April 12, 2014

Great moments in marketing research: WaMu's focus groups

From the 2011 book Lost Bank by Kirsten Grind about Washington Mutual, which collapsed spectacularly in 2008: In mid-2003, a market researcher named Kevin Jenne is sent to Orange County and Illinois to conduct focus groups on WaMu customers who had recently acquired Option Adjustable Rate Mortgages. These allowed borrowers to choose anything from 15 year fixed repayment to letting them pay only 1% interest for five years while the principal "negatively amortized" (and then the hammer would come down around 2008 when the interest rate reset to the current index and the principal left to be paid off was larger than when they started). Jenne's assignment was to study these Option ARM borrowers to learn how to persuade more people to get Option ARM mortgages.
The 31 people who attended the dual sessions had two things in common: all of them held Option ARM loans, and few, if any understood what that meant.  
Jenne listened patiently, as, over and over again, the borrowers described what they believed to be their loan terms. They had gleaned startlingly few details about their loans from the mortgage broker or the WaMu loan consultant who had helped them through the process. Most of them knew they held adjustable-rate loans. They also thought the loan was cheaper than a regular mortgage, because they didn't have to pay as much each month. Approval hadn't been a hassle, the customers said -- WaMu had required little paperwork or income documentation. That's where their knowledge stopped. "From their perspective, it was a low payment loan, and that's all it was," Jenne said. "No one understood the option thing." 
Some of the borrowers in the focus groups were first-time homebuyers, still awed by their new ability to capture the American Dream. Recently, President George W. Bush had announced plans to increase minority homeownership by 5.5 million people, piggybacking on the goals of his predecessor, President Bill Clinton. "We want people owning something in America," Bush declared at an expo in New Mexico. "That's what we want. The great dream about America is, I can own my own home, people say."

In reading Bush's minority mortgage speeches denouncing redlining, downpayment requirements, and onerous paperwork requirements such as pay stubs, a recurrent phenomenon is Bush's Yoda-like reverse syntax. Did Bush always sound like this, or just on the topic of minority mortgages?
The focus group borrowers, some of them members of minorities, were effusive about their buying power. "They had been told by so many people that they couldn't afford one," Jenne said. Now they could. 

According to the federal Home Mortgage Disclosure Act database that exists to make sure minorities get enough loans, over half of the dollars lent in Orange County in 2003 by Washington Mutual's subsidiary Long Beach Mortgage went to Hispanics.
Few of them understood what negative amortization meant, or that it could make their debt grow in the long run. ...  
Half an hour into the first session with borrowers in Orange County, Jenne could tell that quizzing these people on their loan terms was futile -- they didn't know their loan terms. He got up, excused himself, and left the room. ... Jenne walked into another room at the sterile interrogation facility, behind a two-way mirror, where two mortgage production employees from the Home Loans Group had been observing the discussion. ... "I don't think we're asking the right questions," Jenne told them. The questions he had put together seemed useless. But the mortgage employees disagreed. They wanted him to ask about indexing, even though the customers barely understood interest rates. "Find out what the index means to them," they instructed Jenne. 
... He asked the group of borrowers: "How does your interest rate change?" 
No one responded. 
"It changes, right?" Jenne probed. 
The borrowers looked around the table at one another. Finally one said, "Yeah, it changes." 
"I think it's indexed," offered one woman. 
"Yeah, yeah, indexed!" agreed another. They had answered a question correctly! 
"Well, what's it indexed to?" Jenne asked. 
Another long awkward pause ensued. 
"My loan is indexed to the Nikkei," proclaimed one borrower. 
Another long, awkward pause ensued. 
"Your mortgage is based on the Japanese stock market?!" Jenne thought to himself. "Of course I didn't say that, he said later. "But I'm going, 'Oh, my heavens.'" Strangely, in another focus group, in Illinois, another borrower also believed his loan was indexed to the Nikkei. Jenned never discovered where borrowers had received that information. "I don't think they were being told this by someone," said Jenne. "I think that the only index they had heard of, like on TV or something, was the Nikkei. It was just bizarre.
The borrowers did seem worried about the loan terms. One of them said, "It's really scary to me what's going to happen in five years." Another echoed the same sense of foreboding with a slightly more compressed time frame. "Something terrible happens in three years." Said a third borrower: "I'm a little nervous about it. I have this feeling of impending doom. It's almost too good to be true."
On the other hand, the borrowers seemed comfortable in their ignorance. "Despite their lack of understanding, participants were almost universally happy with their loan choice," the report noted. ...
The Home Loans Group wanted Jenne to recommend ways to market the Option ARM. So, Jenne and his team noted in their follow-up report that the best way to off-load the product onto customers was to tell them little about it. That avoided the problem of complicated loan terms and words that no one understood. "Focusing on the right 'need to know' information is critical to developing more Option ARM sales. Participants seemed easily overwhelmed by the product details," the report concluded.
... Jenne came to believe that the Option ARM wasn't just a bad idea -- it might be evil. "After awhile, I lost that feeling," Jenne said. "Then I came back to it later on. And then I thought, 'No, no, this product is definitely evil.'" 
Whether or not [CEO] Kerry Killinger saw Jenne's research on America's hot new mortgage product -- and it's likely that he didn't se it -- WaMu doubled its annual Option ARM production to $68 billion in one year. By early 2005, WaMu promoted its loan as its "signature mortgage." It made up more than 25% of all the mortgages WaMu made or purchased.

A few observations:

The vast Mexican surge into places like Orange County over the last few generations represented basically Fresh Meat to exploit for Newport Beach MBAs with spreadsheets. When you hear the Donor Class of the GOP talking about the need for "immigration reform," that's what they mean: more Fresh Meat.

