On Looting
Now that we own their sponsor, U.S. taxpayers should get a free Man U jersey with income tax payment. Or we should be able to have Rooney punch a banker. Either way.
Does listening to pundits discuss he financial crisis make your head spin, leaving you both angry and confused? Do you know that something in the discussion is just not right... in an Orwellian sense? Do you feel like you're watching the aftermath of the largest theft in the history of the world?
If so, you're not alone... and you're right to feel this way.
In the early nineties, a pair of economists classified the behavior that led to this debacle, described the environment that would make such behavior likely, and suggested that it would happen again as the natural result of that environment.
Sixteen years ago, two economists published a research paper with a delightfully simple title: “Looting.”
The economists were George Akerlof, who would later win a Nobel Prize, and Paul Romer, the renowned expert on economic growth. In the paper, they argued that . . . investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.
In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.
The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”
[Emphasis added.] Sound familiar?
On certain low-documentation loan programs, such as stated income/stated asset (SISA) loans, income and assets are simply stated on the loan application. On other loan programs, such as no income/no asset (NINA) loans, no income and assets are given on the loan application form. These loan programs open the door for unethical behavior by unscrupulous borrowers and lenders.These loan programs are designed for borrowers who have a hard time producing income and asset verifying documents, such as prior tax returns, or who have untraditional sources of income, such as tips, or a personal business. These loans are called liar loans because the SISA or NINA features open the door for abuse when borrowers or their mortgage brokers or loan officers overstate income and/or assets in order to qualify the borrower for a larger mortgage.
For more on how these loans were abused by lenders, see this Washington Post article from 2007. (And if you have more time, devote an hour to listen to "The Giant Pool of Money," a fantastic report by This American Life.)
So what about the idea that a lot of smart people just made innocent mistakes, or that this is a systemic problem that no one could have predicted? Looting is not just an error in judgment, but knowing, self-interested behavior.
The term that’s used to describe this general problem, of course, is moral hazard. When people are protected from the consequences of risky behavior, they behave in a pretty risky fashion. Bankers can make long-shot investments, knowing that they will keep the profits if they succeed, while the taxpayers will cover the losses.
[The distinction between moral hazard and looting is an important one.]
With moral hazard, bankers are making real wagers. If those wagers pay off, the government has no role in the transaction. With looting, the government’s involvement is crucial to the whole enterprise.
Knowing that their financial institutions were too big too fail, bankers made choices that were only rational in an environment where personal gains were all that mattered, and where a government bailout was seen as inevitable. The government was the escape route, the getaway driver... and the thieves got away scot free.
We should be angry. We've been robbed.