in a house, and lenders control whether or not a borrower gets to live in a house. If a tenant quits paying rent, the landlord evicts the tenant. If the borrower quits paying the rent on money, the lender (money landlord) forecloses on the borrower. Both landlords and lenders evaluate customers based on their ability to pay, and both want the property occupants to care for the property.
In fact, the only real difference between the lender-borrower relationship and the landlord-tenant relationship is who has to deal with the ups and downs of real estate values and how certain expenses are allocated. Tenants miss the volatility in real estate prices whereas owners do not.
In Orange County between 2002and 2010, when you consider the cost of housing and what was obtained for that cost, it has been better to be a tenant, particularly since appreciation in that period was near zero.
Only in delusional mid- to high-end areas has the appreciation gained since 2002 compensated for the additional cost of ownership paid at 2002′s moderately inflated prices. Late buyers paid more rent for money from a lender than tenants paid rent for houses from a landlord. With equity positions unchanged, it is hard to argue owners had a better deal financially, emotionally perhaps, but not financially. Timing the housing market is important.
She needed $200,000 dollars for something
The former owner of today’s featured property extracted $206,720 from her property during a seven-year stretch. Can anyone convincingly argue that she was duped into spending $250,000 and she has no responsibility for her actions? Can anyone argue that the lenders fulfilled their fiduciary responsibility to their investors when they underwrote these obvious Ponzi loans?
- This property was purchased on 10/19/2000 for $233,500. The former owner used a $186,640 first mortgage, a $46,660 second mortgage, and a $200 down payment.
- On 3/1/2002 she refinanced with a $254,000 first mortgage.
- On 2/27/2003 she refinanced with a $255,000 first mortgage.
- On 2/13/2004 she refinanced with a $391,000 first mortgage.
- On 4/12/2007 she refinanced with a $390,000 first mortgage.
- On 11/13/2007 she opened a $50,000 HELOC.
- Assuming she maxed out the HELOC, the total mortgage equity withdrawal was $206,720.
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Proprietary OC Housing News home purchase analysis
$389,000 …….. Asking Price
$233,500 ………. Purchase Price
10/19/2000 ………. Purchase Date
$155,500 ………. Gross Gain (Loss)
($31,120) ………… Commissions and Costs at 8%
$124,380 ………. Net Gain (Loss)
66.6% ………. Gross Percent Change
53.3% ………. Net Percent Change
4.2% ………… Annual Appreciation
Cost of Home Ownership
$389,000 …….. Asking Price
$13,615 ………… 3.5% Down FHA Financing
3.51% …………. Mortgage Interest Rate
30 ……………… Number of Years
$375,385 …….. Mortgage
$107,657 ………. Income Requirement
$1,688 ………… Monthly Mortgage Payment
$337 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$97 ………… Homeowners Insurance at 0.3%
$391 ………… Private Mortgage Insurance
$268 ………… Homeowners Association Fees
$2,781 ………. Monthly Cash Outlays
($320) ………. Tax Savings
($590) ………. Equity Hidden in Payment
$15 ………….. Lost Income to Down Payment
$69 ………….. Maintenance and Replacement Reserves
$1,956 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$5,390 ………… Furnishing and Move In at 1% + $1,500
$5,390 ………… Closing Costs at 1% + $1,500
$3,754 ………… Interest Points
$13,615 ………… Down Payment
$28,149 ………. Total Cash Costs
$29,900 ………. Emergency Cash Reserves
$58,049 ………. Total Savings Needed