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The Banking Crisis is Due to the Lack of Ethics in Unchecked Profit Seeking

I want to spend just a few minutes today on the banking crisis, and from this synopsis it will become immediately clear where the fault lies in our current financial problems.

Currently, legislation is putting a lot of blame on mortgage brokers for not telling new house owners they could not afford their mortgage loans. Frankly, the fault lies nearly 100% with the banks. If you come to me, a mortgage broker, because the bank won’t give you a loan, you already know you’re a credit risk. You already know that affording the house is a stretch, and you already know enough, when seeking a loan, that interest rates will reset in the future and you might not be able to afford that big house. You’re asking me as a mortgage broker to find you some way to buy that house no matter what. I should refuse you? If a bank is willing to give you a loan, that’s the bank’s fault, not mine. You’re just coming to me to help you find that bank. You already know the risks. It’s the bank’s fault for funding you if they do so.

And if on a transaction that costs hundreds of thousands of dollars you aren’t worried about being able to afford it now or in the future when rates will rise, or during a time when you might lose your job, … in other words if you say you weren’t aware of the risks, that’s just hogwash.    I don’t know if I’m talking to a human being when I hear that sort of nonsense "I didn’t realize" because I know that in most cases they knew it was risky but were gambling that prices would go up, interest rates would stay low, their job would be safe, etc. Those folks knew the score on that hundred thousand dollar plus transaction. Everyone has those thoughts of risk go through their mind when the dollar sum is so large. They just gambled hoping nothing would happen. And if a bank loaned them the money, it’s the banks fault; if they lost money, it’s their own bad fortune. Sorry, you just shouldn’t have gambled that much.

Frankly, the mortgage broker’s job is to find you a loan if you want one from a bank dumb enough to give you one if you are a bad credit risk. It’s the bank’s fault for not doing its due diligence and making dumb loans, not the broker’s fault. Most customers know what they’re doing — how can that be the broker’s fault? If a bank is stupid enough to give you a 100% loan with no deposit, no money down, who is really to fault?

Now let’s take a look at the banks. When I worked on Wall Street in New York years ago, my firm sent me to a presentation on Texas oil wells being sold in some type of deal. When I got back to the firm, my boss told me, "No matter how nice they make it sound, when a Texas oil well deal makes its way all the way to New York, it’s a bad deal. If it was a good deal, the locals would have already snapped it up. You would never even be given a chance."

Please remember this principle for the rest of your life because it has served me well — if some type of deal makes its way to your doorstep after having traveled thousands of miles, ask yourself (1) why are YOU in particular so lucky that you ae given this great opportunity/chance- (you’re not lucky) and more importantly, (2) if it’s so good, why didn’t the locals snap it up?

So now time to look at the banks.

Previously a bank would make a loan to a consumer, and was careful because they’d hold the loans til maturity. Then some bright people said, "Hey, let’s sell these loans instead of holding them, and we can make more money on the fees." So stop and think about this — now all of a sudden, you’re not going to be so careful in making loans anymore because you’re not going to hold them, you’re going to sell them. Why pay attention to the risks anymore? You’re just going to give the problem to someone else. Can you see what will happen? You don’t need to be Einstein to predict what will happen next.

Immediately the loan quality of your portfolio will start seeing deterioration as profit maximizers try to sell more and more risky loans, because they’re going to bundle those bad loans together with "good ones" and sell them to others. Convincing themselves that sold in a bundle the risks of the ever incresing bad loans will even out, good old capitalists cheat themselves into thinking they’re not doing anything unethical when in fact they ARE making bad loans, and on purpose — to make money by passing the problem on to someone else. Loan quality will deterioarate precisely because banks are no longer holding the loans they originated. PERIOD!

Did everyone get that? Does anyone believe that the quality guidelines on loan origination when you no longer hold the loans yourselves will NOT be relaxed over time in order to generate more and more loans that can be sold to others for a fee? If you’re going to hold the loans  you’re going to be particularly careful which ones you originate but if you aren’t planning to hold them, then create as many as possible and then sell them elsewhere. A kid in high school can figure this out, and it’s exactly what happened. When you realize that these bundled loans are the same as the Texas oil well deal that makes its way to New York, you just discovered the gist of the mortgage crisis. In order to maximize their profits because they were not longer holding the loans themselves, banks started making lots of bad loans, bundling them with other loans, convincing themselves this was ethical and safe since the bundle would offset the risks on individual mortgages, and loading up the whole system with bad debt. All because it was "more profitable."

I think you’re starting to get the picture. When corporations focus on profit maximization and forget about the underlying ethics, we all suffer. Now they are trying to pass the blame on to mortgage brokers. Sure there is some blame there, but the majority of the blame lies squarely with the banks. They wanted to make more money, so they made bad loans they would never hold themselves, bundled them with other loans whose quality would slowly deteriorate as well, and the whole mess escalated, escalated, escalated as others got into the game. No one stopped and said, hey this is risky and also a bit unethical. Let’s not invest in these. Everyone was making money, so no one mentioned the unmentionable - that the banks themselves would never hold these loans for themselves in the first place (the local Texans) and that being the case, they shouldn’t have sold them. 

And so that’s how the world works … a child could understand it. Everyone made money on a faulted system until the system collapsed. yes people should lose jobs because they should never have engaged in this practice in the first place. People will always do all sorts of things to make money, and it’s very hard to say NO sometimes to some practices that go on, but that’s what must happen if capitalism is to survive. MAximize, maximize, maximize profits causes people to engage in all sorts of illicit or unethical activites in capitalistic systems when the mantra is every increasing profits. As far as I’m concerned, if an organization makes steady profits that are greater than the risk free rate, in many cases that’s good enough.

At least that’s the way I now see it.