Irresponsible lending pressure? Really?

Guest post by Chris Chinn. You can follow him on Twitter @yeloson.

In the November/December 2013 issue of Foreign Affairs, there’s an article by entitled “Why Banking Systems Succeed — And Fail
The Politics Behind Financial Institutions”.

The essay starts on obvious and solid ground — that the political interests of varying groups in any society shapes how its banking policies are made — but along the way drops out the culpability of the banks in the 2007/2008 crisis. Instead they place the blame on the government regulations and special interest groups in as the primary driving force in the bank collapse, while pretending there wasn’t a massive profit incentive for the banks in the whole process.

In other words, in their view, the fault for the collapse lies with regulations designed to make banks consider low-income people for financing, rather than with the trading around of mortgages.

Let’s review what’s wrong with this claim and what really happened:

1. Normally, a bank loans you money so you can pay them back, with interest. That’s how they make a profit on loans.
2. They are looking to make sure you can pay them back, so they don’t lose money. This is how they avoid making bad loans.
3. They began “selling” loans on from the local source point to each other and to other Wall Street firms. “I have a loan debt that should make X money over Y years, but I’ll give it to you for $[amount]”
4. Normally, this would still require the buying bank to seriously consider whether the loan was solid or not before buying… BUT…
5. They started allowing banks to buy/sell them in massive packages and re-label the stability of the loans being sold, after deregulations.
6. So worthless loans are now packaged in a big bundle and relabeled “AAA” loans (because collectively they can’t all fail!) and resold for a higher price than they’re really worth.
7. Now loans are no longer profitable based on the expectation of getting paid back, they’re profitable based on selling them on to other banks.
8. In this way, it doesn’t matter who you loan to, as long as you find a buyer for the loan. So banks start giving loans left & right.
9. People who would normally never have access to loans to get a house, education, etc. are given loans, not because of “good corp charity” but because of the quick profit on the bundle re-sale.
10. You can see from all the court cases coming out about banks deliberately targeting low income communities, misinformation, etc. RIGHT NOW.
11. So, naturally for all the reasons banks wouldn’t give those loans previously (“We expect it will fail to pay off”), the loans collapsed.
12. So the hyped up imaginary price that the loans got resold for, was now meeting reality: it was a bundle of loans that wasn’t going to pay off.
13. And, because it was so profitable to trade in these bundles, most of the banks had their money tied up in them – and the value disappeared overnight (to become “distressed assets”).
14. It wasn’t the usual speculation route, like stocks, banks treated subprime bundles like normal loans, so they could slide it under regulatory oversight.
15. It’s like investing most of your life savings into a lotto ticket then finding out it actually wasn’t worth $100 million.
16. So then they get the government to bail them out — because we actually do need banks to keep everything running. But they made bad investments and passed us the cost.
17. A bunch of folks’ pension funds, etc. were also based on these speculative loan funds, and now their retirements are gone too.
18. The houses got repossessed when people defaulted on the subprime mortgages the banks never should have loaned, but since now everyone is hurting, who can you sell the houses to? Oh, no one. So they sit there empty.
19. And a lot of people are stuck with debt burdens they can’t pay off. They should never have gotten the loan, but the bank had incentive to encourage them into it.
20. And yet some are blaming the poor people for “not paying their loans” as if millions collectively decided to be deadbeat at the same time… and as if the banks didn’t want to make those loans.