These dialogues capture quite well the happy-go-lucky agreeableness combined with an aversion to hard mental effort that are a trademark of Mexican-Americans in Southern California (and perhaps elsewhere). When Michael Barone talks about Mexicans as the New Italians, he misses a key distinction: Italian-Americans tend to be suspicious and pessimistic. They put a lot of cognitive effort into trying to understand why this too good to be true offer is too good to be true. They save a lot because they expect the worst.

Mexican-Americans tend to spend a lot because they expect the worst, but it would also be too much work to figure out what might happen, so why not have a good time now?
         

89 comments:

Whiskey said...

This piece nails it. Steve, one of your finest and that's saying something. Particularly the Newport Beach MBA crowd who you really nailed.

The first thing you ask yourself in Newport Beach -- "where did they get their money?" and there is a LOT of it. Just look at the place.

Anonymous said...

http://nymag.com/nymetro/shopping/features/9299/

The founder of Deadspin on his previous career as a professional focus group member.

Alfa158 said...

I happened to work down there during the mortgage gold rush and it was like a 21st century version of Sutter's Mill. It wasn't just the sharpest MBAs getting rich, a whole motley assortment of people from every walk of life were working in these mortgage factories grinding out toxic mortgages. Some looked like the young graduates and affirmative action admission kids with unmarketable degrees you normally saw working at Enterprise rent a car, but for a while they were going out after work on Fridays and taking turns picking up the tab for $10K bottle service in the toniest bars. It was amazing how fast it crashed. One of the largest brokers went from 700 some employees to the 2 founders virtually overnight.

anony-mouse said...

Epicurus was a Mexican-American?

And I believe that Italians tend to be suspicious and fatalistic, not pessimistic. They seem to be too happy to be the latter.

Beefy Levinson said...

When you hear Catholic bishops go on about the need for immigration reform, what they usually mean is: "We're losing all of our Anglo sheep, so we need more Mexicans to keep butts in the pews." Unfortunately, it takes about three Spanish Masses to raise as much money as one English Mass.

Anonymous said...

Well, it's obvious we can't all get rich flipping real estate at high velocity unless we import the entire world population. Then think how rich we'll be! Oh, boy, I can hardly wait!!

Dave Pinsen said...

"When you hear the Donor Class of the GOP talking about the need for "immigration reform," that's what they mean: more Fresh Meat."

Only if there's easy credit available. The typical situation is that the folks who are the most susceptible to being ripped off don't have much money to rip off; the mortgage meltdown enabled Main Street mortgage brokers to essentially ripoff Wall Street and the GSE's via ignorant borrowers.

That said, the borrowers in the WaMu focus group mentioned above don't sound like Mexican immigrants, who probably wouldn't know what an index was or have ever heard of the Nikkei.

Steve Sailer said...

The focus group was in English so these are American-born or long-time residents. They sound like the folks I grew up around.

Of course, all the mortgage companies were gearing up at that point (2003) to better deal with Spanish-only borrowers, which really kicked in in 2004-2007.

The book has some funny stuff about WaMu's SoCal superstar "mortgage consultant" was a broker named Tom Ramirez who moved billions in loans, large amounts fraudulent.

Anonymous said...

I'm not going to argue that people should know what capitalized interest is off the top of their heads. I'm not going to argue that people should know what negative amortization is either. I do think people should make some sort of effort to understand the terms of their mortgage when they buy a house. I don't feel bad for any of the people in that focus group. Having had quite a bit of contact with the "working poor" during my adult life, I have concluded that the vast majority of them deserve no pity at all.

They seem to constantly make bad choices, and it costs them. Their inability to delay gratification never ceases to amaze me. I remember one acquaintance of mine talking about his trip to his trip to get his taxes done. He would have had to wait a whole two or three weeks to get his $1,200 refund. No worries though, because they hooked him up with a refund anticipation loan, and he walked out the door with $1,000 that day. I've seen the rent to own store repo furniture and TVs. I've seen a coworker gets the rims he bought for his car repossessed in the parking lot at work. I can't offer any compelling reason not to take advantage of people in the bottom one or two income quintiles. They're guaranteed to piss the money away with nothing to show for it anyway.

David said...

>Mexican-Americans tend to spend a lot because they expect the worst, but it would also be too much work to figure out what might happen, so why not have a good time now?<

The same seems to apply equally to American-Americans, such as the boys with the spreadsheets, the fine folks at WaMu, and Jorge Bush. This seems evil but it's too demanding to think about that. My feelings aren't solid. So, hell, let the good times roll. The government will bail everyone out if worse comes to worst. It's in the Declaration of Independence or something, isn't it?

>Only if there's easy credit available.<

Credit becomes available when the suckers appear.

Anonymous said...

What does Michael Barone know about Mexicans? What does any DC intelligentsia know about Mexicans? He doesn't know squat. He just looks at numbers, mostly from his tony home in Washington DC, and assumed they'll go the Italian tract. Barone is my level-headed then most, but Italians in 1910 US and Mexicans in more recent decades US are apples and oranges. Other than being Catholic and arriving here relatively poor, they really don't have too much in common.

Re: WaMu - They were a great bank that lost their way because of greed. A lot of average people owned stock in WaMu (esp. in the Northwest) and they got screwed. Kerry Killinger and every other exec ultimately responsible are still loaded, and I'm sure happily playing golf and/or still working in the industry. Nobody went to jail for a single second. It's really disgusting. That was an excellent book by the way!

