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Bad bankers lose money, Part II

Here we move from the subject of odious debt to the subject of foolish debt. That is, debt that is foolish on behalf of both the borrower and the lender.

The bankruptcy legislation signed into law by President Bush last year should have sent a clear signal to shareholders of the banks that lobbied for that bill.

Why would these banks want or need such a law? Only one reason: They know they've built a house of cards and they hope against hope that the government will save their butts by somehow keeping the whole thing from toppling.

Say for instance you're a banker and you've made a loan to Ernie Bishop the cabdriver. You have all the papers there — his salary, insurance. And you can personally vouch for his character. You've done your job as a lender and you know that Mr. Bishop will be willing and able to repay the loan. That being the case, you don't care about some bankruptcy bill. You don't have to care about it. You've done your job wisely and well, and the money you've loaned out will be repaid without you needing to call in the cops or the Congress to threaten Ernie and his family.

Now, imagine you're a banker who's not satisfied with only the tiny stream of business you can get from people like Ernie Bishop. You want to grow, baby, grow, and to do that you're going to have to make a lot of loans and you're going to have to make them fast. You don't have time to check all the papers, or to bother with whether or not you can vouch for their character personally.

So you send out fliers announcing that everyone — absolutely everyone — is "preapproved" for a loan. You send out three billion fliers a year — or roughly 10 for every man, woman and child in the country. You start lending money hand over fist, throwing out money so willy-nilly that you scarcely even bother keeping track of who you're giving it to. "Identity thieves" are scamming fraudulent loans from you with little more than a middle name and a date of birth, but you're growing, baby, growing, and you're making money so fast that you can shrug off this theft as an inconsequential cost of doing business.

Just look at the balance sheets, baby, look at all that glorious debt!

Then somewhere in the back of your mind, or down on the fifth floor, in accounting, some green-visored Jiminy Cricket starts clearing his throat and killing your buzz. All that debt, he points out, is only an asset if we can be sure it will be repaid. And an honest accounting seems to indicate that much of it can't and won't ever be repaid.

You look again at those balance sheets and at all that reckless debt. And you realize you're screwed.

Your only hope — and it's a long shot — is to get a law passed that says that people who don't have the money to repay these loans are legally compelled to repay them anyway.

Some part of you knows that such a law won't work, that all the kings horses and all the kings men can't collect money that just isn't there, that Congress cannot magically legislate that people unable to pay you back have to pay you back anyway.

A responsible banker wouldn't want, or need, or be bothered with, such a ridiculous law. An irresponsible banker will fight for it with the desperation of a drowning man.

We saw this law get passed. We saw which banks were fighting for it. What kind of fool would want to invest in such a bank?

  • Quinn

    Has someone compiled that list? Where can I find it? I’d like to make sure I don’t have any debt with those lenders. That law scares the crap out of me. I’ve got a massive amount of educational debt and I’m struggling as it is. If the economy continues to tank for those of us making less than $200,000 a year (I made SIGNIFICANTLY LESS) I forsee myself struggling even more, I’d like to know if I’ve got an economic pitbull in my backyard.

  • stingraylady

    Ditto the above comment. My overall feeling was that all the large banks were on board with this bill. Can you provide a list of some that weren’t? It’d be worth more than a little inconvenience to make a statment by banking with those that weren’t aboard this particular ship, particularly if we can do it en masse.

  • Roger

    Q and S, might I suggest your friendly neighborhood (or workplace) credit union? Credit unions sure weren’t on board with this kind of reckless and greedy lending.
    You can find a credit union near you at http://www.creditunion.coop/cu_locator/index.html
    -Roger

  • cjmr

    What Roger said. We got our mortgage through our local CU. We got a much smaller loan than we could have had we gone with a “more aggressive” mortgage company–but they made damn-sure we could afford it before we signed any paperwork.

