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03/16/2008

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Scott

As someone who is hoping to buy a home in about a year, I am angry that so much fuss is made over current homeowners. Congress is working to prop up housing prices by preventing more foreclosures, which takes money out of my pocket and gives it to those who chose to ride the current wave. It should be called the Housing Unfairness Act of 2008.

Nick Pyati

The assertion here that we can discount as a cause the lack of comprehension and/or information on the part of borrowers because similar mistakes were made by better educated parties is logically flawed. It is entirely possible, and in fact plausible, that these concurrent mistakes were made for distinct reasons: borrowers did not understand what they were signing, and bankers, hedge fund managers, etc. were overtaken by greed. Naturally, it is possible that members of both groups made decisions for either reason, or for a third reason or some combination of reasons. The point is that the argument that where the same decision has been made by two parties it must have been for the same reason is facile. Having done a (very) small amount of legal work in the subprime mortgage sector, my impression is that ignorance and confusion, and not irrational optimism, are very often at the heart of poor decisions.

Furthermore, the application of moral hazard as applied to borrowers here lacks sophistication. When evaluating whether a particular bailout action is likely to create a moral hazard, it seems important to consider at least three questions: first, whether actors are likely to engage in this sort of behavior again (regardless of the bailout), second, whether affected actors will understand the bailout well enough to exploit it in the future, and third, whether the bailout will in fact shift the cost-benefit analysis for actors significantly enough to change behavior. In the case of subprime mortgages, I doubt that the first two questions suggest that a moral hazard has been created: even where borrowers would be engaged in subsequent mortgages (or financial transactions of similar magnitude), it is unlikely that they would be confident enough in their understanding of the government's action to rely substantially upon it in the future. The third question is most dispositive. For borrowers, the experience of mortgage foreclosure and the accompanying helplessness, fear, stress, and uncertainty can be so devastating that government relief would be unlikely to encourage them to continue taking risks; it is possible to provide relief without incentivizing risky behavior. The man who is saved on the operating table from severe injuries suffered during a car crash is nevertheless likely to wear his seatbelt and drive the speed limit for some time afterward.

MS

Becker writes, “Abusive treatment is awful, but still the vast majority of children abused do become law-abiding and responsible adults.”

Yet a high percentage of violent criminals experienced significant neglect or abuse during their childhoods. Similarly, a higher percentage of severely neglected or abused children commit violent crimes than those who did not suffer such treatment. Consider a similar use of statistics - a large percentage of smokers never develop lung cancer. That hardly proves that lung cancer is unrelated to smoking. While severe childhood neglect and abuse do not legally excuse criminal conduct, such a background should be a factor to be considered by courts when determining a sentence (within the sentencing range set by the legislature).

(Also note, a different question is whether severe abuse or neglect occurred or whether the defendant is fabricating such allegations. That is a factual determination to be made by the court and is completely separate from the question of how to weigh that factor when determining a sentence.)

Oskar Sigvardsson

I've heard these arguments for a non-interventionist government before, but I don't buy them.

This essentially boils down to a question of utilitarianism: does the good effects the "lender-of-last-resort" policy outweigh the bad patterns that might form, with investors taking much larger risks. I argue that they do, absolutely.

I don't really see any evidence that a hands-off policy of the Federal Reserve does make investors more cautious. The last bubble was the dot-com bubble, and that burst spectacularly, without the Federal Reserve stepping in to rescue failing companies (at least, not to my recollection). That didn't slow down the sub-prime bubble one bit; you'd think wall street would've learned their lesson, but apparently not.

And really, when faced with the choice of letting Bears Stearns go down in flames, with potentially disastrous consequences for the market, I'd argue that it is the duty of the central bank to step in, simply to stop a domino-effect that might lead to a new depression.

Teresa

It's such a wonderful blog full of wisdom.