SFG said...

Long as we're talking ripping off various ethnic groups, how did Madoff pull it off? You'd think he'd be up against some serious sharpies given who he ripped off...

SFG said...

"They seem to constantly make bad choices, and it costs them. Their inability to delay gratification never ceases to amaze me. I remember one acquaintance of mine talking about his trip to his trip to get his taxes done. He would have had to wait a whole two or three weeks to get his $1,200 refund. No worries though, because they hooked him up with a refund anticipation loan, and he walked out the door with $1,000 that day. I've seen the rent to own store repo furniture and TVs. I've seen a coworker gets the rims he bought for his car repossessed in the parking lot at work. I can't offer any compelling reason not to take advantage of people in the bottom one or two income quintiles. They're guaranteed to piss the money away with nothing to show for it anyway."

It's wrong? Honestly, this is why we need Christianity. There is just no logical reason not to rip these people off, so you have to give people the idea they might go to hell.

Luke Lea said...

Moral hazard.

Anonymous said...

OT: Here's an old article from William Safire

Siloviki Versus Oligarchy
http://www.nytimes.com/2003/11/05/opinion/siloviki-versus-oligarchy.html

I don't think it's an especially good article, but it's important to point out that so many of the people The West attacks Putin for cracking down on are people who should be cracked down on.

Daniel said...

@ David

>>Credit becomes available when the suckers appear.

Credit becomes available when the Federal Reserve Bank does the bidding of its masters and conjures it out of air.

David said...

>I can't offer any compelling reason not to take advantage of people<

Remember that when your superiors take advantage of you.

Bert said...

Michael Barone? He's still around? I thought he went the way of Mort Kondracke.

Mountain Maven said...
This comment has been removed by the author.
Anonymous said...

"It's wrong? Honestly, this is why we need Christianity. There is just no logical reason not to rip these people off, so you have to give people the idea they might go to hell."

How quaint. Doesn't all this flipping and ripping people off increase the GDP or GDI or one of those highly accurate government numbers? And didn't some economist discover that the GDP is god?

Truly, we need to import a more ruthless class of citizens who understand these things.

Chris said...

"My loan is indexed to the Nikkei," proclaimed one borrower.

...Strangely, in another focus group, in Illinois, another borrower also believed his loan was indexed to the Nikkei. Jenned never discovered where borrowers had received that information. "I don't think they were being told this by someone," said Jenne. "I think that the only index they had heard of, like on TV or something, was the Nikkei. It was just bizarre.


Steve you have a great eye for finding these kinds of surreal things in books and news articles.

But here's an even stranger possibility. What if these people's mortagages actually were indexed to the Nikkei? What if there was some asshole mortgage broker out there offering mortagages indexed to the Nikkei, just because he could? It's not like he would have trouble finding customers who would not know any better...

notsaying said...

I blame the people selling and pushing the mortgages for the Great Recession a lot more than I do the people who were in this focus group. How many white people understood those mortgages? Not many of them did, either. Many assumed if a bank offers a product, it has to be OK.

That banks are regulated makes it easy for people to assume that. What we need is much better regulation, which we still don't have, and much more frequent and lengthy punishment for fraudsters.

I would not assume that Mexicans are genial dolts.

Let's see what happens once we legalize the illegal and 90% of them realize five or ten years later that they'll never make it into the American middle class and their kids might not, either. Too many people chasing too few jobs, too many new immigrants coming after them, too many 1%ers refusing to pay a decent day's pay for a decent day's work.

That's what I call a recipe for lifelong poverty. Let's see how the Mexicans respond to that. They won't shrug that one off, I'm pretty sure of that.





Anonymous said...

OT: video shot by Russian troops during Russia's recovery of the Crimea.

Anonymous said...

Credit becomes available when the Federal Reserve Bank does the bidding of its masters and conjures it out of air.

Regular banks in the US, not just the Federal Reserve, have a legal license to create money. Your local bank doesn't need to sit and wait for deposits before making loans, although traditional models of banking you see in textbooks describe it this way. If a borrower appears it can just credit the borrower i.e. create money out of thin air and give it to the borrower. These might be bad loans, but as long as the bank can sell the loans to someone else it can make money making bad loans. Of course the system as a whole still ends up with a bunch of bad loans.

Hunsdon said...

SFG said: It's wrong? Honestly, this is why we need Christianity. There is just no logical reason not to rip these people off, so you have to give people the idea they might go to hell.

Hunsdon said: You nailed it, brother. No 'logical' reason not to rip them off, it's something beyond logic. Snookering these schnooks with a complicated scheme is just as wrong as strong-arming them for their lunch money.

PS: not to get all huggsy-muggsy, but I really enjoy and appreciate your comments here.

Mountain Maven said...

Those who can t move here are shrugging it off in Mexico. They lack gumption.

bjdubbs said...

The lesson WaMu took from the focus group was, tell the customers even less about the product. They won't understand anyway, there's no reason to tell them in the first place. Great sales minds at work.

Anonymous said...

OT: video shot by Russian troops during Russia's recovery of the Crimea.

The soundtrack sounds like Vivaldi. Couldn't they have used some good Russian Classical music? There is plenty to choose from. How about Borodin? Rachmaninov? Rimsky-Korsakov or even Tchaikovsky?

Still, I think Russia will kick NATO's ass!

Anonymous said...

Banks? Gold, silver, brass and lead...

Finian said...

Epicurus was a Mexican-American?


=====================


Epicurus believed in the simple life, basically paring your desires down to the absolute basics and doing just enough work to sustain that. Enough food, some shelter, the presence of your loved ones, not being indebted. That sort of thing. He never believed in spend spend spend, let the good times roll.