  • Lucia

    My DH and I have never carried a credit-card balance, and lenders have a word for people like us: deadbeats. Really, that’s what they call people who never run up any interest. We might be less obsessive about it were credit-card rates not so absurdly high, as a banking acquaintance once explained to me they must be to balance out the relatively high (compared to bank loans) percentage of credit-card defaults. Well, I said, they should tighten their standards. Yes, he said, but then many fewer people would be able to get credit cards. And this is a bad thing because…?
    I concluded long ago that lenders throw credit at people because they want them deep in hock: too deep to climb out easily (or ever), but not so deep as to throw in the towel. Then, when not so deep got deeper, they had to make the price of throwing in the towel higher — with the likely unintended consequence that people will take on even more debt before finally giving up.

  • mangala

    I work for a bank (albeit a Canadian one, and not in a lending sort of position), but I absolutely agree that there is a problem with the way credit is given.

  • Duane

    I’ve always been with a credit union but my wife banked with Jefferson National Bank when we were married, and since she did the bills we did 99% of our banking with them.
    Then we had a deposit not go through (found it on the floor of the car) and all of our bill-paying checks started bouncing. We rushed to the bank and put in enough money to cover the remainder of the checks that were going to hit. Jefferson National Bank promptly took the money and applied it to their bounced check fees and then bounced the rest of the checks that went through (and made even more money in bounced check fees).
    We closed our bank account that day and haven’t done business with a bank since.

  • bulbul

    Let me be the right-wing/libertarian voice here for a change: lenders want to make more money, so they do what feel they have to do. What about the borrowers? Is it too much to expect a little responsibility from them?
    Could anybody please explain to me the difference between a bank and a credit union and perhaps give me an idea about current mortgage rates? Thank you.

  • cjmr

    Banks v. CUs 101:
    A bank is owned by a corporation. A credit union is owned by its members (depositors). The board of the bank is voted on by its stockholders and is responsible to them. The board of a credit union is voted on by its members and is responsible to us. They are insured by different federal agencies (FDIC for banks and NCUA for credit unions). The membership of a credit union is usually explicitly spelled out in its charter–membership may be limited to employees of a certain company and their families, for example, or to teachers, or to people who live in a certain city. A credit union cannot solicit business blindly.
    Do you want to know about mortgage rates, or different types of mortgages, or differnt types of mortgage lenders (which don’t have to be banks or CUs)?

  • bulbul

    cjmr: thank you :o) As for the mortgages, the basic rates for the most common mortgage types will be enough.

  • colin roald

    Is “google mortgage rates” so hard?

  • cjmr

    Mortgage Rates:
    Here’s a selection from Saturday’s WaPo Real Estate Section:
    30 year fixed: 5.5 – 6.0%
    15 year fixed: 4.8 – 5.7%
    1 year ARM (rate changes every year): 3 – 5.5%
    3/1, 5/1, 7/1 ARMs (rate fixed for a number of years, then changes every year): 4.5 – 6.5%
    30 year interest-only: 6.25%
    ARMs usually adjust every year (some have a fixed rate waiting period and some adjust even more frequently than that), but are often only allowed to increase by a certain percent each year, and many have a interest rate ceiling that they won’t ever go above.
    In an interest-only mortgage, unlike in a standard mortgage, no principal is required to be paid off. This allows the creditor to take the maximum income tax write-off, since mortgage interest is deductible in the US.

  • cjmr

    colin,
    It actually took me less time to look that up in the newspaper and type it in than it did to get the same information via google–I just checked. And I didn’t have to give up any personal information to do so.

  • bulbul

    cjmr: thank you very much. I trust these numbers are not that remote from the reality?
    colin: I tried that, but I am very skeptical as to the accuracy of the information. After all, the initial quote from my bank was waaaaay off from what I actually got.

  • cjmr

    Those are the rates that people with very good/excellent credit would be offered. People with less than perfect credit would usually be offered 2-5 % above that depending on the lender. I believe them to be typical for the Wash. DC area, they are taken from a column that is printed each Saturday and includes rates for most of the region’s prominent lenders.