Bertil Hatt

I'm sorry, bu on many cases, I have to disagree. For people who are not (the favourite discussion budy of) a World-class leading law scholar, contracts are impossible to understand. An entire industry rely on this incomprehension: lawyers. Part of this industry is law colleges. If the law was easy to understand for anyone with an IQ higher then 80, Judge Posner's insights wouldn't be needed.

More generally, I think that you are too harsh on many people because some behave poorly, and others are dishonnest. Behavioural economics has piles of example from generally economic students (not the brightest bunch, as you know from teaching to them -- but a fair sample of representative "honnest man") showing bias, misunderstanding and easy influence.

I almost was the victim of a classical phishing scam today: my computer was stollen yesterday, and en e-mail warns me of "Surprising activity on your PayPal account" --- wouldn't you fall into that trap? Thankfully, my browser comes with warning pop-up. Looking at it more carefully, I recognised the simplest phising case; honnesty is limited, but our attention is even rarer. An economist of all people should not consider that trust is over-rated, and ecourage people into hiding important elements in thick, unreadable contracts. You should realise that understanding is the rarest ressource, and encourage having the risks clearly explained in bold, red, large font. Scammers and reasonnable investors would be sorted out this way.

Diversity

The moral hazard that is not "lurking", but blatant in the present financial crisis is that the decision-makers of most financial institutions gain if the institution shows a profit in the period and do not lose significantly if it makes a loss. Whatever the official regulatory structure of the markets, that set of incentives will lead to the institutions taking more risks than they would if the decisions were taken by the beneficial owners. That is to say, risk will always be underpriced. Governments cannot and should not protect beneficial owners from all the effects of their fool-hardiness, but Congress (and other legislatures) might consider a simple retrospective Bill making Directors and responsible corporate executives liable to pay back to the corporation all benefits other than salary received over (say) the past three years, should the corporation fail to meet its obligations. The main effects would be on future behaviour, but it might mitigate the present sense of injustice felt by, for example, shareholders in Bear Stearns and creditors of other, lesser, failed institutions.

Wes

While I have about as much sympathy for defaulting borrowers as I have for bank robbers, as an investor I would also hope that capitalism could somehow provide me with a bank that made it a high priority to avoid being robbed and also to avoid lending money to borrowers who were unlikely to pay it back.It seems, though, that we are still in the Middle Ages of capitalism. Just as peasants in the Middle Ages needed governments but hadn't yet figured out how to compel the government to act in the interest of the entire population rather than the government leaders, individual investors have yet to figure out how to compel the top management of financial firms to act in the interest of individual investors rather than the top management. Just as kings in the Middle Ages enriched themselves while making poor leadership decisions, top management of financial firms enrich themselves while also making poor leadership decisions.We keep hearing from the conservatives how top management is only compensated so richly because they deserve it. Well, looking at this mess in the financial sector, I'm finding it hard to believe that top management deserves their lavish compensation. Sure, kings in the Middle Ages could always point to a worse king and say "If I wasn't compensating myself so aggressively, I'd be as bad as that other guy." The thing is, when the founders of the USA finally got around to devising a better form of government, the better form of government wasn't just that the kings got even more compensation than in the Middle Ages.Ultimately, it's not about checks and balances or regulation. It's about attitude. Until the public gets real about the limitations of corporate leaders in the same way that the founders of the USA got real about the limitations of government leaders, we'll be stuck with a system where the corporate leaders get rich and everyone else suffers.

Alex

There is an error of logic, common in newspaper reasoning: the assumption that 'responsibility' is mutually exclusive. There are two ways that the word is commonly used: responsibility to perform an act (such as mowing the lawn), and responsibility for a condition (such as the condition of your children).

Responsibility for acts is naturally mutually exclusive: if one person acts, another need not. Responsibility for conditions is not so straight-forward. Of course, if you are writing a contract, it makes sense to allocate as much as possible responsibility unambiguously between the parties. But I am not convinced that the moral responsibilities allocated to us by our place in the world are divided so neatly.

