Is it just me, or does this make anyone else nervous.
Read this.
Then read this.
Deja vu? Is it just me, or is this exactly history repeating itself. The most disturbing confluence is:
- Cheap Credit
- Bad Loans
- Reinvestment in Real Estate
Basically, credit gets cheap. Banks compete too much because of the cheap credit. Bad loans are made because of the competition. Given the cheap credit, people reinvest in the real-estate, essentially refinancing themselves so it is never paid off.
In that environment, it was just a matter of time until bad loans creeped unacceptably high. Even worse, naive interpretation of loan failure statistics gave a false sense of security. When times are good, the bad loans look okay because they aren’t failing. As soon as the economy contracts, everything goes down like a house of cards.
The crazy bit is that the issuing of bad loans is incentivized. It’s a Loan Officer’s job to make loans, under-producers are fired, banks compete, and the process of elimination wipes out any Loan Officers with restraint. As the banks each try to get an edge, they find ways to creatively relax loan requirements. When all is done, whoever loosened the loan requirements is at fault, leaving the investors in the bank, possibly the depositors, and the loan-holder picking up the pieces.
While it would be nice to point the finger at the Loan Officers, company boards, or some middle management, I bet that most of the time it wasn’t even a single person, but a group of people working uncoordinated. Sometimes it would have been a large investor who was overly pushy trying to squeeze out some more stock value. Other times it would be a loan officer struggling to cram in a deal that was already borderline. Maybe it was a bank manager trying not to come up on the bottom of the list.
As usual, the wisdom of the market can make major things happen, but it doesn’t prevent abuse. It’s a raging inferno that’s just as content to power our economic engine as it is to blow the engine apart.
At some point all of Wall Street was silently overrun with people who’s predictions, worse-cases, and guarantees weren’t based in reality. They should have been the last line of defense. Some auditors or fund managers should have raised a flag–and their management should have taken them seriously. I have a hunch that nothing currently being considered can really address that–the human tendency to avoid bad news runs deep.
About Jayson Vantuyl
I live in San Francisco, California; have an awesome son, David; and make machines do (subjectively) interesting things. I'm generally an all around handy fellow.