|
||
The Credit Crisis and Trust Networks
What do analyses of social networks and trust have in common with the subprime-mortgage credit crisis? Quite a bit, it turns out.
The NYTimes on Sept. 2, in "Can the Mortgage Crisis Swallow a Town?" introduces the Egglestons of Maple Heights, Ohio. They're a hardworking family trying to sell their house in a market where prices are falling -- because too many neighbors are selling -- because banks are foreclosing -- because owners bought exotic mortgage-crack they can no longer afford.
The same article describes a business victim: Mark Stefanski, CEO of Third Federal Savings and Loan, a Cleveland thrift that his parents founded in 1938.
Unlike most of his competitors, Mr. Stefanski resisted the urge to cash in on the subprime lending boom..."The model has shifted," says Mr. Stefanski. "It became very lucrative. But it was totally irresponsible for the sake of greed." Not that Mr. Stefanski didn't notice the profits to be had. "Absolutely, we were tempted," he acknowledges. "We arm-wrestled and talked, but we decided not to change the model. We felt it wasn't the right thing to do."
Mr. Stefanski is no social worker. He lives in an affluent suburb of Cleveland and earned nearly $2 million last year. But he does not hide his feelings about just what went wrong in places like Maple Heights. "The whole system was based on raping the public," he says, matter-of-factly. "Not everyone should own a home -- just those who can afford it."
Third Federal has a branch in Maple Heights, Mr. Stefanski says, and in the past, "we owned Maple Heights." But in recent years, he says, "The predators just jumped on it."
Third Federal's share of the mortgage market in northeastern Ohio fell to a low of about 11 percent by 2001 from more than 30 percent in the early 1990s.
Back to trusted social networks.
There's a lot of interest in using digital technologies to create trusted networks. The economic gains of lowered transaction costs from trust are real -- it isn't just a blogosphere fad.
The problem with trust is -- at heart it's an analogue function in a world of digital suitors.
Put too many degrees of separation between you and another, and trust falls down. The decay rate of trust from my LinkedIn friend to my friend's friend is huge.
As my friend David Krathwohl says, "I'll trust a seller's eBay ranking to buy a book; that doesn't mean I'll introduce him to my daughter."
Which brings us back to mortgages.
When a bank owns the mortgage, the bank earns money -- or not -- when the borrower pays back the loan--or defaults. But when the owner of the mortgage is many times removed--when the mortgage is sold, then securitized, then re-sold as part of a package of collateralized debt obligations (CDOs) -- that incentive is removed. The nth "owner" of the mortgage -- the CDO buyer -- doesn't re-check the credit risk.
Bank regulations once addressed loose lending; there is no such regulation on the underlying credit risk for CDOs. As the Sept. 2 NY Times Magazine article "Subprime Time" describes, they depended on ratings agencies.
Like addicts seeking a faster high, banks and ratings agencies switched to the fast fees of transaction income over the longer returns of relationship banking. Ditto the ratings agencies, and the securitizers.
The new system made for a more liquid market; sounds good, right? It spread risk; another good. And it substituted efficient markets for local cottage industries. More good.
But the whole thing also rested on turning relationships into transactions. This is the dark side of business process re-engineering, Web 2.0, and globalization -- everything can be sliced and diced and outsourced to others in the name of efficiency and liquidity. But at each point, a diet of transactions-only starves relationships -- and therefore trust.
Degrees of separation matter. Not everyone reacts like Mr. Stefanski, and he can't carry the load alone.
Too many degrees and you get the musical chairs game: I'll be gone, you'll be gone, let's just do this deal and get out before the music stops. Greed thrives, ethics starve. And as with all relationships deprived of the currency of the Real, things can get pretty transactional pretty fast.
It's ironic. What sounds like sound principles of insurance (spread the risk), banking (liquidity), and networking (spread the contacts), ends up producing endemic greed, visiting disaster on consumers, and punishing ethical businesspeople.
Trust doesn't travel well digitally. A song loses no data when it's digitally copied -- but digital replication of trust loses heart. A "trust network" based solely on transactions is a network devoid of all but the narrowest version of trust -- a track record with no memory of what it is supposed to be tracking.
