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Stever Robbins on Allocating Blame October 10, 2008

Posted by tomflesher in Uncategorized.
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I love Stever Robbins. He’s undoubtedly one of the smartest guys around, and he helps me stay motivated and Get It Done on a regular basis in his Quick & Dirty Tip-giving persona. Today, he wrote up a blog post that I’m not sure I agree with entirely. I’d like to make an attempt to tackle this one and share some thoughts.

I’m sure he’ll be gentle.

I made a rough outline of Stever’s blog post. I think this is a fair summary of his argument (in my words, not his, and ordered to group premises rather than preserve the order of the post):

Financial corporations, whether first- or second-tier owners, have the specialized knowledge and ability to evaluate consumers and the instruments they sell to consumers. Specifically, they overrelied on rating agencies, failed in due diligence, failed to insure themselves against risk that was difficult or impossible to fairly evaluate, and pushed financially illiterate consumers into poorly-structured and hard-to-value financial arrangements.

Because many of the consumers were financially illiterate, the financial corporations are more to blame than the consumers.

I don’t think Robbins’ argument fails, necessarily, although I disagree with some of the more hyperbolic statements referring to legal concepts (Use eminent domain to reclaim investment bank salaries? This business model “implicitly defraud[ed]”* consumers?). I do, however, feel that Robbins has created a false dilemma in which the blame must be shouldered by either the financial corporations or the consumers.

In my opinion, the proper division of blame is closer to equal, for two reasons. (Well, okay, more like one and a half.) The first is that I do not consider ignorance to be an excuse for engaging in a bad deal. It can certainly be a reason one entered into a bad business deal, and it can be very sad, but not understanding the parameters of the agreement is not an excuse to treat a business deal as less than valid.

The second is that if a consumer is unable to understand the parameters of a deal, the consumer – not the salesman – bears the responsibility for gaining that understanding. If a first-time homebuyer is unable to understand the terms of a mortgage, then that homebuyer should take it upon himself to ask questions, discuss the deal with people more knowledgeable than he is, and generally seek out the available information. It’s foolish to buy a car without a test drive and a look under the hood; many people are car-illiterate, but that doesn’t absolve them of the responsibility of having a mechanic or a trusted car-literate friend examine a car before they buy it.

(For the record, I think that a more realistic allocation of blame must involve the moral hazard problems inherent in one party writing a mortgage and another party administering it. The incentives are all wrong. Fixing that problem, however, is beyond the scope of this silly little MA student’s abilities.)

I think Stever is right about a lot of important things in this post: the corporations were irresponsible, everyone needs a better grounding in personal finance, personal finance education would be a great priority item for tax dollars, and the corporations should suffer for their failure to conform to standards. I just think that he should be a bit more even-handed in allocating blame.

* Obviously, in cases where the legal definition of ‘fraud’ is satisfied, there should be appropriate criminal and civil remedies, but those need not be crafted specifically for this situation. Fraud is fraud, whether it involves mortgages or anything else.



1. Stever Robbins - October 19, 2008

In my post, I didn’t mean to imply that consumers weren’t to blame. In fact, my opening sentence said the banks were “more” to blame, implying that the consumers definitely did stupid things.

My point is simply that as a responsible businessperson, looking at the conduct of the banks, they engaged in horrible business practices, PURELY from a business point of view.

If Kraft buys tainted food from a Chinese agriculture firm without imposing their own quality controls and it turns out to be tainted, that’s KRAFT’S fault. It’s incumbent on Kraft to be smart about its suppliers, even if its suppliers offer great terms.

In the case of mortgages, homeowners are the banks suppliers. Banks had standards for a reason, and the standards were good enough that banks could make smart lending decisions, with well-known statistical repayment rates. They relaxed those standards consciously and knowingly, figuring they could pull in low quality buyers and rely on Fannie and Freddie to save them if the low-quality buyers defaulted.

While this sounds reasonable, let me return to the world of food to describe the same situation: this is like a restaurant that starts serving grade B food, assuming their insurance policy will save them if customers get sick and sue. Though legal, I think most of us would agree that this both undesirable and ultimately will be bad business.

In my book, good businesspeople treat insurance as a safety net when prudent business practices fail, not as an excuse to abandon prudence, decide risk no longer exists, and recklessly pursue short-term profit.

Your second point–that consumers should have asked the right questions–I agree with wholeheartedly. But right now, I’m thinking JUST from the business point of view.

As I say in my post, we have every reason to expect that our numerically illiterate population (we rank something like 26th out of 30 in international math test scores) won’t even know what questions to ask, much less understand the implications of the answers.

If I’m selling my tainted food to someone who doesn’t know what the big “Grade B” sign in my window means–AND I KNOW THEY DON’T KNOW–then again, I’m risking my business hoping I can get away with it.

If any financial professional tell me with a straight face that an average consumer (or even an educated one) understands the implications of the 200 pages of 8-point type that comprise a modern mortgage agreement, I’ll grab a copy of my mortgage, open to a page at random, and quiz him on the points therein. You have to live in a very, very different world to believe that consumers are making a smart decision. And if you’re going to be loaning those consumers $200,000 and recording that on your books as an asset, then *from the perspective of your business*, it’s YOUR responsibility to make sure that asset really has that value. I.e., that it will be repaid.

To make my point about consumer knowledge: RIGHT NOW, without looking, tell me (a) do you own the browser you’re looking it? (b) under what circumstances are you allowed to upgrade? (c) what are the penalties for copying it? (d) can you legally make a backup? how many? and on how many physical machines can you run it? (e) can you give a copy to a friend, even if you deinstall it from the machine it’s running on? (f) can you get a refund if it doesn’t work?

Of course you can’t answer any of these questions. Because none of us take the time to understand the full legal ramifications of our choices. To think otherwise is naive. Banks aren’t naive.

And if I’m going to sell you a mortgage that’s specifically packaged to sound like a great deal, with me knowing you may not be able to pay it back (whether or not you know it), I’m not sure I should be allowed to take home my $100 million pay check and then be shocked when you don’t repay.

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