Brad

What happened was that banks and other mortgage lenders had a financial incentive to originate these loans. They sent salesmen to people who were unlikely to understand the risk involved in these loans. These loans were primarily sold to the poorest, least educated homeowners. Sales techniques included lying and cheating.

The loans were packaged and sold on the market to investors who did not insist on quality.

It looks to me like the banks and the investors are counting on a federal government bailout. I'd be surprised if the homeowners got any relief.

You've got to understand this if you want to apportion the blame.

Carlos

Mr Becker, I believe you have pay homage to one of the great thinkers in western history when you said:

"people who are accustomed to having other persons or governments make their decisions for them lose the ability to make good decisions for themselves. Free societies lead to better decision-making partly because men and women accumulate more experience at making decisions that affect their well-being and that of others."

Kant, in his famous essay, "What is enlightment?" said:

"Enlightenment is man's emergence from his self-imposed immaturity. Immaturity is the inability to use one's understanding without guidance from another. This immaturity is self-imposed when its cause lies not in lack of understanding, but in lack of resolve and courage to use it without guidance from another. Sapere Aude! [dare to know] "Have courage to use your own understanding!"--that is the motto of enlightenment......But that the public should enlighten itself is more likely; indeed, if it is only allowed freedom, enlightenment is almost inevitable."

curtd59

Wes,

Nice, literate response.

However, money, interest, credit, debt and the pricing system are an information system. By printing so much fiat money, the governmnet inserted "lies" to that information system and caused the problems for both banks and consumers.

As an investor you should have, at the time, held the bank accountable, otherwise you're just claiming ignorance.

But given that data processing (computers) have centralized bank talent (and intellectually impoverished the banking system) and any trivial conversation with any banker, regardless of bank, would immediately demonstrate that these people have little if any understanding of what it is that they do, and certinaly no understanding of economics, and finally, no understanding of the limits of quantitative formulae or models.

So, we are all at fault here. And you as an investor, if you have this knowledge cannot say you were unaware of the situation.

Cheers

Octavian

I've been put off by this whole mortgage mess plan from the beginning. These big financial institutions were trying to make a buck by pulling the wool over peoples eyes and they got caught in their own bubble. It was greed, and they need to learn from it. This bail out stuff will only make things worse. Our economy needs to learn, and this kind of interference is just that...interference.

Saint Darwin Assissi's cat

Becker and Posner ... ya'll rock in your writings. LOL at Posner's comment: "maybe I don't have enough imagination." I would hate to see someone without imagination if Posner does not have an imagination coupled with a fast pen driven by a brilliant mind and desire to express himself. I liked Becker's comments about Bears Stearns ... first thing I thought of was Enron, World Com, Merril Lynch ... 14,000 employees without jobs and their Bears Stearns retirement invements have been wiped out ...someone(s) has(ve) profited from this ... if discovered, will they commit suicide like many think Lay did? Will they be able to enjoy their new found wealth the Pope in Italy has characterized as obscene ... along with global economic environmental toileting by major corporations ... people have gotten more eager to shift blame as they watch legal shows ... read legal thrillers. First thing every good lawyer does is sue everyone and then the true defendants are sifted out during the litigation process; it seems, today, no one takes personal repsonsibility any longer. When the average person sees a woman getting millions for a hot coffee spill etc. etc. no puzzle to see that from age 6 people learn to point the finger. Pride, anger, greed, gluttony, envy, lust and sloth are not eliminated by coporate or government veils. In Las Vegas, NV persons with no education have purchased homes by working 2 to 3 minimum wage jobs ... now they are losing those houses not realizing any benefit except the time they hopefully enjoyed living within the structure ... the banks don't want these houses back do they? What are banks going to do with a bunch of empty houses no one can afford to buy? The displaced former homeowner is left without housing ...

richard

it is forbidden to clarify the facts of the sub-prime problem.
a large proportion of the defaulters are african americans and hispanics.how can we debate the issues when all are afraid to say so?
let us have the facts and we can debate sensibly.

