Banging on the Bankers

A lot of the resistance I've gotten for saying that people ought to pay their debts comes from people angrily declaring that after all, the banks are vicious predators.  In some cases this is true . . . certainly, in the case of Tom Vellucci, which I debated with Felix Salmon last week, the servicer seems to have offered him an unsustainable modification in the hopes of squeezing the last drop of savings from a dying man.

But I don't think this is an adequate argument.  Steve Waldmann, for example, seems to view walking away from your mortgage as a sort of game theory move, a just retribution in our society-wide game of tit-for-tat with banks that aren't behaving like good people.  I sense that he is not alone.

But this is awfully naive game theory.  A simple tit-for-tat strategy assumes a simple world in which there are only a few possible actions, all of which send clear signals.  What signal does walking away from your mortgage send?  Maybe it says, "People are mad at banks and they shouldn't charge such rapacious fees."  On the other hand, maybe it says, "People have stopped feeling any responsibility to pay their debts, so you should make it harder to get a mortgage, and more punitive to walk away from one."

The other problem with this notion is that tit-for-tat, and indeed every related strategy, requires that you can target the punishment at the bad actors.  But in many of the cases we're disputing, there's no evidence that the banks or investors who are getting shafted are the same banks or investors that are shafting others.  It's like ripping off Korean grocers because a waiter at a sushi place once overcharged you.

If we think bankers are, say, being abusive with their overdraft fees, we have better ways to fix it than turning into a nation of deadbeats.  We could, umm, regulate their overdraft fees.  Or we could publicize the banks that charge outrageous fees, and try to do business only with the ones that pay better.  If banks made stupid loans, they'll suffer by losing money.  But I find it hard to say that anyone is entitled to voluntarily default just to punish a bank for . . . being stupid enough to lend you money.  I mean, it's sort of elegantly self-referential, but one cannot do it without indicting oneself right along with the bank.

Of course, there's quite a bit of populist anger at the feeling that bankers haven't suffered--that they've just gone right along making money.  This is not actually true; many bankers have lost their jobs, and the job losses were heaviest in the sectors that performed worst.  RMBS is not exactly a hot line of business right now.

But of course, many other bankers are still minting it hand over fist, which especially rankles because we, the taxpayers, are the only reason that they're not pricing refrigerator cartons and prime real estate under bridges.  It's one thing to pump money into the banks, if that's the only thing standing between us and the Great Depression, but no one wants to pump it into the bankers' pockets.

But still, the answer is not to gratuitously walk away from mortgages.  Much of that paper isn't held by banks, but by pension funds and similar institutions that did nothing to anyone.

Unfortunately, I'm not sure what the answer is.  As long as banks are both extremely profitable, and competing for talent, they'll continue to pay huge salaries.  There is no direct way to intervene without gross violations of our legal system, or severely impairing the few banks we do have control over--banks who, let us remember, still owe us a great deal of money. A few months ago, I asked why banker salaries are so high, and ultimately I ended up with the fact that they're so high because so few people can make so much money.  When that's the case, no one wants to risk getting a "deal" on second best--which is why managers pay a lot to the firms that do their IPOs, and those firms pay so much to the bankers.

But that doesn't really answer the question of why, over the last thirty years, it became possible to make so much money in the financial sector--or why that sector became so grossly bloated.  Some of that activity was just regulatory arbitrage that added no value to society, like the leasing deals that allowed municipalities to transfer depreciation to taxable entities able to take advantage of it.  Much more of it was . . . well, I don't want to definitively say that it had no value, but I'd like to hear the authors of much of this activity explain to me what value, exactly, it added to society.

My libertarian readers are no doubt writhing, but the fact is, financial activity takes place in a web of law, and during periods of financial innovation, that law is often inadequate.  We've had a couple centuries to work out the kinks in stocks.  We've had thirty years of experimentation with mortgage-backed securities, and at the very least, they clearly need some work.

I don't think it's particularly left wing to say that our financial sector clearly became too large and well-remunerated--particularly when we note that at least some of that was due to our increasingly sclerotic taxation and regulation schemes in the rest of the economy.  But I'm not sure what to do about it.  It sounds fun to take a wrench, wade into the shadow banking system, and start banging heads.  But that's tricky to do without imposing great costs in terms of both liberty, and economic activity.

Or like I said earlier:  a system in which people just walk away from their mortgages is not a system in which the little guy prospers.  It's a system in which the little guy can't get a mortgage.  Our current combination of laws and social sanction does a remarkably good job of combining access to credit, with relief for those who need it.  There are many potential equilibria in this game scenario which are much worse than the current one.

Waldmann, and I think Salmon, view the tightening of credit as a feature rather than a bug, of course--they'd like to return to the days of paternalistic credit markets.  But I'd like to suggest first, that fifties economic nostalgia is highly overdone, and extremely colored by the fact that the narrators of that economic history were overwhelmingly the children of the relatively educated, affluent, and successful.  And also, that the price of tighter credit and more punitive default terms will fall hardest on those who really, really can't afford to pay it.  Damon Runyon didn't just make up the crowded living conditions, the loan sharks, the reliance on pawnbrokers.  Those are relics of that golden bygone era when bankers didn't extend credit to people without solid incomes, substantial assets, or affluent relations.  Fewer people got themselves into trouble with a bank, it is true.  But there are a lot of worse ways to get into trouble.  And as with the War on Drugs, I'm pretty strongly averse to more paternalistic policies which improve the lives of the middle class while making poorer people worse off.