It's the Banks' Fault (op-ed)

Sometimes I hate being right.

I wrote an article 10 years ago called It's the Banks' fault, really. I was frustrated with the financial meltdown, and the government-bank bailout, but mostly I was frustrated with the lack of accountability.

  image credit -  flickr ville misaki

image credit - flickr ville misaki

 

Have you been to Las Vegas lately? I get to Vegas every couple of years, and I'm always blown away by how fast it grows. There are always shiny new casinos, and each one is bigger than the last. Then the older casinos keep updating themselves, adding additional rooms and more extravagance in an effort to stay relevant.

This has been happening consistently since the 1960s. And why? Because the casinos control the game!

  image credit -  flickr matthewpaulson

image credit - flickr matthewpaulson

 

The casinos have the money and they set the rules for each of the gambling games.

  • Who wins under every possible outcome - each turn of the card, roll of the dice, and bounce of the ball.
  • How much you'll get paid under every circumstance, and when you can cash out.

They have all the power and control, and they have set up the rules of the game such that they win more often than they lose. Period. The end. You can win one weekend, and I might win another time, but by and large, over the long run, the casinos win more than the people who gamble.

Could you imagine if the opposite were true?

What if the casinos set up the games for a short-term increase in the number of guests, rather than the long-term profitability? They would compete with each other to lower their winning percentage, a little at a time, until eventually they went below the 50% mark - and started giving the edge to the gamblers.

The gamblers would start winning more money, more frequently, and word would spread. More people would fly to Vegas from more parts of the world, and every casino's hotel would be fully booked. (Short-term goal achieved!)

But it wouldn't take long before that many gamblers, all playing with winning odds, would break the casinos.

In this scenario, all of the Las Vegas casinos would go bankrupt, and the city itself would collapse. And would we expect a government bailout?

This is exactly what happened with the banks in the early 2000s.

  • The banks had the money to make mortgage loans.
  • The banks wrote the legal language of the promissory notes. (You're not allowed to edit the loan paperwork at the closing table, right?)
  • The banks had made tens of millions of loans over the years, and had all the statistical data to determine which borrowers were more likely to repay their loan.
  • The banks set the pricing of the loan.
  • The banks were given fully compliant borrowers, and were allowed to investigate creditworthiness in just about any way imaginable.
  • And ultimately, the banks were the ones who decided which loans got made, to which borrowers, and under what terms.

But, instead of taking a Las Vegas Casino approach by setting favorable terms, the banks took the "what if" approach, and decided to give up their advantage. They stopped underwriting, and started making loans under whatever terms the borrowers wanted.

So what would you expect to happen? They stated making $500,000 loans to single-mom schoolteachers, and all sorts of other scenarios that common sense would say didn't make sense. Of course the banks lost money - lots of money. Tons of money. And rightfully so.

The banks who participated in this "close your eyes" style of lending should have been run out of business. And the people in charge - the top 4-5 levels of management - should not have kept their jobs. But they did.

The bailout let the banks, and the banks' management teams, avoid any real consequences. In fact, a few years later these same banks were reporting record profitability! It's the opposite of what should have happened.

And if bad actions don't have any consequences, do you think those actions are going to stop? NO! It doesn't matter whether you're a young child or a Fortune 500 CEO - everybody's behaviors are shaped by consequences to actions.

Grrrr. I'm still frustrated by the whole ordeal. So why drag all this back through the mud? Because I read something recently - Patrick Watson, a big-time, well-respected economist, and Neel Kashkari, president of the Minneapolis Federal Reserve Bank - totally agree with me! (see the article Capitalism Can't Work Without Losers). And worse, they think the table is being set for another round of bank-induced instability.

Being smart with your money is a great idea for us and our families. But then I guess we aren't cut out for running a big bank...

- Chris Butterworth