Monday, August 18, 2008

How banks convinced people to go broke

I posted recently on the opacity of credit score calculation, and Xanthippas linked to an article refuting the idea that people are mainly to blame for what happened to them as a result of signing up for sub-prime mortgages. None of this is to say that people are not responsible for making their own decisions, but rather that as things currently stand, people do not have the means or information to make truly good decisions. Not only that, but according to this article from the NY Times, the banks deliberately tried to convince people that borrowing on the equity in their homes was a good idea.

“Live Richly.”

That catchy slogan, dreamed up by the Fallon Worldwide advertising agency, was pitched in 1999 to executives at Citicorp who were looking for a way to lure Americans to financial products like home equity loans. But some in the room did not like it. They worried the phrase would encourage people to live exorbitantly, says Stephen A. Cone, a top Citi marketer at the time.

Still, “Live Richly” won out. The advertising campaign, which cost some $1 billion from 2001 to 2006, urged people to lighten up about money and helped persuade hundreds of thousands of Citi customers to take out home equity loans — that is, to borrow against their homes. As one of the ads proclaimed: “There’s got to be at least $25,000 hidden in your house. We can help you find it.”

Not long ago, such loans, which used to be known as second mortgages, were considered the borrowing of last resort, to be avoided by all but people in dire financial straits. Today, these loans have become universally accepted, their image transformed by ubiquitous ad campaigns from banks.

Since the early 1980s, the value of home equity loans outstanding has ballooned to more than $1 trillion from $1 billion, and nearly a quarter of Americans with first mortgages have them. That explosive growth has been a boon for banks. Banks’ returns on fixed-rate home equity loans and lines of credit, which are the most popular, are 25 percent to 50 percent higher than returns on consumer loans over all, with much of that premium coming from relatively high fees.

However, what has been a highly lucrative business for banks has become a disaster for many borrowers, who are falling behind on their payments at near record levels and could lose their homes.

The portion of people who have home equity lines more than 30 days past due stands 55 percent above its average since the American Bankers Association began tracking it around 1990; delinquencies on home equity loans are 45 percent higher. Hundreds of thousands are delinquent, owing banks more than $10 billion on these loans, often on top of their first mortgages.

None of this would have been possible without a conscious effort by lenders, who have spent billions of dollars in advertising to change the language of home loans and with it Americans’ attitudes toward debt.

Please read the rest of the article. This is the kind of thing that should have been known before people went out and bankrupted themselves. You can still, of course, blame people for having been convinced by these articles, but if you do that, blame yourself for being fooled by magic tricks. It's the same thing; convincing people to see what you want them to instead of what really is. It's hard not to be fooled by sophisticated marketing backed by billions of dollars. I try to be as skeptical as I can be, but no matter what we end up having to believe somebody at some point. Therefore it's not too hard to see how millions of people were taken in by the idea that they needed to borrow against the value of their home, especially given that most of these people were already feeling some economic stress in the economy we've continually been told is better than it is.

You can blame the people who were taken in by the scam, but at least realize that it was a scam and the people taken in were victims, not knowing participants. For some reason, there are still people who refuse to believe that these big "respectable" banks would deliberately rip people off. The truth is that they're trying to do it all the time. And we're all so busy working, going to school, and/or raising families we don't have the time to fact-check everything they say. That's why we rely on the government to do it. Governmental oversight is key to keeping things fair for us, which libertarians and other conservatives can't seem to grasp. The government should have been there to shut down this lending before it happened. And since they let it happen, instead of talking about bailouts for lenders, we should be hearing about bailouts for borrowers. Loan forgiveness, or allowing us to "restructure" our debts as would a business, or enforcing lower interest rates on debts, protecting us from exorbitant late fees or overage charges, etc, etc. It should be done. The American people are who this government serves, not big business. Not even billion-dollar banks.


Torrance Stephens - All-Mi-T said...

thanks for the info
that was a nice tight and terse read makes me think

Xanthippas said...

Good article to highlight.