The Worst Is Yet To Come: Anonymous Banker Weighs In On The Coming Credit Card Debacle | Hacker News Reader

The Worst Is Yet To Come: Anonymous Banker Weighs In On The Coming Credit Card Debacle

executivesuite.blogs.nytimes.com

35 pointsjseliger55 comments

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Profit always comes from risk.

If I can borrow a house and live in it and get bailed out in the ensuing default storm, I win.

If I build my house in an area prone to flooding and can get bailed out, I win.

If I can originate a gazillion loans at a fee and without repercussions for defaults, I win.

If I can run a company into the ground while getting nice perks and a salary without any repercussions, I win.

If I can get elected to high office through lies or distortions or conduct my term in an incompetent or questionable or criminal fashion and leave the mess for the next office holder, I win.

Welcome to capitalism, now increasingly featuring socialized risk.

And with the recent discovery of Too Big To Fail, this form of capitalism just gets better.

A good credit score does not equate to the ability to repay debt.

This seems to be a recurring theme across the world. I tend to be left of many debates on this forum. But this is a strange thing to have settled on: It is the lenders' responsibility to make sure that their customers can afford repayment. Consumers will take as much credit is offered to them. The complaint is rarely about making information available to consumers. It's about making the correct decisions for them.

Don't get me wrong. I'm not blaming media or politicians for taking this line. It seems true. People do not seem to be able to manage their debt. A stable solution will effectively put the decision of how much to borrow in the hands of someone else: Banks, Governments etc. not consumers.

Then this article goes on with the assumption (again, seemingly correct) that consumers are incapable of resisting the banks' marketing. Since many desicions are essentially made at the bank, they make a decision on a high credit line at a high interest rate. He suggests correcting this by making unsolicited direct marketing illegal. Supposedly, consumers would then actually look for a card with a reasonable interest rate instead of accepting whatever is given to them.

Substitute the word "adult" for "consumers" in what you say,

"Adults will take as much credit as offered to them." (No, they won't.)

"A stable solution will effectively put the decision of how much to borrow in the hands of someone else: Banks, Governments etc. not adults." (Wrong again.)

etc. By contrast, if you replace "consumers" with "children" then it still makes sense.

Really, whatever solution we come up with needs to punish people according to the rules as they stood at the beginning of the game. No new ex post facto rules, please. Banks and (some) adults bet on black when the wheel went red. Let them pay.

If your definition of adult does not include most of the population over 18 (or 21), you should find a new word. That one is taken.

We can always sub-categorize:

American adults? or Adults who take credit when offered to them without thinking about consequences

I think his point was whether this category of people should be labeled as adults because they don't perceive or that they ignore the risk of not being able to repay, which leads to hardship for not just them but other innocent people.

Let's not run too far.

There is the empirical fact (unless you disagree with it) that if people are offered more credit then is good for them, they take it. Responding to that by saying: 'An adult can be trusted not to do this', is just silly. We are taking about a big chunk (possibly a majority) of adults here.

"There is the empirical fact (unless you disagree with it)" - what an incredibly interesting thing to say!

> Substitute the word "adult" for "consumers" in what you say, "Adults will take as much credit as offered to them." (No, they won't.)

What you are doing is suggesting that being an _Adult_ carries with it certain behaviours such as not spending more money than the adult can afford to repay. However, the word Adult actually means being of a certain age, and perhaps you would like to assume that everyone of that age has that level of maturity and prudence.

I think what you really mean is that adults ought not to o these things, and if they do these things, they are defective in some way, and therefore don't count. This is a little like those drug studies where anyone that dies while taking the experimental drug is tossed out of the study.

So when I say "Martha over there got a $26,000 line of credit even though she is a home-maker with no income and no assets in her name," you say "Martha isn't really an adult, she is a foolish child in a woman's body."

The simple fact is, adults do many things you and I might consider reckless or illogical such as borrow more than they can afford.

As proof of this, I give you George W. Bush.