As pleasant as it sounds for individuals, that's not the kind of society in which I would want to live, anymore than one governed by the Mexican American attitudes shown here. For it to have anything approaching prosperity, it would require workers and I refuse to be a parasite. But please, understand Stoicism before you use it as a punchline.

Finian said...

notsaying said...

I blame the people selling and pushing the mortgages for the Great Recession a lot more than I do the people who were in this focus group. How many white people understood those mortgages? Not many of them did, either. Many assumed if a bank offers a product, it has to be OK.

=======================


I'm white and I don't understand them so yeah, I understand your point and largely I agree with it. That said, if you think stochastically about this, you're going to get a much bigger problem from the millions of mestizos than you are from millions of whites. Start looking at the various subgroups of whites and Hispanics, and the differences are increasingly stark.

Anonymous said...

Blogger Beefy Levinson said...
When you hear Catholic bishops go on about the need for immigration reform, what they usually mean is: "We're losing all of our Anglo sheep, so we need more Mexicans to keep butts in the pews." Unfortunately, it takes about three Spanish Masses to raise as much money as one English Mass.

4/12/14, 3:39 PM


=====================


They're doing the same in Ireland. And they're too lazy, corrupt and downright awful to even attempt to address why we don't want them essentially running the country (serious deep state stuff, including essentially taking over sections of the civil service) anymore. Nope, let's import lots of Eastern Europeans and Africans. People are totally fungible and that's the exact same as reversing the decline amongst the Irish nation, right?

kurt9 said...

My question is this: Since WaMu was issuing all of these dodgy mortgages and knew that they were dodgy, why did they not securitize and sell off all of these mortgages as mortgage-backed bonds? Why did they keep them? To this day I still cannot understand why they did this.

I knew it was a housing bubble starting around 2003. I knew that the banks and other mortgage brokers were offering these kind of sub-prime and option ARM's and where then securitizing them as bonds and selling the resultant bonds through Freddie and Fannie to investors (suckers). I thought the banks would sail through the collapse in pristine shape. I had no idea that they were either keeping or even buying these bonds from other lenders. Even then this was completely irrational to me.

Maxwell Power said...

Michael Barone? He's still around? I thought he went the way of Mort Kondracke.

Wait until you accidentally find out John McLaughlin's still on TV some places

Mountain Maven said...

I have known the people too dumb to know what they are buying. I have also known the amoral wall st types who only want to get rich. We set up a million rules to protect the former from the latter but it doesn't work. Particularly when the Wall St crooks make up a new product and then the marginally smarter ones to dupe the dumb ones.
Here's my solution:
1. Send more white collar bad guys to jail, that's what they understand as unacceptable risk. Fines don't work.
2. Stop illegal immigration.
3. Teach some practical skills in school rather than failing half the country in algebra.
4. Live out and preach the Gospel, in season and out.

Anonymous said...

The' poverty' they' suffer 'in America is 'middle class' in Mexico.

Anonymous said...

OT: an article by someone named Thomas Theiner with some advice for the people of Ukraine:

Destroy all gas pipelines & bomb the Belarusian gas pipeline, thus launching the boycott of Russian energy that the West has refused to undertake until now.
Flood Ukraine with small arms by arming every patriotic citizen to unleash a massive guerrilla war when Russian forces invade.

Provide guerrillas with Anti-tank Guided Missiles, Man Portable Air-defense Missiles, mines, explosives and everything else in Ukraine’s arsenal to ensure the guerrillas can resist effectively for years.

Call on Ukrainians in the West to attack and kill members of the Putin regime, their associates and close relatives.

Remove uranium from Ukraine’s nuclear reactors and prepare to disperse it in Russia by all means possible—the Budapest Memorandum depriving Ukraine of nuclear power status is clearly moot now.

Prepare to shell Belgorod with whatever missiles and artillery Ukraine has in its arsenal to flatten that city.


Mr. Theiner has a twitter feed. This is interesting.

Anonymous said...

Guess where one of those right wing Republicans went to Texas Chuck Devore. OC had bad loans in both Santa Ana but also in white south county. OC only has Mexicans and Asians while the Great Harris County of Texas has Mexicans and Blacks and Asians are still far behind. I bet OC and San Diego even being expensive will in some ways beat Houston and Dallas Tx with their Mexican and Black popualtions.

Anonymous said...

FYI: Mozilla just took down their comments/feedback board because the comments were running 93 percent negative on the Eich pogrom:

https://input.mozilla.org/en-US/feedback

The comments/feedback board was there this afternoon; now it's gone.

cap vandal said...

I think the so called 'victims' made a good bet. For the first time in their lives someone was willing to give them the sort of leverage that would make Donald Trump envious.

And what did they have to lose? They were renters before and became renters again. Toward the end, banks were paying delinquent mortgagees to move out instead of going through a lengthy foreclosure and getting the house back with the plumbing ripped out, &c.

The lenders are supposed to be the adults in this relationship. And it is reasonable to expect more from lenders higher in the food chain. I don't even care much about the bottom layer of mortgage brokers -- they were selling this stuff to people that should have known what they were doing.

I have an ARM that is indexed to some sort of short duration treasure -- I dunno. I'd have to look it up. If it had been indexed to the total return of the Nikkei, the option ARMS would have been in fat city when the Nikkei crashed in 2008.

One of the real problems with the option arms is not the index, but the spread over the index. For some of them, it was 5 or 6%.

Anyway, great story .... I always enjoy reading about companies that implode.

