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The economic crisis: Are the consumers or the banks to blame?

Categories: Money

6 comments

I am going to try and not get too technical here — I am not a finance expert, by any means — but I have to tell you that I’ve been thinking a LOT (too much) about the current economic crisis and who is responsible for it.

On the one hand, it’s now become pretty apparent that the main players in our credit system failed: Banks and credit card companies extended credit to millions of consumers who had no business borrowing that much money to buy cars, houses, or to get high credit limits on their credit cards. One of the most fascinating and scary things I’ve read on this subject is an email from a banker who witnessed the ridiculous degree to which banks and credit companies got lax with doling out credit. His email was recently reprinted in the New York Times and it’s worth a read if you’re interested in this topic. I had no idea, for example, that when you apply for a credit card the credit card company does not verify the household income number you put on your application. Wow.

This paragraph from the banker’s email really drove home the fact that banks and credit card companies, by being so lax with giving out credit, have a lot to do with the current collapse:

I recently had a client apply for a credit card. She is a homemaker, with no personal income. The house she lives in is in her husband’s name. She would have asked for a $3,000 credit line, just to pay miscellaneous expenses and to establish some credit on her own. So the computer is told that her household income is $150,000; her mortgage/rent payment is zero. The fact is that her husband’s mortgage payment is $7,000 a month (which he got with a no income verification loan). She had a good credit score, but limited credit since she has only lived in this country for the last three years. The system gave her an approval for a $26,000 line of credit!

But here’s the flip side: What about the millions of consumers who went out and bought houses they could not afford and spent lines of credit they could not pay back? My credit card has a $25,000 credit line (no doubt based on the household income we used to have before I became an entrepreneur). But I wouldn’t dare spend anywhere near that because we can’t afford it. When we applied for a loan for our current house we were offered more than we asked for. Sure, those gorgeous bigger homes we could have afforded with that higher loan amount look great, but we can’t afford the monthly payments. In other words, we’ve taken responsibility for our finances and our credit, even though the credit card companies and banks have clearly been too generous with it.

I understand, of course, that both my husband and I are well-educated people, with a solid understanding of credit, various loan structures, monthly budgets, etc. Many of the consumers who took out those no down-payment, no interest adjustable loans were not financially savvy and trusted their bank. I think it is absurd that we don’t require some type of financial literacy courses in our schools and even colleges, because it’s a core life skill, right up there with reading, writing, and communication. But I think this is too easy of an excuse, I think many of the people who overspent beyond their means are plenty smart and educated to have known they were doing something that would eventually get them in financial trouble.

So I’m stuck trying to figure who is to blame for this mess. The answer is probably quite complicated — the banks with lax credit rules, consumers borrowing and spending beyond their means, the government without proper credit markets oversight, our education system without proper financial fundamentals for students. But I am curious what your take is on this topic so sound off in the comments!



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6 comments so far...

  • very well written. Couple of days ago (don’t remember the time or the channel) but it was one of the local news channels, abc or nbc, reported that the Asian (immigrant) community doing well because they mainly use cash for their expenses. In other words they buy what they can afford.

    It’s interesting to see the money managment skills of the immigrant community versus the community that was born and raised here. I came to this country when I was 11 and I am able to clearly distinguish the difference.

    Not to say that everyone is the same but certainly there were many irresponsible actions and misunderstandings about the concept of a credit card, loans and such.

    I applied for a business line of credit about two months ago and was rejected. That wasn’t right. At that time I had a full time job, my husband’s income, assets, the only debt we have is the mortgage, everything else is paid off, not because we are rich, but because we live within our means. I also have a high credit score. I was very upset.

    These underwriters went from one extreme to the other. Where is the rationale, can’t these people who get college degrees and work well paying jobs think? Seriously. It’s like those underwriters can’t think. They just follow the hype. Think people. Think.