richard

it is forbidden to clarify the facts of the sub-prime problem.
a large proportion of the defaulters are african americans and hispanics.how can we debate the issues when all are afraid to say so?
let us have the facts and we can debate sensibly.

richard

it is forbidden to clarify the facts of the sub-prime problem.
a large proportion of the defaulters are african americans and hispanics.how can we debate the issues when all are afraid to say so?
let us have the facts and we can debate sensibly.

richard

do we know why there are so many sub prime defaulters in the usa in comparison to europe?

richard

do we know why there are so many sub prime defaulters in the usa in comparison to europe?

richard

do we know why there are so many sub prime defaulters in the usa in comparison to europe?

richard

i believe philantrophy is the answer to the sub prime mess.the gates foundation and other similar organisations can use their wealth to help minorities in the usa buy homes on terms that are easily affordable.
as for the banks they have made such a mess they should be regulated.they obviously cannot police themselves.

Wes

In the ideal capitalist world, the government would stay out of the economy. In the real world, governments at least have to decide how much new money to print (create). If the government floods the markets with a bunch of newly printed money then inflation will go up and interest rates will go down. This is good for borrowers and bad for savers. If the government doesn't print up new money (or even takes existing money out of circulation) then interest rates will rise and inflation will slow. This is good for savers and bad for borrowers.The things is, over the last eight years the US government has been running massive deficits and become more and more of a borrower itself. So, as a borrower itself, the US government has a bias toward helping the borrowers at the expense of the savers. There's all this talk of how people should save for retirement but then the government prints up a whole bunch of new money and the inflation rate far outpaces the interest rate and pretty soon everyone's retirement savings are worthless. But, at least the US government doesn't owe as much in real terms anymore.That's not to say that there aren't problems with the banks. If I stop by a restaurant for a burger and ask to do a detailed inspection of the facilities (assuming I even had time for that), I would get laughed out of the restaurant. Similarly, if I go into a bank to open a checking account and ask to do a detailed inspection of their security system, I would be laughed out of the bank. The expectation is that when I buy a burger at a restaurant, the burger is safe to eat and that when I deposit money at a bank, the bank will take necessary steps to prevent my money from being stolen.I also expect when I deposit money at a bank that the bank will not loan that money out to people who won't pay it back. That's not something I should (or even could) verify for myself. That's the basic product that the bank is supposed to be offering. From what I can tell, though, most banks in the USA did go ahead and loan out peoples' retirement savings to other people who weren't expected to pay it back.However, at the end of the day, the bank management may have been the smart ones because they knew that, not only would the government bail them out, but that they would personally wind up with all kinds lucrative bonuses.

neilehat

I think might just practice some "individual responsibilty" by not commenting on the deregulation of the Financial Industry, the rise of liars, cheats, thieves, frauds, scroundels and Corporate malfeseance. Any one ever heard of a "pig in a poke"? I won't even mention speculative mortgage backed securities, hedge funds, derivatives, etc.. You'd think Bear-Stearns and others would be smarter. Nah! They were the most vociferous in demanding Deregulation.

And now we've got to bail them out. That money going into the industry ought to come with some "strings" attached.

personally responsible

While I generally agree re personal responsibility, there are obviously limits. I don't think some intervention to soften the hardest blows would eradicate the lesson. And the people must have some faith that the system is working for them.

But responsibility goes both ways. If you give high credit card limits to college kids, guess what? I guess we needed to change the bankruptcy laws so the college kids will learn their lesson [I know, not necessarily your position]. Also, there are issues regarding the ever growing complexity and volume of information about our economy, our financial system, technology, consumer products and our ability to understand all of this and take personal responsibility.

That said, I agree that intervention should be based on what's good for the economy, the financial system as a whole and our country.

Jake

Get real, folks. Nowadays, and it has been so for years, you cannot close a mortgage loan transaction without having reams of paperwork shoved at you that discloses the terms that the lender wants. Should you read it, you'll understand the deal. Should you not, you'll join many others in the electorate who vote for cake and parades, having no clue about how grown ups conduct business.

Bah.

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