Anonymous said...

Mexican-Americans tend to spend a lot because they expect the worst, but it would also be too much work to figure out what might happen, so why not have a good time now?

Of course, it helps that the money is flowing from the taxes paid by hard-working Gringos.

Anonymous said...

"My question is this: Since WaMu was issuing all of these dodgy mortgages and knew that they were dodgy, why did they not securitize and sell off all of these mortgages as mortgage-backed bonds? Why did they keep them? To this day I still cannot understand why they did this."

Great question. Michael Lewis wrote a book titled 'The Big Short' where he searched for people that got rich shorting the housing bubble. There were a few, but with all the hedge funds and risk capital floating around, it is an amazingly small number.

As far as WaMu -- as far as I can tell:

1. Everyone else was doing it.
2. They sold a lot upstream to Wall Street to be repackaged as structured products -- CDO's. And they thought that their stuff was better than the stuff that was sold (which was true).
3. The West Coast largely survived the 1990 meltdown and they thought that was the worst that could happen.
4. There were no loan losses for years, as they could just resell the foreclosed properties at a price at or above the loan balance.
5. More or less everyone thought that inflation would be high enough to bail them out.


Steve Sailer said...

A lot of the drops were very abrupt -- for example, I went camping at the end of July 2007 and when I got home less than a week later, subprime mortgages were worthless.

Steve Sailer said...

WaMu's head lawyer forced a big internal audit upon its Long Beach Mortgage subprime subsidiary in 2003 and found tons of fraud.

But nobody seemed to learn anything generalizable. WaMu seemed to assume because they scaled back on subprime after that that everything else was, by definition, hunky-dory. These negative amortizing Option ARMs that WaMu pushed heavily in the mid-2000s were giant fraud magnets since they didn't require much cash on the barrelhead for a full five years, but, hey, they weren't, technically speaking, subprime so what could go wrong?

Anonymous said...

http://www.nytimes.com/2014/04/11/us/poverty-and-violence-push-new-wave-of-migrants-toward-us.html?_r=1

Bush: illegals love this country

Anonymous said...

This is obvious in retrospect, but I found it very difficult to make money off the knowledge that there was a lot of rot in the system.

The Tisches went short too soon. I found it impossible to put enough pieces together to get a clear indication of how it would play out.

For example, if a bank has $60 billion in option arms, and 1/2 of them default and they can sell the property for 1/2 the loan balance, that puts the portfolio loss at 25%. This was a lot worse than anything they had ever seen -- so, they could write down the $15 billion over 4 or 5 quarters -- worst case.

Toxic mortgages seemed to be maybe 300 to 500 billion out of over $10 trillion in total mortgage debt.

It was very hard to see how interconnected everything was. In addition, I have seen a lot of market volatility, but have never seen sheer panic like in late September 2008. By the time the fog began to clear, it was May, 2009 and markets had already started to rebound.

I would say that a lot of people had a general idea that there were serious problems but very few could see enough of it to get a sense of how bad it would be, and how it would chew up the economy. Fairly late in the game I started to read Irving Fisher and looked at the 1930's depression. Perhaps the simplest explanation is that everyone that had been an adult in the 1930's was dead.

Steve Sailer said...

Why did WaMu and Countrywide and lots of other firms get stuck holding the hot potato?

One problem was technical: it took some period of time to package mortgages into securities (a couple of months on average?) so they got stuck with inventory when there were abrupt crashes in the perceived value of mortgages at the end of July 2007 and in September 2008.

The bigger problem was that most of the players weren't wholly cynical. They thought these were good investments so when the market prices was declining and they couldn't get as much for them as they had expected, they tended to hold on to them, expecting better times ahead.

Anonymous said...

Strangely enough, in the UK there are the seeds of a nascent property bubble beginning to happen right now - a mere eight or so years after the last.

House prices in London have reached truly absurd levels, put simply simply they are completely unafforadble *everywhere* in London apart to those with inherited wealth, rich foreigners or a handful of city workers. What you seen in today's London is the old fashioned 'wage paradox' which economists used to harp on about when discussing Lagos etc - 'How do people manage to actually *survive* when their outgoings massively exceed their income?'. A shity, rundown 120 year old two bedroom flat conversion in a nasty crime ridden London ghetto typically costs around $750,000.
Wages have stagnated in the UK for years now, whilst living costs have soared.

The property bubble, no doubt inflated with foreign money coming in to fund the UK's massive traded deficit is no doubt the *only* source of economic growth in the UK, thus the Chancellor, George Osborne dare not take the corrective action that is needed to cool it down. British industry was ass-raped long ago, and so simply cannot be counted on to provide growth.

Pertinnet to all the above is the previous Labour government's policy of massive, uncontrolled and unrestricted immigration, with the concomitant abolitio of all immigration control whatsoever - a true 'opn borders' policy if there ever was one.
Something like 7 million immigrants entered the UK during New Labour's reign of error. "If you seek Labour's monument, look around you".

Silver said...

"Regular banks in the US, not just the Federal Reserve, have a legal license to create money. Your local bank doesn't need to sit and wait for deposits before making loans, although traditional models of banking you see in textbooks describe it this way."


Wrong. What part of fractional-reserve banking do you not understand? A bank must take deposits if it is to keep some fraction of them in reserve.

Udolpho.com said...

"I can't offer any compelling reason not to take advantage of people in the bottom one or two income quintiles."

I can't think of any compelling reason not to tax away your income and section 8 your neighborhood.

Titus Didius Tacitus said...

Usury.

Anonymous said...

