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The financial mess - Phil's Rambling Rants
February 26th, 2009
03:19 pm

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The financial mess
I wrote this comment over on filkertom's journal, but I'm saving a copy of it for myself here.

Let me preface this by saying that the current financial mess, like any problem big enough to be worth talking about, is complicated; there isn't just one thing that caused it or one thing we can change to fix it.  There are as many suggestions for what caused the mess as there are people talking about it, and every cause I've seen suggested probably contributed a little to the mess.

For the most part, we're missing the point if we think we should just blame the top executives.  For the most part, those executives didn't start out as what we'd think of as solidly ethical, get to positions of power, and then suddenly become slime.  They all started their careers years ago in a system that rewarded short-term thinking and didn't care about long term stupidity, and a lot of other people started their careers at the same time.  The reason the ones at the top now got there is not that they were more evil, it's that they were better at playing the game as it exists.  The more clever they were at coming up with bizarre schemes that would make them a bunch of money today and leave someone else holding the bag tomorrow, the better.  The ones who would stop and say "hey, wait a minute, this isn't sustainable, we should do something sane" made less profits in the short term, and had to go get jobs as shoe salesmen.

To pick specifically on the dodgy mortgage brokers some others were picking on above:  if you were working as a front-line broker for a sub prime company 5 years ago, and you made sure that the people that came to you wanting loans really understood that their payments were going to go up a whole lot after two years and convinced them not to buy that house if they wouldn't be able to afford it, and the guy in the next cube over just glossed over all those boring numbers with a smile, when performance review time came around, you got to start flipping burgers and the other guy got a bonus.  Yeah, you probably are more ethical than the other guy, but if we blame him, and not the business climate that rewarded him and punished you, we won't be any closer to avoiding having the same thing again.

And as for what created the system where all we care about is short term paper profits, we don't just get to blame a few Wall Street execs.  All of us who put our savings in diversified mutual funds and never did anything more than look at the account balance on our quarterly statement and smile bear some of the blame.

If you want to fix it long term, make it harder to do well in the long term by investing in companies that are screwing the future for profits today.  Take the tax incentives away from parasitic paper shuffling like derivatives and short selling, and instead favor buying actual shares and holding them for years.  Find a tweak to the system that makes it more attractive to invest in a small number of companies and then pay attention to what they're doing, rather than just diversifying over such a wide swath that you don't care if one company fucks up as long as the market rises.

But mainly, try to suss out what's wrong with the system and how to make it better, rather than looking for individuals to blame.

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From:shockwave77598
Date:February 26th, 2009 09:33 pm (UTC)
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Well, I'm sorry, but I'm sticking to my guns. Firsthand experience showed the big bank taking the fees for a fixed rate loan, then trying illegal methods to try and force me into a ARM. The only thing that saved me was knowing that everyone has a boss, and everyone wants to stay out of the boss's sight. And since I doubt my own branch of gigantoBank was alone in shaking people down techniques, I have to conclude that a lot of the ARMs out there are because the banks took advantage of people after getting all the fees and payments for the loans up front, saying that all that money would be lost if they didn't do as they were told. So as far as I'm concerned, these fatcats can sell one of their Learjets and live within their means, like they preach to us.
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From:catsittingstill
Date:February 27th, 2009 12:03 am (UTC)
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he big bank taking the fees for a fixed rate loan, then trying illegal methods to try and force me into a ARM

Wow.

Nothing like this happened to me, but I had the luck to be in the market later, after the collapse, and by then I knew enough to have howled to high heaven and walked away from my fees if necessary before taking on an ARM.

I'm glad you wriggled out from under their con job. Good on you.
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From:tigertoy
Date:February 27th, 2009 12:59 am (UTC)
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I'm certainly not trying to claim that didn't happen to you, and I'm perfectly happy with staking whoever decided to pull that on you to an anthill. But I believe (without any actual evidence) that most of the people who got ARMs that they couldn't handle when the teaser rate reset were not people who qualified for a fixed rate loan and then got bait-and-switched. I think a lot of people got sold ARMs without understanding that the rate would reset (and the mortgage originators encouraged that ignorance), and a lot more believed that they could automatically refinance into a fixed rate loan before the teaser expired (again encouraged by the originators). And I stand on my contention that that kind of behavior on the part of loan officers was what the market wanted, so it's what it took to hold a job/get bonuses/get promoted as a loan officer. Firing all the loan officers wouldn't have helped, because the market would have winnowed the replacements to behave the same way.
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From:billroper
Date:February 26th, 2009 09:40 pm (UTC)
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Well, there already is such a tweak. It's called the capital gains tax rate. You're much better off owning individual stocks than a mutual fund if you have the time and inclination to pick your own balanced portfolio.

