Why it made business sense to make bad loans

subprime

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The subprime mortgage crisis was caused by bankers intentionally lending money to people without good incomes, sold assets or good credit records.

This is hard for a lot of people to understand.  As a friend of mine said, why would a bank lend her money unless they had good reason to believe that she would pay them back?

The answer is that what’s financially destructive for a bank as a corporation can be profitable for a banker as an individual.

Irresponsible-Borrowers-Cartoon4During the run-up to the subprime mortgage crisis, bankers got big bonuses for making high-interest loans, without regard to how risky those loans were.  In many cases, they were able to package financial instruments based on these mortgages, get high ratings for them from credit agencies and unload them on suckers.

There’s name for this practice.   It is “control fraud“.

But the Obama administration has chosen not to prosecute bankers.  Instead it is going after the small fry who put incorrect or incomplete information on their applications.   Thomas Frank wrote an article in Salon about how a California jury refused to convict a bunch of “liar’s loan” applicants on the grounds that you can’t mislead someone who isn’t interested in knowing the truth in the first place.

The article is worth reading for its clear explanation of how control fraud works, but I think Thomas Frank is over-optimistic about how much of a precedent the California jury’s verdict will create.  It depends on how many judges will allow this kind of defense to be made.  Many of them rule that the only issue is whether the form is filled out correctly, and that the largest context is irrelevant.

Alternatively the government could allow the banks to face the consequences of making bad loans.  This would provide an incentive for boards of directors to think about long-term consequences as well as short-term profit.  But the Obama administration, like administrations before it, has chosen to bail out the banks on the grounds that their failure would disrupt the economy.

The problem with bailouts is twofold.   Bailouts give recklessly-managed banks an advantage over prudently-managed banks.   And at some point the too-big-to-fail banks become too big to save.

LINK

Finally Wall Street gets put on trial:  We can still hold the 0.1 percent responsible for tanking the economy by Thomas Frank for Salon.

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