  • lightning

    Let me be the right-wing/libertarian voice here for a change: lenders want to make more money, so they do what feel they have to do. What about the borrowers? Is it too much to expect a little responsibility from them?
    ??? “right wing”, yes. Screw the little guy. But “libertarian”?
    Actuarial statistics are quite well established. The banks *know* the percentage of debts that will be bad. They went ahead and made the loans anyway.
    “What they had to do” was to lobby for the Government to play the part of Vito the Enforcer for them.
    A “libertarian” viewpoint would be that the banks should suck it up and take their medicine like little men. You make loans on lottery tickets, you get what you deserve.

  • bulbul

    ??? “right wing”, yes. Screw the little guy. But “libertarian”?
    Both stand for personal responsibility and that sort of stuff. I was actually filling in for Scott (my apologies) :o)

  • colin roald

    http://www.bankrate.com publishes the same kind of numbers as cjmr got from the Post. They’re on the home page, no sign-in or anything required.
    There are also numbers on http://finance.yahoo.com/, also on the main page.
    I would be surprised if the numbers aren’t accurate as what they are, which is kind of a best-case scenario.

  • none

    A “libertarian” viewpoint would be that the banks should suck it up and take their medicine like little men.
    And what about the people who took out all those foolish loans or accepted those credit cards in the mail? Shouldn’t they have thought twice, assessed their financial situation realistically? In other words, the banks might have been ‘predatory’ in offering the loands. But those who accepted them were outright stupid.
    Disclaimer: I do not necessarily agree with any of the above.
    The Bankruptcy Bill is really outrageous.

  • bulbul

    Last anonymous post = me.

  • Toby

    What kind of fool would want to invest in such a bank?
    What will the bank’s next quarterly look like?
    What other question could possibly worth asking?

  • Anno-nymous

    I have to say, giving out loans only to those whose “character” can be vouched for is bad. It’s a *good* thing that you no longer have to have connections to get a loan, that you can present a banker you’ve never met with your solid credit report and walk out with a loan. The fewer barriers and the less costly it is for the disadvantaged to get loans, the better. The more the system is based on financial “merit”, the better.
    Of course, the flip side of merit is that people who haven’t demonstrated an ability to pay off loans can’t get them, or have to pay higher fees to cover their risk of default. This is all as it should be, or, at least, it is unavoidable — even though it often means that the poor who have the least to spare are forced to pay the highest rates.
    That said, I completely agree with you (Fred) that it is absolutely despicable for the banks to loan money recklessly under a system of looser bankruptcy, then work to tighten the law to retroactively make bankruptcy difficult for those who already hold debt acquired under the older regime. It is less despicable — still greedy, still bad for the country, still bad policy — to tighten bankruptcy laws for those who in the future will be less able to take financial risks, less able to recover from illnesses in the family, etc.

  • dyspeptic grad student

    Both stand for personal responsibility and that sort of stuff.
    That’s a laugh. “Right wing” stands for “protect the interests of the rich and powerful,” and “libertarian” stands for “screw you, Jack, I got mine.”

  • bulbul

    And liberal stands for “gimme all your money so I can give it away”?

  • Puck

    Making loans based on the ability to repay is ultimately racist (certainly in effect if not in intent – though I suspect the latter).
    I don’t suppose the old Christian proscription against usury might help here? – nahhh – anti-Semitic. Right.

  • J

    Let me be the right-wing/libertarian voice here for a change: lenders want to make more money, so they do what feel they have to do. What about the borrowers? Is it too much to expect a little responsibility from them?
    Right, except that if banks wanted responsible borrowers, they might have done better to look into that BEFORE they lend money rather than AFTER. Anyone who can fog a mirror can get a credit card, home loan, or equity loan these days. Ten felony convictions? A trail of bad debt a mile long? Previous foreclosures? These things may jack up your interest rates, but they will rarely prevent a loan officer from stamping “Approved” on your form. BANKS need to be made more responsible: Their philosophy of “Loan first, ask questions later” needs looking into.

