The Lower Class Middle Class
I encourage you all to add CNSNews.com to your normal circuit of news sites. They have a bit of a Conservative slant, but they’re not nearly as biased as a large portion of the mostly Liberal mainstream media. They posted a story today discussing how the Community Reinvestment Act played a pivotal role in creating our housing bubble. [link]
According to Wikipedia [link] (which I acknowledge is not a terribly reliable primary source, however, information that it cites from elsewhere is used here), “the CRA seeks to ensure the provision of credit to all parts of a community, regardless of the relative wealth or poverty of a neighborhood.” Did you catch that? Let’s remove the doublespeak. “parts of a community” = “people”. “the relative wealth or poverty of a neighborhood” = “their ability to pay back loans”.
So the quote should read “the CRA seeks to ensure the provision of credit to all people, regardless of their ability to pay back loans.” It sounds a whole lot more ridiculous when the fluffy language is removed. Think about it for a second — the act encourages lenders to lend to people in relatively impoverished neighborhoods. If the neighborhood is relatively impoverished, then on average, the people living there are relatively less likely to repay their debts, making them a riskier prospect for lending. Why then should banks be pressured into lending to these people??
Politicians like to spin it by saying that people should be able to acquire credit based on their ability to repay the loan, rather than where they live. What the politicians are missing is that where a person lives is a factor in determining their ability to repay a loan. In the same way that I’ll pay more for renter’s insurance if I live a terrible neighborhood, living in that neighborhood suggests something about my ability or willingness to repay debt. If I’m so good at repaying debt, why do I still live in such a crappy neighborhood? It’s a valid question.
Having said that, the CRA isn’t the whole story, when it comes to the housing bubble. The CRA all by itself isn’t a smoking gun. However, the CRA pressuing banks into lending to lower income borrowers, combined with the securitization (making them into securities, selling them on the market) of the loans, combined with the historically low Federal Funds Rate, made money very easily accessible. This, combined with increases in real estate speculation, just set us up for failure.
I don’t blame the CRA for the whole thing, but it certainly contributed in no small part to this culture that everyone is entitled to own a home, nice things, and free-flowing credit. That culture is ultimately what is responsible for the housing bubble, and though the CRA didn’t single-handedly cause that culture to come about, I argue that without the CRA, it wouldn’t have.
The last thing I’d like to touch on is the concept of predatory lending. I mentioned this briefly in a previous blog, but I’d like to go into a bit more detail. Some critics of “predatory lending” cite “risk-based pricing” as a predatory lending practice. This is just silly! If you’re less likely to pay me back, then I’m going to charge you more for the loan than I would someone who’s more reliable. It’s experiment time!
Let’s say for example that I loan $100 to each of 100 people. I’ve lent out $10,000. Now, if I estimate that 20 of those people won’t pay me back, then in order to break even, I need to get $125 back from each of the 80 people that will actually pay, so to break even, I have to charge at least a 25% interest rate. Now charging the interest rate increases the repayment amount, which would cause a few more people to fail to pay me back, but it’s a diminishing effect, so I’ll leave it out for simplicity’s sake.
Now imagine I lend a different $10,000 to a different 100 people. Let’s say these people are much more likely to pay me back — I estimate that only 4 of them will fail to pay me back. So to break even, each of the 96 people who pay me back must pay me $104.17, a 4.17% interest rate. The point is, if a person is in a higher risk group, the bank rightly charges a higher interest rate, because that group, on balance doesn’t pay back their loans as consistently. This is not rocket science.
Then there’s the concept of Caveat Emptor. Here’s the think, folks. You’re not buying a box of chicken nuggets. You’re buying a home, which in all likelihood is the most expensive thing you will ever purchase. Don’t you think you should do your homework first? How do adjustable rate mortgages work? What are “points?” What is a “good” interest rate? These are all questions you owe it to yourself to research. Mortgage lenders, like all other businesses, exist to make money. People go out and buy a home without understanding the terms to which they agreed, then they want to blame the mortgage company for not adequately explaining it? Last time I checked, it was up to the person signing the contract to understand what they’re signing!!! And I’d like to know how it’s possible to lend someone too much. Sure, I’ll qualify you for a $750,000 loan. It’s a 3/1 30-year ARM with a 3% introductory rate and a 10% change cap. That means after 3 years, the interest rate can change, and it can change every 1 year after that by as much as 10% per year. That means at the end of year 3, your interest rate can go from 3% to 13%, and the following year, it can go to 23%. Additionally, let’s do the math here: Let’s say I offer you a 30-year fixed rate mortgage for $750,000 at 6%. Based on CNNMoney.com’s Mortgage Calculator [link], your monthly payment would be just about $4,500 per month. Can you afford this payment? Too many people saw the dollar signs of how much the bank was willing to lend them, and they went all-in, never really considering that a) they can’t actually afford the payment, or that b) their payment could change. Understand the terms before you sign. If you don’t, then I would argue that you’re not responsible enough to own a home in the first place, and have no sympathy for you when you lose it.
This pervasive attitude of entitlement is killing us. We act like we all deserve to own a home, whether we can really afford it or not. We act like we have a right to have the big screen TV, the BMW, and the garage to park it in. The middle class thinks they deserve all the amenities the upper class can afford, and as a result of their over-spending, the middle class relegates itself to a debt-ridden life, ultimately resulting in a lower class existence.
If we’re to make it, we need to learn to live within the confines of our wallets, rather than the expanse of our egos, and that, folks, is the bottom line.
^Z
