Idiots and Ethics

After I posted the “Bigger Idiot” entry, several people asked me if this principle could ever have an impact on society in general, and not just on the handful of speculators (the “Idiots” of my post) who would purchase items on the hope of the price going higher still. Granted that millions of people own stock, isn’t this sort of irresponsible speculation a self-correcting problem, limited to those people with more dollars than sense? I regret to say that while the more exotic manifestations of this syndrome (Beanie Babies, tulip bulbs, and so on) are limited by the size of the market, the basic principle can be found everywhere in our society, and its effects are sadly not limited just to those who speculate. A good case in point is the so-called real estate bubble, and the current sub-prime mortgage crisis.

If you don’t follow such things, a sub-prime lender is simply anyone who loans money to people who can not qualify for loans from mainstream lenders, most often because they have poor credit. Until recently, many of these sub-prime lenders were actually divisions of mainstream mortgage companies operating under different names. A sub-prime mortgage works just like any other, except it is much more expensive (usually in interest rate and other costs as well), making it much harder to pay off the loan than it would be for someone with an ordinary loan.

The basic concept is that since the lender is extending credit to someone who is more likely to default on the loan, they are charging a higher interest rate to compensate for the increased risk. In fact, many companies went into the sub-prime market believing that there was very little actual risk; if their debtors defaulted on their loans, the companies could foreclose on the properties, take possession of them, and then sell them to someone else. As long as the housing market stayed strong, there was almost no down side. And as long as the market stayed strong, the sub-prime customers could always just sell the property again if they couldn’t make the payments, suffering no great loss and possibly even netting a profit, if they could sell for more than their original purchase price.

Thousands (possibly millions) of investors did just that, in fact, jumping into the runaway housing market on the assumption that they could become real estate moguls using someone else’s money, and that even if they failed, they could just default on the loans and walk away, no harm done. This had the effect of driving many buyers, including some prime borrowers (who were not willing to take this kind of risk) out of the market altogether, and forcing many others (often young couples and families) to pay prices, take out loans and accept risks that they would normally have avoided.

The situation has been made even worse by what are called predatory lenders – unscrupulous lenders offering consumers loans on terms that no one could possibly handle with an eye towards acquiring defaulted property (or at least huge fees and bloated payments) and without regard for the effect on their “customers”. Although the exact impact of these practices (and, for that matter, their legal definition) remains in dispute, it is difficult to deny that the housing market has been filled with opportunists throughout the “bubble” of recent years.

The problem is that, just as with the Beanie Babies and tulip bulbs, this sort of speculation is only possible if the market continues to run away and grow. If the market stops growing, or even cools off a bit, the entire thing will come crashing down. Regrettably, this means that ethical companies as well as predatory ones, and honest consumers as well as wildcat speculators, will all suffer from the effects of the market downturn, which would appear to be setting off a global financial crisis. As more large companies suffer huge losses (and some go under completely) jobs will be lost, fortunes will be destroyed, families will lose their means of support, and more homes will be lost to payments that can not be made.

Clearly, then, speculation of this type can have catastrophic effects on our society, and will almost certainly draw the worst sort of con artists and profiteers. The question is, do we have the right, in a free-market economy, to intervene in these situations? And if we do, how are we going to accomplish that intervention? But that’s going to be my next post…