When I was a kid, I was (naturally) a big fan of kid rights. I always thought that kids should be able to vote, enter into contracts, be considered legally a "person", drive if they could reach the pedals and see out the windshield, and decide whether or not they went to school.

My reasoning for this was not that kids were so smart or mature that they could do this responsibly. It was that the vast majority of adults were dumb and immature and can't do this responsibly, and yet we give them all these rights and privileges anyway.

Since becoming a legal adult in 1999, I have seen little to make me believe I was wrong in this assessment.

It's interesting - if you consider children=dependent and adults=independent, modern society has made children of us all. Everyone (except wackos like the Unabomber) is dependent on someone else now - the economy is just too intertwingled to function without other people. Folks leave the nest of their parents to become dependent upon their employers, and then leave that behind to grovel at the trough of investors, and if that doesn't go well, they become slaves of the credit card companies. That seems to be the price we've paid for all our cool new toys.

I, for one, welcome our new Neverland overlords.

Not all people are created equal.

There are distinct changes in the brain that happen, as well as changes in hormones that also may support age-based restrictions on activities.

The etymology of Adult means "fully grown." I believe the gp of this comment is using the word to mean fully grown in emotional and behavioral maturity in addition to physical maturity. So, perhaps what the gp is saying that physically mature individuals who do these things are not emotionally or behaviorally mature, and so cannot be considered "fully grown." Their arrested development means they are functionally 'children.'

Extended (perpetual?) adolescence is an interesting (recent?) social phenomena.

"However, the word Adult actually means being of a certain age, and perhaps you would like to assume that everyone of that age has that level of maturity and prudence."

It is pretty common usage to use the term adult to imply maturity, responsibility, etc. For example, when Apple was hemorrhaging money in the mid 90s, there were a lot of jokes about them needing "adult supervision," in spite of the fact that the people working there were above the age of 18.

"I think what you really mean is that adults ought not to o these things, and if they do these things, they are defective in some way, and therefore don't count."

I think he is simply saying that people can freely make whatever bad choices they want, but they also must be allowed to freely experience the direct consequences of those choices. Pretty much the standard libertarian viewpoint.

"As proof of this, I give you George W. Bush."

Another example where "adult supervision needed" jokes were made. (When Robert Gates came on board, for example.)

I would take it a step further. I think you are mistaken in your use of the word 'mature.'

So many people take it as meaning that set of behaviours & emotional states that 'should be associated with adults. They then go on & complain that adults do not display these behaviours ('men are so immature').

If it's not something we can assume people will grow into/out of, it has nothing to do with maturity.

Yeah the credit score thing is pretty useless. After I graduated college, I had about 30K in student loans and 10K in credit card debt(used one of those 0% APR offers).

I just started repaying the college loans, and made 3 or so payments on the credit card...and my credit score? 763(that meant that there was a 2% rate that I would be delinquent)

Granted I didn't have any collections or anything like that...but still thinking that someone with 40K in credit card debt and no job had only 2% default rate just seems wrong.

"But this is a strange thing to have settled on: It is the lenders' responsibility to make sure that their customers can afford repayment. "

I don't think it's strange at all. The lender is the one that assumes the risk that it may not get the money back. Thus, it's up to the lender to do whatever verification it deems necessary (and legal).

Yeah sure. It's not strange that the lender should choose to do this given the facts. That isn't strange.

What is strange is that if the lenders choose not to do this, & lend (ie sell) as much as people will borrow (buy) like most other markets, there will be a massive default rate. Presumable a person should be able to work out if they can repay a loan before taking it. Presumably they don't want to have a loan they cannot afford to repay.

Common sense (& the assumptions underlying economic theory) would suggest that this should be enough to make sure people don't loan too much in all but end cases.

The reason I say it's strange is that the running assumption that doesn't even seem to need to be mentioned any more in these sorts of articles is that consumers are determined to take out loans they can't repay & the banks, governments or whoever else need to police this. Supposedly, a big chunk of this 'crisis' (the sub-prime) comes down to that: banks not policing enough.

