Thoughts on the Financial Crisis

I have a Persian friend in Houston who has an uncle who owns a used car lot and has become a millionaire by making sub-prime loans to mostly poor, black, urban customers. He has been in this business for almost two decades, and his is an American Dream story as he left Tehran after the revolution and came to the US with nothing. I do not resent his wealth, or how he made it, in the least. In fact, I suggest we put aside the straw man of resentment of wealth for the remainder of this discussion.

Back to my Persian friend's uncle. I asked him a couple of months ago (while staying in his home in Houston) how it was that he had stayed successful in the sub-prime loan business for so long. He said that the reason was that he kept track of all of his customers. He personally reviewed each of their applications. He didn't let the business get so big that he lost track of who he was loaning to. People with bad credit need cars (and homes) too. To get these, they have to pay higher interest rates, because they're more of a risk. This is a good, honest business to be in. I believe we're all in agreement here.

Another fine business to be in is the business of buying loans. I refinanced my student loan several years ago thanks to a company that was willing to buy it from my original lender, and now my interest rates are lower. Quite a few people do this with their home loans. It's even a fine business to be in if you are in the business of buying loans from a company that has bought those loans from another company. And why not chop up those loans and repackage them for sale to yet another company, and so forth? I believe we're all in agreement still. At some point, however, the original loan becomes abstracted from its origin to a degree that the degree of risk involved in holding it, or rather some part of it, beggars analysis. Its value becomes unfathomable.

Nevertheless, in the mortgage market leading up to the crisis the value of a great many of the loans were in doubt from the start. I have another friend who lives a few train stops from Wall Street, who up until recently was in the business of brokering sub-prime mortgage loans, mostly to black, urban customers in Connecticut. He made a good amount of money doing this.

Unlike my Persian friend's uncle, my Connecticut friend did not keep track of what happened to those loans or those people (as a broker, he naturally wouldn't have). He knew, as did everyone else who worked for the type of brokerage firms he worked for during that period, that he was in a business that would not last. They knew it was not sustainable, and they knew that an inordinate number of the loans they were orchestrating would eventually go into default. He and others in the business knew that the variable interest rate and other schemes that were used to make all this happen were bad for the buyers.

My friend knew, they all knew, that the whole thing would come to an abrupt halt sooner or later, so they made as many loans as they could and watched carefully for the right time to bail out. And they knew that in the end people would lose their homes--or the value of their homes--that the economy would take a big hit, and that the fallout from all of this would usher in a new era of government regulation that would prevent, for a long time anyway, others coming after them from doing the same thing they did to get rich. Now, I ask you, what's more American than that?!

I don't resent my friend for doing this. Though he stretched the rules, he didn't break the law, and he worked very, very hard. The problem is that the whole market became a big game of hot potato. The brokers got in and got out--they were just the sales guys and they did what all sales guys have done for as long as there have been sales guys. The first lenders knew they wouldn't have to service the loans for long, so they made as many as they could without concern for consequence. The companies that subsequently bought those loans could afford to act without prudence because they in turn had customers for those loans who were eager to chop them up and turn them into large blocks to be used as collateral to finance even bigger investments. I'm more than a little dubious of the suggestion that fear of class actions suits from those representing ethnic minorities and women created this game of hot potato, and I wonder why anyone would see it this way?

Everyone, at every level, assumed, reasonably, that he would not be the one left with the hot potato. And now the big problem: Almost everyone acted within the law, and everyone acted is his own rational self interest, but these actions did not lead to a desirable outcome for the economy. Is it possible that rational self interest is not sufficient for a strong economy?

This weekend in Nashville there is no gas, or very little of it. The problem, according to The Tennessean, is that a major distribution channel serving Nashville has been operating below normal capacity due to infrastructure damage inflicted by Hurricane Ike. The problem has been exacerbated by panic, and so Nashvillians have been driving around town obsessively topping off their gas tanks and hording gas by filling up gas cans. There have been fights at the pumps and so there are police stationed at the few stations left with any gas to sell. At this point, anyone acting in his own rational self interest would probably try to top off his tank, as I did yesterday.

Something like the Prisoner's Dilemma comes into effect here. In conditions of scarcity, I am better off to treat the attempt to obtain a resource as a zero sum game even if cooperative behavior could lead to a mutually rewarding outcome, because I can't rely on others to act cooperatively. Acting as a rational, self-interested agent, a Nashville driver like myself should probably hoard gas, because if I don't the next guy will, and then there won't be enough for me later on.

Next week the government of Tennessee has arranged for a special supply of gas to be delivered on trucks and barges (1.42 mil. gallons) to cover the shortage. By week after next everything should be back to normal. There are rumors that even with this, gas in Nashville will be rationed next week. It would seem that, given the circumstances, and albeit temporarily, government needs to arbitrate at a level higher than rational self interest allows.

Regarding those individuals and institutions invested in Lehman Bros., et al., it may have made sense, from the perspective of rational self interest, for them to pull out. The Prisoner's Dilemma would suggest that, roughly speaking, because I can't depend upon other actors to act cooperatively, I'd better pull out while I can even if I thereby screw everyone else, including the US economy (hey, I need gas in my tank, and I don't trust those other Nashville sonsofbitches to take only their fair share and no more).

So, I find it hard to buy the analysis that the economy would be fine if we just realized that it's all in the mind, that the fundamentals are intact, and that there's nothing to fear but fear itself. While this may all be true, it amounts to a protest that humans are human. Precisely because humans are human, and because there's no indication that human nature is going to change anytime soon, we're going to continue to need governments to intervene in markets by rationing gas, guaranteeing bad loans, buying bad assets, and regulating the sale of hot potatoes. What form that regulation takes is crucial, of course, and in principle I'll grant that too much regulation is a bad thing, if in principle you'll agree that too little is as well.

What's it like to lose an iPhone?

I didn't handle it well. Paced around, afraid I was missing vital text messages and voice mails from business partners, and Tejas friends in the path of Ike.

For the first time in years began to think about where I was in the city in relation to the nearest usable phone. No more pay phones.

Before cells, for the duration of trips between between work and home, or around the city, we were cut off. Not a big deal unless you're the only one.

Thought about how men keep their wallets, keys, phones, close to their groins. Women keep none of these things close to their groins.

Losing a phone brings castration anxiety. No longer feeling the bulge at my beltclip, but rather a lack.

Women buy cheap phones for two reasons: (1) They never want to be cut off (the phone must be replaceable immediately like a commodity object), and (2) for them the phone is never the objet petit a.

Yesterday I set up my new iPhone to invoke a pass code prompt after four hours of non-use. If several incorrect strings are entered in succession, the handset will erase my data. If I lose this phone I don't want to have to reset all of my Web service passwords again.

The new AT&T store in Green Hills is shockingly spacious given the lack of anything to do besides queuing up. I approached the service counter on the right--there are two, one on each side--only to be told that I needed to "check in." The host was at the very back of the store. The interior is designed to soothe, not to inspire, as if AT&T presumes that you'll feel like you're at your dentist's office.

In the end, I bought my replacement iPhone at the Apple Store, where I could cruise for artsy cougars at the genius bar while ogling the American Apparel models they call Mac Specialists.