That WaMu commercial is classic. Someone should meme the hell out of it, making clear at the end that Wa Mu went bankrupt.

Anonymous said...

I have been in the mortgage industry for 15 years. I used to work at some shops that specialized in these wacky loan products. I was at a conference a year before the **** hit the fan and there was some guy from Golden West bank who was talking about Option ARM loans. He admitted they were riskier products but insisted they were good because of the careful underwriting. Golden West like WAMU used these Options ARMS to greatly expand its loan portfolio. A little while later Wachovia Bank bought Golden West. Wachovia purchased Golden West to expand their presence out West. When the bubble burst these Option ARMS explode on Wachovia ruining the bank.
The CEO of Wachovia was Ken Thompson who spent his life taking a small regional bank in NC and through acquisitions becoming on the top bank in the US. He went one acquisition too far. The Feds had Citigroup give financial CPR to Wachovia although Wells-Fargo ended up acquiring Wachovia. Us tax payers, ended up eating the losses on these Option ARMS directly and indirectly.

Anonymous said...

You know, Bush's "Ownership Society" idea really isn't a bad one. Give people a stake in society and they'll behave in ways to preserve that stake.

In retrospect, it would have been better for people to own some kind of productive capital rather than over-sized houses in the middle of nowhere, where $4/gal gas would crash the whole thing.

Anonymous said...

The Big Short covers this in detail and is well worth a read.

Steve, I think the biggest problem with WaMu and Countryside was that they had very little in AAA mortgages to help hide the subprime garbage in their CDO tranches.

countenance said...

This article really surprises me and shocks me, unless it doesn't. Low IQ people with next to no if not zero future time orientation only judge a deal based on what's happening now?

When Michael Barone talks about Mexicans as the New Italians, he misses a key distinction

That key distinction is that Italians are not Mexicans. The first group of people gave birth to the European Renaissance, the other group of people, the Chicano variety, eat lots of beans.

David said...

>Mozilla just took down their comments<

what is Mozilla

Jeff W. said...

One thing worth observing is that none of this could have happened if the U.S. was still on the gold standard. Interest rates under a gold standard tend to stabilize at 3% or 4% on non-depreciating money.

With much higher real interest rates, these suckers could not have been fleeced. They would not have been able to afford the payments and would not have qualified for loans.

There were real estate bubbles in the gold-standard days, most notably in the 1920's, most notably in Florida. But for real, 2007-style real estate bubbles, you need fiat money.

David said...

I am surprised to learn that WaMu had focus groups.

This commercial declared that the bank made its decisions by a different method

...a groovy, Obama-tastic method!

anony-mouse said...

'Please understand stoicism...'

Epictetus not Epicurus was a stoic.

Anonymous said...

This song by Godley and Creme would not get any airplay these days ...

geschrei said...

While this aspect of the WaMu Option ARM saga is fascinating and very instructive, I have yet to see anyone mention the most truly outrageous aspect of the entire debacle, and the real reason these financial instruments ended up nerarly destroying the world economy, much less the mortgage business.

Namely, WaMu (and other lenders) were legally allowed to declare these deferred interest payments on their balance sheet as income in the form of "negatively amortized interest", even though in many cases the payments were never going to be paid.. Here's a 2006 Business Week article that mentions the practice, while laughably underestimating the eventual impact on the overall economy.

Karl Denninger started The Market Ticker in 2007 specifically to call attention to the outrageous legal fraud occurring in the banking industry. I was led to his site back in February of '09 by a comment here, and have received an invaluable education on the financial system, both in the US and worldwide, and why a catastrophic collapse far worse than the Great Depression is now inevitable. Unfortunately fir the rest of you, Denninger's frustration with the lack of concerted action to curtail the practices that are leading to that cataclysm (or even provide punishment for the parties responsible for the '08 crash) has prompted him to begin a gradual shutdown of the Ticker. As a result, many of his articles on WaMu and other egregious scams are no longer available online.

Ah well, it's been fun while it lasted.

dcite said...

" Other than being Catholic and arriving here relatively poor, they really don't have too much in common."

A lot of Hispanics are going the Protestant Evangelical route. I see their churches all over the suburbs of DC/Maryland. The Italians never left Catholism. It's downright rare & shocking to find one that became Protestant. They'd be atheists or Buddhists before that.

E. Rekshun said...

@Anon: ... the "working poor"...constantly make bad choices, and it costs them...I've seen the rent to own store repo furniture and TVs...

I recently helped a coworker's daughter (single mom, 25 y/o, w/ a 6 mo. old newborn) find a decent, cheap car. I found a very decent '99 Toyota Corolla for $900, and it ran like a top. Three months after purchasing it (and spending $300 to register and put it on the road), the not-very-bright single mom pawned it for $500 so she could pay her rent. Well, no surprise, she could never get the car out of hawk, ended up losing her part-time job, and can't get the her infant daughter to doctor appointments.

DR said...

"The bigger problem was that most of the players weren't wholly cynical. They thought these were good investments so when the market prices was declining and they couldn't get as much for them as they had expected, they tended to hold on to them, expecting better times ahead."

I briefly worked as an entry level quant on the risk management side of structured mortgage derivatives at a major bank in 2007.

First you have to understand the enormous complexity of the securities that were in play. It wasn't just simply "Oh, here's an overpriced house with a no-income tenant with no money down. That could never lose money." There were giant pools of mortgages, with equity and mezzanine tranches to protect from first defaults, IO stripped out to modify pre-payment exposure, hedged with correlation derivatives, then pegged to various credit indices.

