Share 
Facebook
MySpace
Delicious
Twitter
Ping this
StumbleUpon
Comment
Email
Print
In the aftermath of the financial crisis the American public seized on a familiar scapegoat…the greedy banker! PIGGYBANKING
Don’t Blame the Banker (Pt. 1)
It is an understatement to say the past year has been a trying one for the American economy. The residential and commercial real estate markets imploded, the federal government created a record deficit by spending money it did not have to bail out failed institutions and to “stimulate” the economy, the purchasing power of the dollar steadily eroded, the stock market collapse decimated retirement plans, and ten percent of Americans are now unable to find work. In the aftermath of horrific events, humans are not typically in the mood for complex explanations; we prefer simple answers. The need to place blame often leads us to scapegoats. Hence, in the aftermath of the financial crisis, the American public seized on a familiar scapegoat…the greedy banker.
When I meet new people these days and mention my chosen line of work, they often look at me as if I just ran over their dog. Bankers are now pariahs in the eyes of many. Anecdotal stories of so-called “predatory lending” and outlandish Wall Street bonuses have tarnished perceptions of the banking industry, and that is a shame. Yes, many banks took excessive risks, for which we are all now paying the price. However, those mistakes were not made in a vacuum and there is plenty of blame to go around.
It is important to understand that borrowers benefited greatly from the easy credit available during the housing boom. Every loan agreement has, at minimum, two participants, a lender and a borrower. During the go-go times, many Americans with marginal or substandard credit were able to purchase homes with historically cheap mortgages and extremely favorable payment terms. This lending environment provided tangible benefits to borrowers, all of whom signed mortgage contracts that spelled out the payments they would be required to make. Numerous borrowers were ultimately unable to make those payments, but the easy credit provided them an opportunity to live beyond their means, an opportunity many willingly accepted.
Advertisement
Let’s use an example of a young newlywed couple Jack and Jane Johnson. It’s 2006 and the couple is looking to buy their first home. The Johnsons can’t really afford the house they want given their income levels, but the local mortgage banker at City Bank & Trust offers generous financing terms. Jack thinks a promotion could be coming his way at work and the resulting pay raise should help him make the house payments. Whatever their reasons, the Johnsons decide to buy the house; gladly consenting to the risks of the loan in exchange for the opportunity to own a home and to improve their standard of living.
Jane Johnson’s older brother Ken Kelly is a small time real estate investor. Encouraged by the strong market, he, like many Americans buys up houses using little or no money down financing in hopes of “flipping” them for a quick profit. Jack and Jane’s mortgage banker offers Ken an attractive variable rate mortgage on a property he’s been eyeing. The loan seems to fit his short-term investment strategy, requiring smaller payments initially before resetting to a higher rate at a later date. Ken signs on the dotted line, gladly taking on the debt for the chance a big payoff on his relatively small upfront investment.
At the weekly ladies’ poker game Jane Johnson and Cara Carlson marvel at their friend Suzy Sanders’ newly remodeled living room. Suzy explains how they paid for the entire thing with a 5.00% home equity line of credit (HELOC). Cara convinces her husband Carl to look into a HELOC for their house. Carl learns from the local mortgage banker that based on their home’s current appraised value, they have built enough equity to qualify for an $80,000 2nd mortgage. The Carlson’s talk it over and decide they may as well take this opportunity to cash in on the equity they’ve built up in their home. Carl and Cara use the loan funds to pay off a couple credit cards, fully renovate the master bathroom, and pay tuition for their daughter (Carla) to transfer to a prestigious private college.
Unfortunately, Jack Johnson never got that promotion at work and the weight of that mortgage debt eventually became too heavy. He and Jane depleted their savings furnishing their new home. They wind up selling the house for less than they owe on the mortgage and get Jack’s parents to help cover the shortfall. They move back into an apartment. Ken Kelly’s investment property doesn’t fix up as nicely as he hoped and when he’s finished there is an oversupply of similar homes on the market. He leases the home for six months to barely cover his expenses. However, when it comes time for the loan to reset, Ken decides to walk away from the house and file bankruptcy rather than make payments on a home providing negative cash flow. Under state law, he’ll be allowed to keep his own home and the bank will be left to deal with the investment property. In 2008, Cara Carlson has a medical emergency not covered by her insurance. After consulting with a realtor, the family learns the Carlson home isn’t worth near the previous appraised amount. To prevent the Carlson’s from filing bankruptcy, City Bank & Trust agrees to modify their 2nd lien HELOC, taking a loss on the loan. Carla Carlson returns to state college, the family downsizes to a small townhouse, and Carl works to pay off what’s left of the HELOC balance.
Ken Kelly and the Johnsons did their part to inflate the real estate bubble buying houses they ultimately couldn’t afford. One may argue that all three of these borrowers never would have taken on these mortgage debts if the banker hadn’t offered them such cheap financing. This is true. The banker made unquestionably bad loans to all three, accepting significant risks of loss for too low interest rates. In fact, the majority of these mortgage loans were held on local bank balance sheets. Contrary to popular opinion, most banks and bankers are not enriched by making loans that do not get paid back. I am not suggesting the banker be absolved of all guilt for the housing crisis, but he did not profit at the expense of defenseless citizens.
Americans tend to believe in personal responsibility. All three borrowers here willingly took on their debts, because they deemed the potential benefits of the transactions to be worth the risks. While it’s often easier to blame others when things don’t work out, we should recognize the parts played by all parties in this financial bubble. Next time we’ll look at the role of another critical participant in the crisis, Uncle Sam.
Banker Bob worked at two major TARP banks from 2003-2009.