Consumer Negligence is Missing from FCIC Report

On January 27, 2011, the Financial Crisis Inquiry Commission (FCIC) released its long-awaited report detailing the “causes, domestic and global, of the current financial and economic crisis in the United States.”
FCIC Blame Game
As one would imagine, there was plenty of blame to go around. The commission cited critical failures made by policymakers, banks and investors.

Surprisingly, though, it didn’t have much to say about the biggest elephant in the room — greed and negligence at the consumer level. Consumers had a major role in all of this, after all. But that role was scarcely mentioned in the report.

I’m still trudging through the 600+ pages in the report. So far, the blame for the financial crisis seems to be centered on Wall Street, mortgage lenders, and the government officials that received so many campaign contributions from these lenders.

The Federal Reserve got slammed as well. The report cited the Fed’s “pivotal failure to stem the flow of toxic mortgages” by setting certain guidelines and standards for the lending industry. The Federal Reserve, said the commission, was the only organization with the power to prevent this kind of reckless lending. But it failed to do so.

I would agree with most of this. But I don’t understand why the subject of American greed was largely ignored in the report. In other words, why weren’t consumers given their fair share of the blame? Perhaps it’s because some members of the commission are public officials. Wagging a finger at their supporters and constituents would hardly be prudent, from a career standpoint.

Sometimes, Home Buyers Blindfold Themselves

There is a widely held notion that the housing crisis was created solely by unethical mortgage lenders. Certainly, these modern-day robber barons had a role in all of this. But that’s just the supply side of the equation. We must not forget the demand side, and the lessons to be learned there.

During the housing boom, there were plenty of well-intentioned home buyers who were lied to by mortgage lenders and brokers. But there were just as many (and perhaps more) buyers who knowingly bought homes they could not afford. These borrowers were often given adjustable-rate mortgages with low “teaser” rates for the first few years. In some cases, they were even allowed to choose the size of their monthly payments through the (now vilified) pay-option ARM loan.

You know the rest of this story. The full interest cost of these loans got pushed down the road. Many homeowners even saw their loan balances grow from one month to the next, through negative amortization. Monthly payments doubled, and sometimes even tripled, when the ARM loans began to adjust. The rest is history.

There are three sides to this triangle, and they all deserve some of the blame. Policymakers and regulatory agencies failed to predict and prevent this colossal meltdown. Lenders gave mortgage loans to an army of high-risk borrowers — people who would never qualify for a loan under current guidelines.

The third side of the triangle is the one you don’t hear about very often. It’s the consumer side. Many home buyers took on a level of mortgage debt they knew they couldn’t handle. They blindfolded themselves with greed, denial, and the expectation of financial options that never came to fruition. “I should be getting a raise in a year or so, and that will help me afford the larger payments.” Or this old chestnut: “Home prices will never go down, so I’ll be able to sell or refinance the home before my rate starts to adjust.”

Sometimes, the desire for bigger and better can override a person’s common sense. It overshadows the mathematical reality of the situation.

If a Loan Sounds Too Good to Be True…

During the housing boom, a lot of mortgage loans seemed too good to be true. That’s because they were. These loans were the result of investor demand for mortgage securities, and the lending industry’s desire to serve that demand. When there were no more reasonably qualified borrowers left, the industry created alternative mortgage products to serve the unqualified borrowers.

I know what you’re thinking: “But these so-called ‘exotic mortgages’ are a thing of the past. I have nothing to fear today. The lending industry uses common sense again.”

Yes, the riskiest loan products are gone for now — but not forever. Just wait a few years, and they’ll be back. Of course, they won’t be called subprime loans, payment-option ARMs or stated-income mortgages. Those things all have negative connotations these days. But there will eventually be a new crop of high-risk mortgage products. Because American greed never sleeps. And our lawmakers are constantly and heavily lobbied by the financial industry.

Mortgage lending is huge business, especially in the secondary market where bundled loans are bought and sold. So you can rest assured that “creative financing” options will manifest again in the future. The best thing a home buyer can do is know what to expect from the lending industry. And that brings me to my final point.

What You Can Expect from Mortgage Lenders

What is the role of the mortgage lender? What is their responsibility to the borrower? What is the borrower’s responsibility? These are all valid questions, and the prudent home buyer will consider each of them carefully.

Here’s what a home buyer should expect when dealing with mortgage lenders:

  • Lenders are looking out for their own financial interests, not yours.
  • Lenders want to make as many loans as possible, while minimizing their own risk. So they look at you in terms of risk versus reward, not as a person with hopes and dreams.
  • Lenders want to maximize their profits by charging interest and fees on every loan they make. This business model does not include any concern for your long-term financial success. It’s just business.
  • It is not the lender’s job to counsel you, or to help you establish a realistic budget for yourself. That is your responsibility alone.

In other words, your mortgage lender is not your financial advisor. This is something every home buyer needs to realize. I believe that if all home buyers went into the mortgage-application process with this fundamental truth in mind, we would see a significant reduction in the number of foreclosures.