    Vera Babayeva  |  December 2nd, 2008 at 8:44 pm

  • Well, I think people are addicted to spending. It’s like being addicted to cigarrettes. There is fault all around. Mom smoked, teacher smoked, the store didn’t card, the tobacco companies weren’t straight about how addictive it is, the government was happy to collect tobacco taxes and help out the tobacco farmers, and the individual knew it was dangerous and addictive but did it anyway.

    In my book, individual responsibility comes first. The individual is the one with all the information necessary to determine how much spending is OK. He can always lie or hide info from the credit card companies. True, the credit card companies could do a more involved check, but do we really want credit to be that hard for all of us to get? In many countries, only a very privileged few can get any kind of credit, because the lenders are extremely careful, due to the tendency of individuals to lie. Well, relatively, credit is easier to get in the US, because most of us are relatively honest by global standards (believe it or not). This is usually a good thing. Most of us historically haven’t abused it. Generally we make one or two mistakes, get penalized through fees and high interest, and learn our lesson. If we now say that it’s preferable for the banks to investigate every borrower beyond running a standard credit check or whatever other computerized stuff they can easily do, then we’re saying we want it to be hard for us responsible people to use plastic.

    As far as house loans, I don’t know about you, but I was investigated pretty thoroughly when I bought mine. I suppose it would have been possible for me to defraud the banks, but it would have required more than just putting my wishful thinking down on paper.

    I recall the days when there was a lot of fuss about minorities being refused loans more than whites, and people insisting it must be caused by discrimination. Then the banks were required to change their practices so that the ratio improved. Well, to the extent the ratio was due to factors other than discrimination, this either meant refusing loans to creditworthy whites or loosening the qualifications for borrowers. We can argue in hindsight that the former would have been a better choice. But actually, neither choice was fair to the banks. And again, just because people were then able to get loans easier doesn’t mean they were right to take out huge mortgages.

    Then again, the credit card companies are akin to panderers. Over the years, how many times have we received mailings saying “you deserve a vacation - charge it,” etc., etc. They do this with the knowledge that some people will end up paying more interest and fees than they can afford, but since most of us will try really hard to honor our debts, the credit card companies won’t be out much - unless the whole economy goes to pot. I’ve always felt that credit card companies who pull these stunts should (a) not be allowed to collect significant fees or penalty interest, and (b) have a lower priority should folks go bankrupt. There should be a disincentive to encourage self-destructive behavior, even that of adults.

    Now, from a bigger picture perspective, the mortgage / banking crisis didn’t need to lead to an all-out economic “meltdown.” That was caused by politicians who were hoping to use the crisis for their own gain. It caused (and continues to cause) folks who are otherwise unaffected to panic and cut their spending, creating an unnecessary domino effect.

    The other factor at work is the fear of those with means that the Obama administration is going to cut into those means. They are holding back on starting new projects and ventures until they see what is going to happen. Again, this creates a domino effect as their suppliers’ orders dry up and so on, and lots of folks are losing their jobs.

    And now the liberals who will soon have essentially unchecked power will use this “crisis” as an excuse to try to implement more anti-capitalist policies, which will lead to further stagnation in the for-profit sector, fewer taxpayers, and still bigger problems down the road.

    So what we have here is a combination of individual mistakes, mass hysteria, and political greed. A lot of it was totally avoidable and still stoppable, if handled the right way.

    SKL  |  December 2nd, 2008 at 9:31 pm

  • Between those two choices you named. I would say the consumers are to blame. It was THEIR choice to apply for loans, credit cards, etc. Sure, the banks approved their requests, but if they didn’t apply in the first place, they wouldn’t be stuck with a large loan they couldn’t pay back.

    Buying everything with cash is not a bad idea at all (although I don’t think I could ever do it). It prevents buying what you can’t afford. Seriously, credit cards can be pretty evil because they allow you to succomb to the buying temptation. There is great satisfaction and a sense of accomplishment from BUYING. I think that’s how many people get stuck with a heavy credit card debt. It’s so easy to whip it out at the store because the item you’re buying seems to be free when you’re at the cash register, but when the bill comes, you realize you don’t have enough to pay for it. And then you’re stuck with an accumulating balance every month. That’s the downfall of credit cards.