  • Scott Daly

    It is bad public policy, bad governance, and bad business to retroactively change the rules of the game when it comes to bankruptcy. Were there some people that were gaming the system? Of course there were. There always are. No system is ever 100% un-gameable. However, that said as far as I am concerned it is the banks problem to not loan money to people that are unlikely to be able to pay it back, or who have previously defaulted on loans. Last I heard there was no law that said that the banks have to give you money when you ask for it. No law that says you are entitled to a credit card. But I don’t see the problem as being completely with the banks. There are two other forces driving the situation that Fred did not mention.
    The first is investors unreasonable expectations of ever higher and consistent returns when they by stock in a company. Companies are being punished by investors for failing to be consistently profitable every single quarter. Anybody who knows anything about finance knows that companies occassionally have to make large investments that may affect their profitability in the short term in order to position themselves to be profitable in the long term. However, we have investors that engage in massive sell offs of stock if a company misses its estimated earnings per share by $0.02, and come in at $1.23 instead of $1.25. Heck they engage in massive sell offs on the mere rumor that a particular target will be missed. So the banks are under enourmous pressure by their boards and stockholders to rake in more money. How do you do that? You make more loans. And of course these loans will be to riskier people, people who are less likely to be able to pay you back.
    The second factor is rampant commercialism. You are not considered a successfull person unless you have the $500,000 house, and the Lexus, and the 52′ HD plasma TV, and the designer sports polo jacket, and the….. Because of the enormous societal pressures to appear successful through the acquisition of material goods people are much more likely to over extend themselves. Take a look at the people that society has declared worthy of emulation. What is the common factor that they all have? Gobs and gobs of stuff. Add in the fact that declaring bankruptcy no longer carries any real social stigma, and you have a recipe for the house of cards deluxe that is the modern American economy.
    Personally I am waiting for the whole thing to come apart at the seams. And it will. It is just a question of when. I may be overly pesimistic, but I think it will be a crash that will make 1939 look like a tea party.

  • mangala

    And what about the people who took out all those foolish loans or accepted those credit cards in the mail? Shouldn’t they have thought twice, assessed their financial situation realistically? In other words, the banks might have been ‘predatory’ in offering the loands. But those who accepted them were outright stupid.
    One problem I occasionally see is that sometimes the lending bank has given a credit product to a person who does not actually understand how that product works (I see this more with credit cards and especially with overdraft protection, rather than loans) – and in some cases, is not capable of understanding it. This is an incredible failure to do basic due diligence on the part of the lender, I think.

  • colin roald

    Making loans based on the ability to repay is ultimately racist (certainly in effect if not in intent – though I suspect the latter).
    Are you seriously suggesting YOU would loan YOUR OWN money to somebody you didn’t think would be able to pay it back? Why on earth would you imagine other people ought to act any differently?

  • Mnemosyne

    And what about the people who took out all those foolish loans or accepted those credit cards in the mail? Shouldn’t they have thought twice, assessed their financial situation realistically?
    Many of them “foolishly” contracted a serious illness that caused them to lose their jobs, or “foolishly” got divorced with the subsequent bills that go along with that. I guess those new bankruptcy laws will teach people not to get cancer, huh?
    And, again, you seem to be missing the main point: the banks changed the rules after the fact. They realized that they were losing money because of their bad lending practices but, rather than changing those practices, they paid money to Congress and got laws passed to make it harder for people to declare bankruptcy.
    I’m having a hard time seeing what’s so “libertarian” about getting the government to pass laws to protect your industry. Shouldn’t businesses and individuals be on a level playing field in a libertarian world?

  • none

    And what about the people who took out all those foolish loans or accepted those credit cards in the mail? Shouldn’t they have thought twice, assessed their financial situation realistically? In other words, the banks might have been ‘predatory’ in offering the loands. But those who accepted them were outright stupid.
    Disclaimer: I do not necessarily agree with any of the above.
    Your first comment was an attempt to insert Libertarian ideals into these ideas of banking. Under my understanding of Libertarism, both the bank and the borrower are allowed to agree to a loan even if the borrower has poor credit. However, once the loan comes due, then the borrower is responsible to pay back the money, and if he can’t, the bank is responsible for taking a risk that has turned out bad.
    What banks are currently doing is saying, “We want our cake, and to eat it too.” They want to make risky loans, but they still want to be repaid. This is why I get so upset about the airline buyouts, and industry subsities. If a busines model has failed, then the company really needs to take responsibility, either by discontinuing that model or by shutting down. The government shouldn’t be offering breaks to these companies when they start going under. They understood the risks, now they should have to face them.