Follow Charles H. Green on Twitter: www.twitter.com/charleshgreen
Loading comments…
Want to reply to a comment? Hint: Click "Reply" at the bottom of the comment; after being approved your comment will appear directly underneath the comment you replied to
Heh! Heh! The car is paid for; Mortgage is $515 a Month (including Principal, Interest and Property taxes. Wouldn’t you love to live in this state? We are definitely under the radar), Zero credit card (after thirty days) debt, 8K in the savings account, 3.5K in the checking account, and a new apartment (for retirement) in the south of France. All done with an income ranging from 51K to 75K over ten years. It is hard to save money, but if you save until it hurts and keep your health you are not a slave to the state capitalism that is the American economy.
Here is an interesting comparison. Canada's home and mortgage market will not be imploding. Why? Because as a regulated industry in Canada, less than 5% of their market is subprime. And here in the USA more than 20% of the market is subprime. Why? Because it is unregulated.
The market will decide is common wisdom some days, and it seems that the market [well, and the GOP] has decided to drive us off a cliff and into a market depression.
Capitalism is based on buying and selling. When you can't trust anyone, then capitalism cannot survive. You have to have a certain amount of trust.
Even the ratings were jived up on the bad loans.
On my online bank it has a place to see how much home can you afford. It doesn't ask your income, just how big a payment you can make.
Didn't they use to say that you shouldn't pay more than 25% of your salary for a house payment? Now they say 4 times your salary.
What a lot of people miss, a $50,000 income family cannot afford a $2000 a month payment. If you make $100,000 you probably can.
The old rule was that you could spend 28% of your income minus debts for your mortgage payment. Also, you shouldn't borrow more that 2.5 times your annual salary. And you needed a 20% down payment. The change in lending standards (with the help of greedy mortgage brokers and real estate agents) are what created this mess.
My wife received a credit card "offer" from Chase the other day. No, we did not accept (why do credit when debit is available, if you can't afford it YOU CAN'T AFFORD IT)however I would like to reprint some of the wordage. It was a teaser rate zero percent, but, "you may lose the low introductory rate if we don't receive at least the required minimum payment by the requred date AND TIME.." some other excerpts "rates and terms may change: we reserve the right to change the account terms (including apr's) AT ANY TIME FOR ANY REASON" by the way that zero percent interest can change to 32.24% and late fees on amounts over $250.00 are $39.00. Oh yeah I trust the bankers.
These crooks knew a day of reckoning would come, so, in 2005 they laid the protections for themselves with the Bankruptcy Reform Bill.
They will escape the consequences of their greed by a government (taxpayer) bailout, but none of their victims will ever escape the debts they owe these crooks.
Oh, I'm not too sure about that, Desiderata. There comes a time when a man simply says, "they can whistle for it." And I think that very soon you will be seeing that sort of thing happening a lot ... no matter what the law says.
"Let 'em put me in jail. At least that way I'll have a warm place to sleep." Desperation can easily lead to just such an attitude.
You've got a life to live, and not too many years in which to live it. If you made a mistake ... if you owe half-a-million dollars on a pile of sticks and stones and asphalt shingles that cost less than $40,000 parts-and-labor to construct ... you're gonna walk away. You're not going to live the rest of your days in debtor's prison: it just ain't gonna happen. You might fill the house with gasoline and strike a match before you go, but you're gonna walk away. And if they call that fire "mysterious," then du-u-uhh...
In this and in an awful lot of other ways, the amount of "money" in circulation is huge ... much of that "money" actually consisting of debts of one sort or another ... but the amount of "value" and "production of value" is lower than it has ever been before. The factories are closed: the goods come in container-ships from 10,000 miles away and they're painted with lead paint.
It's going to be messy and bloody. I don't use the word "recession" to describe it. I'm fully prepared to matter-of-factly use the much darker words: "great depression."
When the euphemisms finally stop, recovery can finally begin.
Some states have laws that allow middlemen to collect the home payments. Now many of these middlemen ar filing bankruptixe and never turning over the payment to the lein holders or bank.
How can this happen in the USA?
Where are the laws?
Good sir, with all due respect to you I do believe that the TRUE situation is far wider than this .. and more simple.
For a great many years now, the banking and financial industries have been preying upon "the hapless creditor," burying him in debt at interest rates which, not too many years ago, were not only "against the law" but "reprehensible."
Today, this industry thinks nothing of charging 31% interest (or more!) on "a basic credit card." (And it might consider slashing that interest rate to 19%, and then raising it right back up again in six weeks, "an ordinary business decision.")
There was a very good and very sound business reason why "usury" was not only prohibited but utterly reprehensible in the halls of human society for thousands of years ... until ten years ago.
Pure-and-simple human GREED created this entirely-forseeable and entirely-avoidable future.
You must be logged in to comment. Log in or connect with