    I am very lucky that frugality is in my personality. I hate spending money (though of course I have to) so my own hinderances helps my husband and I to spend less and buy things we need and not too much of things we want.

    Linda  |  December 3rd, 2008 at 6:11 pm

  • Great piece! I think both the lenders and borrowers are to blame here… but — having read the NYT piece you cite and plenty of other “evidence” — I place MORE blame on the banking and mortgage industry. They KNEW what was happening and put their heads in the sand. It’s just shameful, there is no other word for it.

    My husband has a PhD. He’s a pretty smart guy. We bought our first house six years ago. He flew out to where we were buying and handled everything on his own, until the final paper signing when I joined.

    I remember he called one night, as we were about to commit to our house, and said, “You know, Rick (not his real name), the mortgage guy, said we could afford more house. He did the numbers. He’s saying we should go for this other house.”

    We had a 30 minute discussion about this and decided Rick was wrong. We were indeed property virgins, but if you cleared away the smoke and mirrors and just used common sense, you could see RIck was wrong. We often bring this up, wondering how on EARTH we would be faring with a mortgage any higher than what we have now.

    So, imagine all the Ricks out there, talking to people who just may live in a fantasy world (like people who run up credit cards thinking they’ll never have to pay the piper) or who just may not be savvy enough to crunch the numbers and understand real estate (what goes up must come down), convincing them that they can afford their dream house. He promises you that the value will shoot through the roof, and in a few years you’ll be sitting pretty.

    I can’t blame people too much if they’re easily persuaded by slick salesmen and aren’t educated enough on the topic. However, I think a lot of people WERE smart enough to know better, but they were greedy and chose denial. I do blame them as well as the banks.

    You’re also correct in saying we need to teach financial literacy. All teens should learn this, it should be mandatory in schools.

    De-regulation and eight years of greed and poor judgment got us into this mess, and now I hope the Democrats can get us out. They’ve got a big, big mess ahead.

    KeegsMom  |  December 4th, 2008 at 11:21 am

  • There is a place in the market for lending to high-risk borrowers. I believe one of the key causes of the financial meltdown is that banks knowingly bundled up these high-risk loans and sold them without disclosing to the buyers the true nature of the risks. Then when people started defaulting on the loans, the financial market went into panic because nobody could tell who was holding good loans and who was holding bad ones. So while individuals are partly to blame, it was ultimately the banks who leveraged themselves and the economy into a crisis.

    SoftwareMom  |  December 5th, 2008 at 4:06 pm

  • If someone lies to you, and you believe it, who is in the wrong?

    I blame the banks and the credit industry. I have read about and experienced first-hand some of the tactics that were being used by lenders. My husband and I are both college-educated, but our mortgage still confused us. When we were refinancing, we negotiated a loan with a lender. Then, when it came time to sign the papers, the terms were totally different than what we had agreed upon. When we refused to sign, we were harassed, bullied, called names, and cussed at. It was enough to make me cry.

    On top of that, those lenders KNEW BETTER. Yes, people borrowed more than they could afford. But I do not for one second believe that all those people did it knowing up front that they were going to end up having to default on their loans. The lenders, on the other hand, KNEW. They are the ones who put our entire financial system in jeopardy. They are the ones who made those high risk loans knowing that it could (and probably would) all blow up in their faces and we (everyone else) would be the ones to pay for it. All they cared about was the commissions they were getting right then, the money to be made in the moment.

    Naivete does not make one immoral. Dumb, maybe. But knowingly lying to people, making loans without doing due diligence, premeditated negligence? That equals blame, in my opinion.

    Robyn  |  December 8th, 2008 at 10:36 am

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