I’m a big fan of NPR’s This American Life (TAL) even thought I don’t listen to it as much now as I used to. When I was driving to NC semi-regularly, I got a subscription to Audible.com and burned some CDs of old TAL. I also got to see a screening of the TV show, which was amazing. It’s now at the top of my queue in Netflix (and if I could buy just one show through cable, I’d probably do that).
Last week’s episode on The Giant Pool of Money has gotten a lot of attention recently, and for good reason. Despite Ira Glass’s fading voice, it’s a great partnership with NPR’s money section that goes over the subprime mortgage crisis (and ties it all back to the eponymous Giant Pool of Money).
Having listened to it one and a half times (I was playing Mario Kart during one listen-through, so it only half counts), here’s how I think things broke down. Over the past ten years, the amount of money governments have been looking to invest in safe returns has doubled to over $70 billion! In the same period, the number of investments of that type hasn’t kept pace. Alan Greenspan and the Fed made things worse by by keeping interest rates low, making them unappealing compared to things like… real estate!
Of course, real estate is messy. These investors don’t want to have to deal with actual houses and mortgage payments and so on. To make it attractive as an investment, the market used a sort of alchemy to change them from the messy, risky things to AAA rated (the highest rating, shared with guaranteed government bonds) investment “vehicles.” A house-hunter would get a mortgage from a broker, who would sell it to a bank. The bank would then group mortgages and sell that package to larger firms on Wall Street (like the infamous Bear Stearns). Those companies then got the mortgage payments with a 5-10% return (much better than the 1% you could get through the Fed) and sold shares in that collection of long-term income. Investment firms would buy shares in many different packages and sell those to investors. Historically, the default rate on mortgages has been about 2%, so the investments were rated AAA.
In order to keep up with demand, companies kept relaxing their rules about what mortgages they’d buy, leading eventually to loans that didn’t require you to prove your income or your assets. Since 2005, some packages of these types of loans have had default rates of over 50%, rather than the expected 2%.
The problem is that everyone based their ratings on assumptions that they changed. The 2% default rate on mortgages was true only for the types of mortgages that had been given out in the past. By changing what they were selling without looking at how that would affect the larger picture, these companies set up the crisis that we’re seeing today.
Listening to the program, I was struck by how similar this all is to our food industry as described in King Corn. We start with a noble goal (cheap food/savings) and build a system to promote it (farm subsidies/subprime loans) and assume everything’s going along fine. In the long-run, though, we have no idea whether or not it’ll work because we’ve changed all our assumptions. Instead of mortgages to people with good incomes, we’re giving mortgages to anyone. Instead of diverse family farms, we’ve got huge monocultures.
Okay, so maybe it’s kind of a stretch. I still can’t help but feel that the problem in both cases is that to make something work widescale, we’ve turned something very local and personal into a semi-arbitrary set of rules. That’ll work for a while, but eventually, people will start doing what the rules reward them for rather than what’s actually best for them and the rest of us. It’s not about bad people or even greedy people. It’s about setting up a system that encourages people to act badly.
I’m happy buying locally because I know that when they do right by themselves, they do right by my community too.