Most of us (including me) simply don't have the time to do the research. So we buy diversified mutual funds and pay someone else to do the research.

Of course, this sort of thing doesn't count for your retirement account, because all of the income from that is going to be taxed at ordinary income rates anyway, so in that case, you may as well buy the mutual funds.
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From:catsittingstill
Date:February 26th, 2009 11:59 pm (UTC)
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Of course, this sort of thing doesn't count for your retirement account, because all of the income from that is going to be taxed at ordinary income rates anyway

Err, unless you have a Roth IRA, right?

For me, I buy the index funds and let a computer do the picking. But in doing that I am sort of parasitizing the general knowledge of everybody out there who *is* studying companies and picking individual funds.
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From:tigertoy
Date:February 27th, 2009 01:14 am (UTC)
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I have never owned either mutual funds or pure stocks outside of a retirement account, but I'm under the strong impression that preferential capital gains rates also benefit mutual fund owners. I remember my mom, in years past, talking about having to do a lot of futzing around to figure out exactly *which* shares she was supposed to be selling when she sold some shares in a mutual fund. If she has to worry about which shares she's selling to find a basis value to subtract from the sale price to determine a gain, that certainly seems to be a capital gain, not regular income.

The biggest tax scam in the stock trading business, which mutual funds certainly do pass on to their holders, is being allowed to offset the gains on one stock with the losses on another.
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From:catsittingstill
Date:February 26th, 2009 11:54 pm (UTC)
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Certainly we need to find ways to make pursuing short term profits and devil-take-the-hindmost less attractive. I agree that we need to restructure the system.

But I think it's still okay to call the slimy people who rose to the top the slime they are. "Don't blame me; I was just hurting people because the system made that the easiest way for me to profit" isn't cutting any ice with me, at least at the moment.
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From:tigertoy
Date:February 27th, 2009 01:24 am (UTC)
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If we blame the slimy people who rose to the top, and we drop them in the ocean but don't change the system, a new crop of equally slimy people will rise to the top. There's a very large supply of slimy people compared to the number of top spots at big companies.

The system needs to change so that sliminess actually decreases shareholder value. When the time horizon for evaluating shareholder value is days, I don't see how to do that at all. If the time horizon were several years, I think it would happen automatically in spite of the efforts of the slimy.
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From:bedlamhouse
Date:February 27th, 2009 03:14 pm (UTC)
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I think you are right about the problem being short-term thinking.

It isn't quite as simple as executives deciding that they themselves needed to profit, though.

It has to do with the change that occurred as stock trading became more open to the individual investor.

What changed was that equity investing used to be a long term proposition - dividends were important but the stability of the stock and the long term potential was the real purpose for investing in it.

Once individuals (whom I call "gamblers") had access to immediate updates and the ability to trade for themselves rather than go through a broker (and spend significant money) for transactions, the focus changed.

"Day trading" led to the need for a stock to actually grow in value in the short term, rather than show a profit or provide dividends over the long term.

Since most of the major stockholders are large entities that can't move quickly (large blocks of buying or selling directly affect the stock price), they had to adapt to these changed expectations or find themselves unable to provide an appropriate or proper return to their underlying pension funds. Many of them added high-growth options because that is what their investors wanted.

Fast forward a couple of decades and this is now the way things are expected to be. Executives are compensated not for the value of the stock but the growth of the stock, so that is how decisions are made.

It is a vicious cycle that didn't come about suddenly because a group of greedy executives decided to make it so. It happened because investors fooled themselves that growth was equal to value, both in real estate and in equities, and this proved to be a false assumption.

After all, IF the real estate market doesn't collapse, THEN you could get a new fixed-rate mortgage by the end of the term of your ARM. Most people I know who got into ARMs believed this is what would happen - after all, real estate had not gone down in the short memories of current mortgage shoppers.

In other words, very few people were trying to screw anyone - especially since most of them were investing in real estate themselves. Rather, it was short-sightedness that is all too human that led folks to believe that what had not happened in a long time simply could not happen.

There have been people predicting a real estate collapse annually for about 20 years. That it finally happened doesn't invalidate most of the years real estate increased in value. Neither did the fact it took so long to actually occur mean it was never going to occur.

The answer, as we have been told over and over and over, is to invest for the long term, look at the value and be reasonable about the risks no matter what "everyone" is saying.

Edited at 2009-02-27 03:16 pm (UTC)
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