Nuanced Notions Part 1

When the dot-com bubble burst, I was quick to judge my industry and my peers. I spoke up for the “little guy” and held in contempt those professionals that I thought took advantage of unsuspecting investors. How else to explain how 70-year old Mrs. Jones ended up with a $1 million IRA account? With a few years and a bit more wisdom, I have come to believe that it usually takes two to tango.

I have come to regret some of the harshness of my past criticism because it too quickly placed blame without a more nuanced understanding of how greed can grip buyers, sellers, promoters and even regulators. Please know that this is not to say that at any given time, there are some bad guys who do bad things. But generally speaking in my experience, those are outliers. That is why I approach the subprime issue with a bit more of a balanced approach. It’s time to come to terms with how the situation emerged, where the fault lies and the solution to get out of this mess.

No matter what kind of crisis emerges in the financial markets, it usually boils down to two simple concepts: greed and fear. When boom times occur and greed grips the landscape, people are careless. When I say people, I mean institutions, individuals and regulators. Everyone forgets all of the important lessons that we have learned in the past. That’s what happened in the late nineties---at some point, investor amnesia took hold and all of the sudden concepts like risk, over-concentration in individual sectors/industries and realistic performance expectations went out the window amid cheers of “it’s different this time!” Then something bad happens and fear infects the environment.

Now we have the same revisionist history when it comes to the subprime lending crisis. When interest rates dropped to rock-bottom levels, it encouraged financial service professionals to create new ways to put the cheap money to work and allowed “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation) to borrow money and purchase homes when maybe they should have been more conservative in their behavior.

When housing prices were rising and interest rates remained low, everything was fine. But as the market changed, so too did the ability of some of the borrowers to repay their loans, causing delinquencies and defaults. Now, many of the subprime and Alt-A borrowers are forgetting that they had something to do with this mess.

Earlier this week, no less than the venerable Wall Street Journal, seemed to imply that many borrowers were “duped” by unscrupulous lenders. Tomorrow, I will discuss whether these claims have merit and if they do, what are the ramifications for the housing and mortgage market.