October 3, 2008
I watched the candidates for Vice President debating last night. Sarah Palin said the credit problem was caused by predatory lending. In other words, the evil banks made loans to people who didn’t have good credit.
This raises an interesting question: What did the lenders know about the borrowers that the borrowers did not know about themselves?
In theory, the people who got loans from the so-called predators had enough monthly income to pay the mortgage plus their other living expenses. The real risk was that the borrowers would become sick, unemployed, unlucky, or irresponsible. Apparently we expect lenders to be better judges of the strangers asking for loans than the would-be borrowers are of themselves. How did the conversation between lender and borrower go in the old days, before predatory lending?
Banker: “Well, Billy Bob, you can afford this loan now, but based on that dumbass hat you’re wearing, I give you two weeks before you drink a case of beer and drive your Chevy into a silo.”
If a potential borrower has the monthly income to repay a loan, how much external risk should the banker accept? I think it’s somewhere in the 2% range. In other words, a good banker should turn down a loan for someone who has a 2% or greater chance of being doomed during the early years of the mortgage, before any equity has built up.
Lenders should be required to assign a doom factor to all loan applicants, like a fortune teller. It would be interesting to know, for example, that Wells Fargo has assigned a 20% doom factor to you. Then you could find out on the same day that you aren’t going to own a house, and you have a 1-in-5 chance of becoming a hobo by 2010.
In one of my earlier career incarnations I was a banker. My job for a few years included reviewing and approving commercial loans for doctors and dentists. One day I declined a loan application for a dentist who, according to his recent tax returns, didn’t have enough cash flow to repay the loan. My boss at the time reviewed my work and turned the decline into an approval without even looking at the financials. When I asked why, he explained that the borrower had a Chinese name. I questioned the wisdom of this lending procedure and he directed me to the files of delinquent borrowers, challenging me to find any Chinese names in there. There weren’t any. I’m not judging, just telling you what happened.