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The Credit Collapse's Cause: Hiding in Plain Sight

By Michael

What’s causing the credit crunch? Blame the Woozle!

My three year-old daughter knows that when Pooh and Piglet go searching for the Heffalump, or, on another occasion, the Woozle, they--Pooh and Piglet --are so confused about the causes of footprints in the snow that they run around in circles scaring themselves half to death at their own tracks.

If I explained to my three year-old the real causes of the credit crisis, I get this sneaky suspicion she would see right through the fear and confusion. She’d shake her head just like she does at Pooh and Piglet, and wonder what all the fuss is about. Because, really, the answer is simple (and no, it's not the Woozle who is to blame).

Real people, just like you and me, borrowed more money than they could reasonably pay back. End of story.

To listen to our political leaders or television commentators on the crisis, you’d think a mysterious creature, a frighteningly greedy malevolent force, was preying on poor indebted victims.

For some reason, political figures and the pundit-ocracy happily blame the following, in varying order:
1. Greedy Wall Street Executives
2. Predatory Lenders
3. Asleep-At-the-Switch Regulators

Yes, each can be blamed, and each makes a simplistic target for righteous anger. But I’m sorry: is it only obvious to me and my three year-old daughter, that none of the people in the list above defaulted on their debt?

I’m pretty sure the credit crunch was caused by people not paying back money they owed.

In my own small business, there’s no mysterious Heffalump frightening me. There’s no Woozle-shaped credit-eating monster. There’s just folks not paying their debts. Nobody forced them to borrow. They signed on the dotted line and they took the money on loan. Only, they’re not paying.

And here’s the worst of it: While I can not prove it, I'd bet that the majority of borrowers defaulting in 2008 knew when they took out their loan that they did not have a sound plan for paying it back. You know what I call that? A predatory borrower.

Comments (2)

October 15, 2008 12:53 PM

Comments (2)

John:

Sorry, but I've gotta disagree with you on this one. The problem originates with "Asleep-At-the-Switch Regulators".

You see, only a few years ago, those borrowers couldn't even get a loan. No matter how much they begged or lied, they didn't qualify. However, until recently, you could just make up your income and they'd give you a loan without checking as long as you paid one percent above the going interest rate.

The problem isn't that the borrowers didn't care if they had a sound plan to pay back the loans. You have to expect that when you dangle money in front of people they'll take it. The problem is that the lenders didn't care if the borrowers could pay back the loans. After all, mortgage underwriters would turn around and sell the loans, so it's off their backs. Then the loans would be repackaged and "insured" by derivatives, so the risk is now off of everyone's backs.

Wow, risk-free loans. What could go wrong?

Bottom line: It was greed on everyone's part, but greed should always be assumed. That's why creating and enforcing regulation is so important. It's harder to be greedy when there's actually someone around to say no.

Posted by John | October 20, 2008 2:04 PM

Posted on October 20, 2008 14:04

Michael Taylor:

Thanks for your comments John. I'm with you on your point that the lack of consequences on the lenders' side meant they took risks well beyond what they should have. You're right that in the case of securitized sub-prime loans, lenders didn't care whether the money would be paid, since they earned their fee and moved on.

Where we differ is partly one of emphasis - I can't agree that borrowers are blameless for taking money "dangled in front of them." I call that stealing, and hardly any politician/talking head is willing to point that out. I'm not sure why people are so delicate on this issue, but I suspect its because people don't want to sound elitist, or sound like they're kicking debtors when they're down.

I think partly I dont want to blame regulators because the logical solution to that analysis would be more regulation...I suspect more regulation restricts lending, shuts people out of the loan market, and typically leads to more paperwork and fine print but little improvement in lending standards.

thanks for your comment, which I mostly agree with except in emphasis.

Posted by Michael Taylor | October 21, 2008 2:52 PM

Posted on October 21, 2008 14:52