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Credit Crunch: Millions of Dumb Decisions, In Their Own Voice

By Robert Folsom
Mon, 19 May 2008 17:30:00 ET
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Over the weekend I listened to a podcast from public radio's "This American Life," about the housing crisis. It was an exceptionally well-done story, which combined simple explanations of the crisis with personal interviews of people who helped create it. And I do mean "create" -- everyone from the manager of a massive hedge fund specializing in CDOs (collateralized debt obligations), to a guy with no full-time job and bad credit who managed to get a $540,000 home equity loan.

I already had a pretty good big-picture grasp of how the housing crisis happened, but there's nothing like learning the details directly from the people involved. Was there really a loan called a "NINA" (no income, no assets)? There was indeed, and they were widespread. In the words of a Wall Street banker who bought those loans, "That's a liar's loan...We are setting you up to lie...Something about that transaction feels very wrong." The $540,000 home equity loan mentioned above was a NINA. The lender simply didn't check the borrower's employment or credit history; now the loan is in default. The borrower says he was not duped, lied to, or pressured. He made it clear that the transaction was a partnership of two choices: a dumb decision to borrow and a dumb decision to lend. The same can be said of millions of similarly dumb decisions.


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There was of course a conspicuously shady side to subprime lending -- one interview was with a guy who, just out of college, joined a boiler-room style mortgage broker. At the height of the real estate bubble he made $75,000-$100,000 per month, foisting large loans on people who (in his words) "didn't have a pot to piss in." The good times came and went at the same velocity. Now he's fighting the foreclosure of his own home.

The broadcast also explained the role psychology played. A mid-level manager said his mortgage brokers would complain when they learned that loans deemed "too risky" for their firm to approve, had in turn been approved by competitors. The manager would complain to higher-ups, who would then further relax loan standards. Soon the whole industry was watching itself and waiting for "who takes the next step" in approving ever-riskier loans. There were many of those steps, and in each case the whole herd would follow.

Collective human behavior is patterned. The patterns are more obvious in some activities than in others, but if you're patient and ask the right questions, the evidence is there. In the financial markets, the evidence is as close as the price -- or specifically, on the price charts. Come see what we see in the markets we follow, by clicking here.

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