It's strange that no one thinks it's strange to assume that everyone wants to bankrupt themselves.

Wait if you don't pay back the loan it's "free money" so I don't think people who get into lot's of debt and then default are necessarily idiots. People pay back loans so they can get more loans or get rid of the lean on the car / home. Borrowing 200k and making a 50/50 bet could be a great investment if you could live without credit for a few years.

The credit crysis comes down to bad statistics. When lenders assume a default rate and ignore how dependent this is on the economy they make bad decisions. Home loans in Detroit are a great example of this.

If you are talking about a moral hazard on the consumer side I have to say I think it's rubbish.

The possibility & unpredictability of a bailout & the terms under which you can get free money are such that it's insanely risky trying to take advantage of it. Swaying stock prices by a couple of percent b is one thing. An individual risking all of his own wealth is something else. Virtually no sophisticated investors would take advantage of it.

The overwhelming market signal should remain: do not borrow more then you can repay.

The crux of the problem was the rating agencies. By law, regulated funds (insurance companies, pension funds, mutual funds) can only invest in bonds that are rated "investment grade" by official rating agencies ( such as Moody's). The rating agencies had two problems: 1) because they were given official status by law, they became less vigilant about guarding their reputation 2) instead of using a mix of statistics and personal judgment to rate bonds, they relied solely on models. It's analogous to managing programmer performance by only counting lines of code written. The banks found a way to game the algorithm ( slicing securities into tranches) and thus were able to sell massive quantities of very risky loans to big, regulated funds.

So you're right, it is the banks job to make sure the customer can afford the loan, and ordinarily a bank would never have made these subprime loans. But in this situation, the banks were able to resell these super risky loans to regulated funds that were obligated by law to invest in them. The result was disaster.

The reason the banks had problems was the need for them to keep a fraction of these loans. Once the default rate increased they where unable to make new loans and at the same time they ended up with a lot of bad debt and because the loans where bundled they did not end up with a house which could be sold.

I'm not going to pretend I understand the mechanics of what went on. What you say sounds like it's in line with the narratives I've heard from what seemed to me like the intelligent sources. But it doesn't really negate what I am saying:

The underlying assumption is that consumers will make bad decisions when given the chance. Banks can either measure their capacity to pay or the tendency to pay (credit score). Relying only on the latter seems to make the assumption (that seems like it should be reasonable) that apart from a problematic minority, lenders will take care not to bankrupt themselves themselves.

Then articles such as this one come along & explain that this is actually insane. Obviously consumers are trying to bankrupt themselves. The only remaining discussion is how to stop them: banks should, rating agencies should, governments should... I find this strange.

Your explanation, while not reassuring describes why institutions will make bad investment decisions.

Perhaps a partial solution would be to require consumers to pass a simple certification exam before being allowed to use certain risky financial products and services, such as high-limit credit cards, adjustable-rate mortgages, equity options, etc. It could be a simplified version of the CFP exam. Anyone who passed would be considered a "financial adult" trusted to handle his own affairs with minimal government oversight. Those who hadn't passed would be protected from getting themselves into deep trouble.

What a crisis this is; I'm usually on the right of debates here and I have to disagree.

It is definitely the consumers fault, but the banks should know better. They have a responsibility beyond themselves, the entire economy relies on the money flows that they control. If every bank acts a bit irresponsibly just to make a few people rich now, they've screwed over a vast number of people outside of the bank.

The cost to the bankers for acting irresponsibly is less than the cost to society. Therefore, I feel they should be regulated (within reason, of course).

I don't disagree with you. Defaults on an individual level are consumers' fault. Magnifying that to the point where the worldwide economy is at risk is banks' fault. They leveraged to a point where everything breaks down at a point that isn't totally unlikely. I can understand that in light of that, seeing banks hound people to take credit makes people understandably cranky.

