Another Look at the Credit Crisis

It's been a long while since I have read a book that is as enlightening and entertaining as The Black Swan by Nassim Nicholas Taleb. It is very heavy reading, but it is great for anyone who seeks insight into the workings of the human mind.

Of particular interest to me was this quote:

"Awareness of a problem does not mean much, particularly when you have special interests and self-serving institutions in play."

This certainly describes the subprime credit mess.

Of course, there was huge denial occurring among people who simply did not believe that the subprime mortgage fiasco could possibly get as bad as it has gotten. In a March 2007 interview, the CEO of Impac Mortgage Holdings said that the problems at big subprime lender New Century weren't as bad as was being suggested. Of course, a few months later that firm filed for bankruptcy. Oooops!

The same CEO said that there would always be a market for borrowers with less than sterling credit. Oooops! It turns out that the foundation of his company was originating and selling such loans with the motto, "Vision. Agility. Intelligence. All are important qualities for a successful business." He saw nothing on the horizon that would to cause him to want to revise his business model.

He might want to consider revising his motto. His company announced a loss of $2 billion for 2007, so the company now has a negative net worth. The company's stock is down to $1.13 per share. Pretty grim.

My point here is not to beat up on Impac. They are one of many companies that believed they had enough vision, agility, and intelligence to continue being successful. They and the other 200+ lenders that have gone out of business were so mesmerized by their business mottos and all the bonuses they were making that they were unable to grasp the implications of what the real liabilities were.

There were a bunch of people, me included, who were standing around saying that this kind of profligate lending was foolish and that some day the chickens were going to come home to roost. But you would have to look at the total number of business executives at the defunct companies, executives at Merrill Lynch, Citicorp, and Bear Stearns to name a few who simply would not reexamine the potential dangers that lurked around the corner.

This shortsightedness is widespread throughout our society because it is a fundamental part of human nature. Thus we saw Enron employees with their 401(k)s invested in Enron stock. They lost their jobs AND their retirement plans We read weekly about investment scams in which some elderly couple was fleeced of their net worth. They all say, "He told us this was a safe investment."

And from the current headlines, we see that people bought houses they couldn't afford. Some were fooled into signing up for a mortgage with toxic terms. Sadly, there aren't many Lone Rangers coming to the rescue, and many people are experiencing heartbreaking situations.

There are also many neighborhoods where some smart couple is living next door to a vacant house that was once owned by someone not so smart. The bank now owns the house and perhaps another five homes within a block or two as well. That bank will likely sell those homes for a lot less than what the smart couple currently owes. I guess that you could call this collateral damage, but it is human suffering nonetheless.

To wrap this up, when you are making decisions about the future of your family, you simply must be aware that a bunch of very smart people didn't see the dangers ahead. Most of those who are being hurt by foreclosure didn't see the potential for damage. Neither will you. That is why it is so important to get educated about the process and to deal only with people and companies that are truthful and trustworthy.