Bubble-Logic

I watched Sixty Minutes two nights ago and found myself yelling at the TV. The story was about subprime, the housing crisis and the real people who have been caught in the mess. While I am pleased that CBS decided to cover the story—even if it is about six months late, it left me angry.

Here’s how it started: a big graphic, blazing a headline, “House Of Cards: The Mortgage Mess,” followed by a voice over that stated “It sounds complicated, but it's really fairly simple. Banks lent hundreds of billions of dollars to homebuyers who can't pay them back. Wall Street took the risky debt, dressed it up as fancy securities, and sold it around the world as safe investments. It sounds like a shell game or Ponzi scheme; in some ways, it was a house of cards rife with corruption, greed, and negligence.”

Like another bubble before it, the housing boom and bust has created a mythology around facts that just don’t add up. It is true that banks extended loans to some people who did not understand what they were doing and who ultimately could not pay back the money when their rates jumped. It is also true that banks made loans to plenty of people who knew exactly what they were doing.

To put this in terms of the tech stock bubble: in the former case, maybe Mrs. Jones did not fully understand the risk she was taking when she bought a load of tech stocks in the nineties (although I am skeptical that people really did not know what they were doing) and therefore was plenty upset when everything collapsed. In the latter case, your cousin knew exactly the risk he was assuming when he started buying IPOs during the same period, but he was still bitter when the losses came and even said that the broker should not have sold him the risky stuff, even though he had requested to make the transaction.

It’s the second group that is making me crazy right now. These people are very upset that the bet they made has turned sour and expect that the rest of us good guys feel bad for them and make it better. I nearly lost it when one of the people highlighted in the story wondered why she should make her increased mortgage payment, to which the interviewer noted, because “That's what you agreed to do when you bought the house.” She then had the nerve to say, “Fine. If the value is going up. But we're not going anywhere. The price or the value is going down.” In other words, why should she make good on a promise when her bet went against her? This is what I call “Bubble Logic,” which only sounds rational to the person whose gotten socked when the bubble bursts.

I am not saying that there was not greed all around in this mess. Both lenders and borrowers got caught up in a euphoric market and poor decisions were made. We can look back on every bubble and see where the good idea was, but ultimately, the excesses sow the seeds for the future demise. In fact, it is only when times are really good that people take more risk—they feel inoculated against lost and are unable to see the downside. “How can I lose in real estate?” many asked…well, now they are seeing for themselves exactly how they can lose: yesterday it was announced that new-home sales tumbled 4.7% from the previous month to the lowest mark in 12 years during December. The median price of a new home fell 10% from a year earlier to $219,200. For all of 2007, sales of new homes dropped by 26.4%.