I think the fact that it's consumers' fault is the interesting point here. This article implies that on average consumers cannot be trusted to loan what they can afford and/or pick the correct credit card. Not because they are being tricked or because information is unavailable or any other market imperfection. Because the average decision making is bad. What does that do to economic models?

The idea that all actors in an economic system are rational isn't a good one. A good example: the current stock market. Those people are really good at finances, they have an idea of what's a good stock and what's a bad stock. Emotions are playing a big part right now though, which causes the market to fluctuate in what I would call and irrational way.

The assumption is crucial though. Anyway it's made in aggregate & in a theoretical perfect market where everyone knows everything.

The thing is with this market that it's damn near perfect. It's a big enough decision to make sure consumers research it, work it out on a piece of paper, hire consultants to help with the decision. There's plenty of legislation ensuring information availability & simplicity.

Still the actors are not on average rational.

Could he mean that banks should protect themselves by developing a better metric for offering credit? It seems like banks have stopped doing their homework and have relied, to their own detriment, on third parties to determine credit worthiness.

"A stable solution will effectively put the decision of how much to borrow in the hands of someone else: Banks, Governments etc. not consumers."

Subprime crisis. National debt.

Are you SURE you want banks or governments making decisions about credit for consumers?

And that is the problem: a loss of financial prudence and risk assessment faculties from the very bottom of our society to the very top. Consumers, banks, governments, all making the same bad choices at every level of society.

As Pogo said: "We have met the enemy, and he is us."

I don't think the lenders were being terribly irrational. Credit-card issuers make their profits from interest and late fees. If a customer racks up a large balance on a card, makes only the minimum payment for years and years, and then defaults, the credit-card issuer will walk away with a net profit, even if it has to write off the principal of the original loan. And usually customers in this situation can be squeezed for quite a while before they default.

One simple way to ameliorate the problem in the future would be to require every credit-card statement to include a warning: "If you do not borrow any more on this card and make only the minimum payment every month, it will take you ____ months to repay your debt completely." Such a requirement was considered when Congress amended the bankruptcy code a few years back, but the bank-industry lobbyists kept it out of the final bill. That should tell you how much the banks wanted their customers to be fiscally responsible.

Don't forget a 25% default rate per year can still be cash flow positive when they are charging a 29% interest rate and adding on other fees.

Just adding the math for those who might have missed my point.

If 3/4 of people avoid default the rest don't so .75 * 1.28 = .9675 which is less than 1, but the 25% that fail don't all fail on the first day so they are probably going to average ~6 months of payments so .25 * .5 * .29 + .9675 = 1.00375 which is larger than 1. Add in some fee's and whatever principle people payed back before defaulting and you are making money.

Next year some people that made it this year will fail but your adding some people to make up for those that defaulted last year. In the end you need people to average 4 years before defaulting which I suspect is normal.

nods

And until the card issuer officially writes down the debt, the principal that the borrower owes to the issuer is counted as an asset on the issuer's balance sheet.

Yep, but they don't write down all of that debt they first charge insane late fee's and interest for a few months and then sell that highly inflated debt to a collection agency or package up that debt before it defaults and sell that to wall street.

"If you do not borrow any more on this card and make only the minimum payment every month, it will take you ____ months to repay your debt completely."

Make sure to specify that it appears on the first page. In large letters.

I'm sure there is a ton of useful information buried in the pages of very small type that come with each statement. Good luck figuring out which parts are important and comprehending the legalese.

Every once in a while I sense what true panic would be like when I look around my local WalMart and ask myself "what would happen if all of those credit cards suddenly stopped working?"

I'm more afraid of this than even the darkest jihad plot from the most extreme nutjob in the middle east. I'm not much for the TEOTWAWKI doomsday scenarios, but if all of the credit cards stopped working? damn! that'd be tense.

I find this very hard to understand.

