Nice writeup -- I don't know all the details of this stuff but the things I do know seem in-line with what you wrote. A good summary!
You mentioned something interesting at the start that I have thought about some:
'I've seen (and been personally hit by) the results of this kind of lending first hand, and it truly sucks - when someone is broke and can't afford to pay their credit card, the last thing they need is late fees and over limit fees that make it impossible to get ahead. It would have done me a favor if the bank had just said "NO, you can't have the credit." '
There's an additional "subprime" sort of thing going on that no one talks about, but I wonder if it has made things worse... or maybe it's really minor and doesn't actually matter; I'd like to know. This is the way that banks give much worse terms to customers who are a bigger risk. I sort of like what you implied about: you should either have credit or a "No". But when banks give someone credit on bad terms, the idea is that the bank needs the higher interest rate, or extra fees, or whatever, as compensation for giving a loan that has higher risk of default.
However, it seems to me that there ends up being a huge batch of home/car loans, credit cards, etc. to people in worse economic situations, so it's even harder for these people to make their payments. My hypothesis is that the banks are increasing the risk of people defaulting because they make the loan terms worse.... It should be fine because the risk to the bank is factored into the price of the loan, right?
... but when all these loans are defaulting at once, and banks start collapsing, then even all the high-interest loans to high-risk customers aren't enough to help out the banks. I wonder if the extra premiums banks put on the bad-credit customers actually help force these same customers into defaulting? Maybe they would do fine if they had loans with the same terms as customers with good credit?
Example: I bought this condo, but I didn't have 20% cash to pay up-front. However, it's cheaper for me to have a mortgage than to rent! This up-front thing is a random obstacle. Still, there's this option of paying < 20% and then paying for mortgage insurance. So I'm explicitly insuring myself for the bank, so they don't have this big risk with me. However, now instead of paying $x each month, I have to pay $x + $80 or so per month. So I have this extra $80 burden each month. It's still cheaper to buy than to rent, so it makes sense. But I'd be an even smaller credit risk if I had $80 extra each month. And even though I'm insured via this $80, I think the housing market as a whole is better off if I don't default on the loan and help cause housing prices to fall.
People with poorer credit get hit with tons of extra fees, higher interest rates, extra insurance payments, etc., and it seems that these penalties are attacking exactly the people in the economy who are most vulnerable. Banks do this, justifiably, to protect themselves, but maybe it has the opposite of the intended effect when people are defaulting on mortgages en masse. I wonder if this mass failure is sort of an emergent phenomenon brought on by banks trying to protect themselves? If banks/credit cards didn't jack up interest rates and fees for higher-risk customers, would a bunch of those same customers instead be able to achieve financial stability? Is there a portion of the "high-risk" credit market that is essentially a self-fulfilling prophecy? Does a bank transform a person into a "high-risk" credit customer simply by the act of categorizing that person as "high-risk"?
I suspect there is a real issue of mathematical Complexity here -- in the sense of chaos theory, emergence, and complex systems. Economists and accountants use a set of models in computing credit risk, but I bet that don't account for the complex large-scale, emergent factors that can impact the whole economy.
Hope I made some sense... this post is long because I'm having trouble describing this exactly right.
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timeasmymeasure
no subject
Date: 2008-09-16 04:28 am (UTC)You mentioned something interesting at the start that I have thought about some:
'I've seen (and been personally hit by) the results of this kind of lending first hand, and it truly sucks - when someone is broke and can't afford to pay their credit card, the last thing they need is late fees and over limit fees that make it impossible to get ahead. It would have done me a favor if the bank had just said "NO, you can't have the credit." '
There's an additional "subprime" sort of thing going on that no one talks about, but I wonder if it has made things worse... or maybe it's really minor and doesn't actually matter; I'd like to know. This is the way that banks give much worse terms to customers who are a bigger risk. I sort of like what you implied about: you should either have credit or a "No". But when banks give someone credit on bad terms, the idea is that the bank needs the higher interest rate, or extra fees, or whatever, as compensation for giving a loan that has higher risk of default.
However, it seems to me that there ends up being a huge batch of home/car loans, credit cards, etc. to people in worse economic situations, so it's even harder for these people to make their payments. My hypothesis is that the banks are increasing the risk of people defaulting because they make the loan terms worse.... It should be fine because the risk to the bank is factored into the price of the loan, right?
... but when all these loans are defaulting at once, and banks start collapsing, then even all the high-interest loans to high-risk customers aren't enough to help out the banks. I wonder if the extra premiums banks put on the bad-credit customers actually help force these same customers into defaulting? Maybe they would do fine if they had loans with the same terms as customers with good credit?
Example: I bought this condo, but I didn't have 20% cash to pay up-front. However, it's cheaper for me to have a mortgage than to rent! This up-front thing is a random obstacle. Still, there's this option of paying < 20% and then paying for mortgage insurance. So I'm explicitly insuring myself for the bank, so they don't have this big risk with me. However, now instead of paying $x each month, I have to pay $x + $80 or so per month. So I have this extra $80 burden each month. It's still cheaper to buy than to rent, so it makes sense. But I'd be an even smaller credit risk if I had $80 extra each month. And even though I'm insured via this $80, I think the housing market as a whole is better off if I don't default on the loan and help cause housing prices to fall.
People with poorer credit get hit with tons of extra fees, higher interest rates, extra insurance payments, etc., and it seems that these penalties are attacking exactly the people in the economy who are most vulnerable. Banks do this, justifiably, to protect themselves, but maybe it has the opposite of the intended effect when people are defaulting on mortgages en masse. I wonder if this mass failure is sort of an emergent phenomenon brought on by banks trying to protect themselves? If banks/credit cards didn't jack up interest rates and fees for higher-risk customers, would a bunch of those same customers instead be able to achieve financial stability? Is there a portion of the "high-risk" credit market that is essentially a self-fulfilling prophecy? Does a bank transform a person into a "high-risk" credit customer simply by the act of categorizing that person as "high-risk"?
I suspect there is a real issue of mathematical Complexity here -- in the sense of chaos theory, emergence, and complex systems. Economists and accountants use a set of models in computing credit risk, but I bet that don't account for the complex large-scale, emergent factors that can impact the whole economy.
Hope I made some sense... this post is long because I'm having trouble describing this exactly right.