When something gets this complicated there's no easy way to say "What will happen if a recession occurs or house prices go down? Do these terms sound reasonable." Instead you pretty much have to model the security as a black box and plug in historical data to estimate risk exposure.

The problem occurs because so aspects of these securities were so new that the market had only existed since 2002 or later. So the historical data you're plugging only comes from a tremendous bull market. That creates a vicious cycle where more highly levered mortgages get offered on the basis of recent historical data. Those mortgages push up housing prices and the returns of subprime mortgages, which in turn make the data look even better and cause the quants to offer even dodgier mortgages.

Portlander said...

why did they not securitize and sell off all of these mortgages as mortgage-backed bonds? Why did they keep them?

To the reasons already mentioned, one more:

Accounting

Those negatively amortizing loans were booking income as the interest accrued. It was a total fiction, as none of it was making its way to the cash statement, but the pro-forma income looked great. Loan some dude at 8%, only charge him 1% for the first 5 years, and in the meantime the other 7% a) gets to show-up in this quarter's earnings b) will compound in next quarter's earnings. A two-fer!

As for Mexicans, I'm pretty sure they figured they were betting with the house's money. If it worked out great, if not, no harm no foul. They had no skin in the game and absolute worst-case scenario is they go back to Mexico. On a monthly basis, an option ARM in the Inland Empire would be cheaper than rent LA.

Anonymous said...

"Italian-Americans tend to be suspicious and pessimistic. They put a lot of cognitive effort into trying to understand why this too good to be true offer is too good to be true. They save a lot because they expect the worst."

A perfect assessment of my Sicilian relatives.

Anonymous said...

You know, Bush's "Ownership Society" idea really isn't a bad one. Give people a stake in society and they'll behave in ways to preserve that stake.

As always, that depends on which people you are talking about.

Scandinavians, probably. Blacks and Mexicans? I doubt it.

Anonymous said...

Wrong. What part of fractional-reserve banking do you not understand? A bank must take deposits if it is to keep some fraction of them in reserve.

No, you're wrong. A bank does not need to take in deposits first before making loans. It can start creating money and making loans with no deposits at all. After making loans, the bank itself can borrow money (at lower rates of course) to cover its fractional reserve or the borrowers might deposit the loan they just took out in the bank and these deposits can cover the fractional reserve. The tendency is for loans to create deposits, rather than for banks to sit around waiting for deposits to make loans.

Anonymous said...

That WaMu commercial is classic. Someone should meme the hell out of it, making clear at the end that Wa Mu went bankrupt.

No doubt. The WaMu spokesman is the articulate black guy who makes fun of the fact that traditional bankers, all white of course, frown upon WaMu's new policies. Yet WaMu went out of business by engaging in such non-traditional methods.

Maybe a metaphor for today's USA.

Rohan Swee said...

DR: I briefly worked as an entry level quant on the risk management side of structured mortgage derivatives at a major bank in 2007.

First you have to understand the enormous complexity of the securities that were in play. It wasn't just simply "Oh, here's an overpriced house with a no-income tenant with no money down. That could never lose money." There were giant pools of mortgages, with equity and mezzanine tranches to protect from first defaults, IO stripped out to modify pre-payment exposure, hedged with correlation derivatives, then pegged to various credit indices.


Let me translate that final sentence for you non-entry level quants out there. In layman's speak, it basically means: "Oh, here's an overpriced house with a no-income tenant with no money down. That could never lose money".

Titus Didius Tacitus said...

David: "what is Mozilla"

It's a gay pride organization.

DR said...

Let me translate that final sentence for you non-entry level quants out there. In layman's speak, it basically means: "Oh, here's an overpriced house with a no-income tenant with no money down. That could never lose money".

If you want to translate it, it'd be more like "Here's 500 overpriced, no-income mortgages. They all probably will eventually lose money, but the probability that more than 75 go bankrupt in the next 18 months is less than 2.5%."

DR said...

The tendency is for loans to create deposits, rather than for banks to sit around waiting for deposits to make loans.

While you're right that banks can borrow money to cover loans, deposits are very special. They're by far the cheapest source of funding for banks (your checking account gets much less interest than short duration bank debt). Most bank lending does not earn enough after defaults to cover the cost of funding of commercial bank debt. It's really only with cheap deposit funding that most bank lending is profitable.

That's why you see Chase build ten million branches everywhere. JP Morgan's primary mission in life is to gather as much deposits as possible. So it really is the case that bank lending is driven on the margin by bank deposits.

patrick said...

"Italian-Americans tend to be suspicious and pessimistic. They put a lot of cognitive effort into trying to understand why this too good to be true offer is too good to be true. They save a lot because they expect the worst."

You just described my father (the grandson of Sicilian immigrants) to a T.

David said...

If A loans B's and D's money to C for a price, while fudging the question of whether C is a deadbeat (and even while suspecting that he is), and they all go broke--because C is in fact the deadbeatiest deadbeat ever--is C mainly to blame?

As W.C. Fields once said, "You can't cheat an honest man."

There was a story some years ago about a high-flying lender who owned and wrecked a fleet of sports cars, financed his own movie, chased "actresses," and generally made a nuisance of himself. After everything turned into caca, a fellow lender summarized the man's incredible erstwhile career as follows: "He would have given a loan to an insolvent arsonist."

That may be too harsh. An unemployed strawberry picker isn't an insolvent arsonist. At least not until foreclosure.

notsaying said...

"@Anon: ... the "working poor"...constantly make bad choices, and it costs them...I've seen the rent to own store repo furniture and TVs...