  • Spherical Time

    Previous comment was me, sorry.

  • Puck

    > Are you seriously suggesting YOU would loan YOUR OWN money to somebody you didn’t think would be able to pay it back?
    Of course not. I’m not stupid.
    > Why on earth would you imagine other people ought to act any differently?
    Because if we all get together and vote the Democrats in – then the govt will force the banks to give us their money. I’m not saying they’d do it voluntarily.

  • colin roald

    Ah. I am embarrassed. I mistook Puck for clueless, but it turns out he’s actually a troll.
    Off to do penance,

  • Mnemosyne

    Because if we all get together and vote the Democrats in – then the govt will force the banks to give us their money. I’m not saying they’d do it voluntarily.
    Yeah, I remember that sweet, sweet check I got from my bank back in 1992 when Clinton was president and the Democrats controlled both houses of Congress.
    Why can’t we go back to those halcyon days of 1992-1994 when the Democrats shut down the capitalist system and redistributed the wealth to everyone? Remember those days? It was a major party, I’ll tell ya.
    Puck, you remember when that happened, right? How the Democrats closed down private industry while they were in power? Tell us how it was for you.

  • bulbul

    Many of them “foolishly” contracted a serious illness that caused them to lose their jobs, or “foolishly” got divorced with the subsequent bills that go along with that.
    Just to clarify, Mnemosyne: I am perfectly aware of that. In fact, AFAIK most of the bankruptcies occur as a result of high medical bills (see this). Notice the disclaimer in my original comment :o)

  • bulbul

    colin: bad, bad, bad boy. Looks like it’s off to Santiago de Compostella for you :o)

  • Mnemosyne

    bulbul, both Spherical Time and I pointed out the inconsistency if you were really trying to make the Libertarian argument: with Libertarianism, businesses are supposed to be just as “self-reliant” as individuals. Under a Libertarian system, the banks would be unable to get this legislation passed because they would be responsible for making sure the people they were lending to were actually reliable. If they make a bad guess, tough luck to them.
    What you were really making was the right-wing Conservatarian argument. (Conservatarian=Republican who likes to smoke pot and thinks that s/he’s the only one who deserves civil liberties.) Not the same thing at all.

  • bulbul

    Mnemosyne: I see. The problem is, I was not defending the Bankruptcy Bill, nor advocating government intervention. I wasn’t even trying to make a consistent Libertarian argument.

  • Spherical Time

    It was phrased as an argument though, despite your disclaimer. I think that’s where we started to run into problems.

  • cminus

    Why can’t we go back to those halcyon days of 1992-1994 when the Democrats shut down the capitalist system and redistributed the wealth to everyone? Remember those days? It was a major party, I’ll tell ya.
    Mnemnosyne, no fair teasing Puck about things that happened when he was two.

  • mrlinzy

    The name of a bank? Maryland Bank of North America, or MBNA. They are the largest issuer of credit cards in the country, they are a major supporter of the GOP and George Bush (for example, third largest contributor in 2000 at $1.7 million), and they lobbied tirelessly for the the new bankruptcy law.
    MBNA has recently been acquired by Bank of America.

  • rob

    Just to note how frivolous all this lending is, my dog has twice been sent pre-approved credit cards in the mail.
    I wonder, if the creditors came a-callin’, would they accept the deposits he leaves on our neighbor’s front lawn?

  • cjmr

    Just to note how frivolous all this lending is, my dog has twice been sent pre-approved credit cards in the mail.
    So has my now 7.5 year old son. He was 6 months old at the time. MBNA does want to start them off in debt early in life, don’t they?


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