Credit cards are virtually non-existent where I am (despite a strong marketing push). For cash-less payments or ATM withdrawals everybody just uses debit cards.

If people go to minus with their accounts (it's possible also with debit cards), they feel really bad.

How can society become so dependent on credit cards that you can get seriously scared what would happen if they stopped working?

Where do you live?

I'm guessing not the United States. Yes, it has gotten that bad here.

I'm in Europe.

I do understand that it is bad in US, but not how it became so.

It probably isn't just because of "credit" aspect of the credit cards.

Even here people buy stuff on credit. Just it is structured in a different way - credit is bound to products, not people. For example it's popular for retailers to offer payments over longer time for more expensive items.

If this stopped to work, nothing much would happen. Few people wouldn't have large screen TVs, or leather sofas, or similar stuff.

Maybe US problem is that credit was too fluid, so that people started to use it to pay for essential things (food, rent, bills, etc)?

Yes that's it exactly. I've even known some people to use cash advances on their credit cards to pay their mortgages.

The problem goes much deeper than that though. Many people use credit cards for all purchases and have structured their lives around not having ready access to cash even for necessities like food. The credit cards have become vital time lag buffers for cyclic pay.

The real panic would occur when people realized that they were out of food, have no cash and payday is 3 weeks away.

The bank that issued the credit card has folded, so it no longer works. You are hungry, and there are 200 people standing next to you in the same predicament.

Many many people have no (zero) cash reserve and don't really understand why this might be a very bad thing.

So I am afraid.

Wow, I didn't realize it was this bad. People can be very silly.

As the old saying goes: "civilization is only four meals away from anarchy".

http://www.timesonline.co.uk/tol/news/uk/article492642.ece

A fool and his money are easily parted. True for consumers, true for banks.

Or as the great Gordon Gekko once said, "A fool and his money are lucky enough to get together in the first place." :-)

Actually, the worst to come is the unfunded pensions (public & private) and social security. That is a debacle foreseen since the 30s.

Holy smokes! A $7000/month mortgage on $150K per year? That's a HUGE mortgage payment. (Mine was considered steep at around $2K/month).

More interesting to me is the question of what actions can be taken to get on the winning side of this.

If its really so inevitable, what sort of positions can I put on to profit the most from this?

Credit for investment purpose is encouraging. But not for consumerism.

You'll find that if you dig down into the situation, credit for consumers is credit for investment purchases. That's one of the root problems here; your default doesn't just hurt you, it hurts everyone invested in you. And that cascaded, big time.

these corrections have lasted a historical average of 17 years. The current one started in 2000 so we have another 9 years to go.

care to share a source on the 17 year claim?

or that the 2000 correction and this one should be viewed as one correction?

http://www.zealllc.com/2007/longwave3.htm

I can't believe that anyone still believes anything they read in the NY Times.

Side note:

Everybody telling you that there is a solution for the current world-wide financial crisis is simply a non-expert.

There has never been a situation like the current one in history:

The Big Failing of Communism is already past. The Big Failing of Capitalism is currently happening.

You rich ones should prepare...

P.S. You don't need to believe me, you will simply see it happening soon...

The Big Failing of Communism is past.

The Big Failing of "Capitalism That Thought It Was Rich Enough To Afford Some Communism" is happening.

Unfunded pension guarantees? Governments ordering banks to make loans they can't afford? The failure of government corporations like Fannie Mae and Freddie Mac due to being disconnected from the market? Massive nationalization of debt in response to the crisis?

Very little of this crisis is "capitalism" in any sense of the term. Government meddling is present in every aspect. Nay, _massive_ government meddling.

There are simply too many bad (really bad) things growing exponentially in our current times.

(Nobody wants to hear it, but it will come: we all will be poor within the next few years. That is, the small world-wide percentage of still-rich-ones will all go away...)

So, the whole planet will have a 'reboot', and since a reboot starts from 0, there will be an exponential growth of wealth for everybody!

Now, the above is either foolish or prophetic...

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