I recently helped a coworker's daughter (single mom, 25 y/o, w/ a 6 mo. old newborn) find a decent, cheap car. I found a very decent '99 Toyota Corolla for $900, and it ran like a top. Three months after purchasing it (and spending $300 to register and put it on the road), the not-very-bright single mom pawned it for $500 so she could pay her rent. Well, no surprise, she could never get the car out of hawk, ended up losing her part-time job, and can't get the her infant daughter to doctor appointments."


It sure was a shame this woman pawned and lost her car.

But if she couldn't pay her rent and that was the only thing of value she had, what else was she supposed to do?

Lots of unemployed middle class white people ran through their savings and 401(k)s and IRAs because it was the only thing they had left of value too.

A lot of bad decisions are voluntary. But nany are the result of desperation.

As a lot more white people are unable to get anything better than parttime, low wage jobs, we will see a lot more white people falling into poverty traps where the car goes, the job goes because of no car, the house or apartment goes because of no job.

The financial backbone of this country has always been that huge group of whites who were financially stable and paid most of the taxes. But our white working class is at least half-destroyed and our white middle class is crumbling and disappearing too.


The social and financial implications of that are huge. Yet nobody in charge seems to notice or talk about that. They are too busy HOPING that things will change for everybody else. Their friends and families are doing great, never better.

Anonymous said...

"Let's see what happens once we legalize the illegal and 90% of them realize five or ten years later that they'll never make it into the American middle class and their kids might not, either. Too many people chasing too few jobs, too many new immigrants coming after them, too many 1%ers refusing to pay a decent day's pay for a decent day's work.

"That's what I call a recipe for lifelong poverty. Let's see how the Mexicans respond to that. They won't shrug that one off, I'm pretty sure of that."

They've been doing it in Mexico for 100 years.

Anonymous said...

Ethno-Leftism

Michael Pershing Carter said...

Students with these college majors had the highest LSAT scores

http://www.abajournal.com/news/article/students_with_these_college_majors_had_the_highest_lsat_scores/?utm_source=maestro&utm_medium=email&utm_campaign=weekly_email

Anonymous said...

steve come chill with us in rrti chat (the solution to the registration question is 1)

ben tillman said...

It sure was a shame this woman pawned and lost her car.

But if she couldn't pay her rent and that was the only thing of value she had, what else was she supposed to do?


Sell it to the guy who knew it was worth a lot more than $500.

notsaying said...

Anonymous 4:15P --

The newly legalized have all kinds of expectation about the US -- and the politicians who want their votes.

They do not want more of the same here, after legalization, as they experienced in their home countries or here as illegal immigrants.

Some have already joined unionization efforts in New York City. Some are actually already in unions.

Odd as it seems, one positive that may come out of legalization is that the newly legalized may stand up better for themselves than Americans workers have done in the past 30 years. If they do -- and inspire more Americans to start asserting themselves -- that would be a wonderful thing, in my opinion. I am for anything that gets Americans to finally start defending themselves against the cheap labor employers.

Silver said...

"One thing worth observing is that none of this could have happened if the U.S. was still on the gold standard. Interest rates under a gold standard tend to stabilize at 3% or 4% on non-depreciating money."

Wrong. There is no reason that interest rates must stabilize at 3 or 4 or any percent under a gold standard. And gold too can depreciate if more is mined.

"With much higher real interest rates, these suckers could not have been fleeced. They would not have been able to afford the payments and would not have qualified for loans."

Wrong. It's because they couldn't afford the repayments at even the low rates that option ARMs were introduced. Higher interest rates would not be an obstacle because the people taking out these loans disregard (or don't understand) the future, which is the main problem.

Anonymous said...

The co-worker's daughter shouldn't be living in her own place. In ye olden times, even if she got to keep her baby, she wouldn't have been allowed the delusion of being the head an individual household. Then she wouldn't have so many opportunities to make bad decisions.

Silver said...

"The tendency is for loans to create deposits, rather than for banks to sit around waiting for deposits to make loans."

Certainly making loans leads to new deposits (and hence new loans and so forth), but that doesn't controvert what I said.

Silver said...

" I am for anything that gets Americans to finally start defending themselves against the cheap labor employers."

Even cheap labor itself, apparently.

notsaying said...

Silver,

I do not believe the ones already here will go home.

When it comes to immigration, I focus on the ones who are not here -- yet.

If we end up combining the energetic disgust of the newly legalized with the passive disgust of citizens and finally, finally get some long overdue action on increased employment of American workers and decreased future immigration, I am all for that, as I said.

It may sound weak and pathetic but let's face it, the recent history of American workers is nothing but weak and pathetic, with layoffs, lower wages and loss after loss.

Having the former illegal immigrants join in with citizen workers and getting somewhere sounds like a dream come true, relatively speaking.

It's too bad we cannot turn the close back and have a redo on immigration over the past 40 years, but we can't.

Anonymous said...

Were these borrowers irrational? California is not a recourse loan state, so in a foreclosure the borrowers loses the home but the bank can't go after other assets. (Not that these people had many other assets.) A teaser rate was like an offer to live rent free until the rates rose.

The only downside risks for the borrowers were getting a worse credit rating, and the possibility that Congress would rewrite the law as in its bankruptcy "reform" to post facto modify agreed-upon contracts in favor of lenders who couldn't judge risk.

It takes several parties to make bad loans. If there was an aversion to hard thinking it was shared by the banks that issued them, the Wall Street firms who securitized them and owe their wealth entirely to government bailouts, and the ratings agencies that gave these securities AAA. An honest government would have tried to put all the executives behind this massive fraud in prison.