The Chuck Ponzi’s Law of Unintended Consequences
Chuck Ponzi April 4th, 2007
Anyone who knows Murphy’s law, knows that it pertains to many of life’s experiences. The law simply states, “If something can go wrong, it will.”
Developers, architects, engineers, and a host of other professions deal with this by over-developing, over-architecture, over-engineering, or over designing what they are working with. If the professional does not, a high rate of failure is assured. It seems that the sub-prime loans (add Alt-A loans to this pile, and most assuredly a good portion of prime loans as well) had some built-in defects with reset shock and delaying of consequences.
The most difficult (and one could argue impossible) event to plan for is one that is unforeseen when the system was designed. It had never happened before, and no one could imagine that it could happen, so how could the designers have planned for it?
With all of the talk of bailouts lately, it seems that many humans have forgotten that many actions have unintended consequences.
Today, an article crossed my desk that highlights that exact problem. Housing bears, hold your breath, you’re going to need it.
The article states:
Civil rights groups called Wednesday for a six-month moratorium on foreclosures resulting from high-risk loans given to people with shaky credit, arguing that lenders should help borrowers refinance their mortgages or face lawsuits.
A coalition of advocacy groups said mortgage lenders should immediately halt foreclosures on so-called subprime mortgage loans made at high interest rates to people with weak credit histories.
Oh, man this one has disaster written all over it, even when stepping aside from the morality of bailing out gamblers, and the inherent Moral Hazard created by it.
Moral Hazard is defined by Investopedia as:
The risk that a party to a transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.
Ah, that about sums it up.
This is an important discussion to have. In a previous discussion, I argued about the problems of moral hazard with a government-led bailout scenario, and how that fallout would likely bury incumbent politicians and create a large enough issue related to our fiscal budget. (Sen. Dodd, anyone?)
This bailout is of a different type for the following reasons:
1. It shifts the responsibility of payment from the homeowner to the bank, not the government.
2. The bank now has to account for even greater risk than just payment ability, but to also account for moral hazard.
Based on this, the only logical thing for banks to do is to restrict credit even FURTHER. That would help some current house-debtors, for sure, but would virtually eliminate any semblance of risk taking by banks. They would have to ensure that substantially greater credit conditions would need to exist and greater buy-in (down payments) by borrowers.
Not surprisingly, the smart guys over at the banks said:
James Ballentine, director of housing and economic development at the American Bankers Association, said the call for a six-month moratorium is an “overreaction” to problems in the mortgage market.
Very true, markets are much better at sorting out risks than consumer advocate groups.
Basically, if consumers know that they will get leniency whenever they have problems with loans, they will engage in riskier behavior than without that assurance. The banks know this, so they will only lend money to those who they are SURE that will not engage in risky behavior, or who also have something to lose by engaging in risky behavior. (Insurance companies use co-pays to reduce moral hazard)
Basically, banks will cut off funding to at-risk parties, which is exactly the opposite of what these consumer advocacy groups are trying to do. It’s cutting off the nose to spite the face. Since banks would never know when they would be required to provide such assistance, they would have to assume that it would always happen.
Therefore, I have created the new Chuck Ponzi’s Law of Unintended Consequences which marries the concept of Murphy’s Law and the Law of Unintended Consequences. Basically, it states:
If there is any chance that someone can get bailed out by someone else, they will, and you will have to pay for it from your own pocket.
Thoughts?
That is terrifying.
I wonder what the advocacy groups have to say about buyers that falsified their income?
It’s not the poor gambler’s fault. They didn’t know what they were doing, their broker filled out the paperwork.
Chuck Ponzi
I swear, if these stupid people get bailed out, I am moving out of this country. We will have surely lost what is left of our collective minds.
Chuck,
I agree with your assessment 100%. If they actually did this, credit would dry up overnight. Hell, if it didn’t I would go out and buy a property with an option ARM with 100% financing (making sure to get a kickback at closing). I would not make any payments, and the bank could not foreclose. Hopefully, a lot of other people would follow my lead and I could actually flip the property for a profit. Either way, I would walk away with money from the first closing and maybe some from the second with no risk. Why wouldn’t people do this? It is free money.
What the people need who are in over their heads is someone to buy them out. If they put this moratorium in place, there will be no buyers.
Live rent free IR.
Wow, you save up 1800$ per month in eq rent. Enjoy life and walk away crying how you were abused.
I wonder if they are proposing… so do the banks eat the loss on not adjusting? Does the public pay for this (AIIIEEEEEEGGGGG)? Does the debt get added on to the end of the loan?
Are the people going to have to make a bubble payment on this?
I’m operating under the assumption that the big, bad, evil banks eat their mess on this one…
Banks say that they don’t want to foreclose (they typically only get 70% of the original value in those cases… but they don’t get the say in this. The Federal Reserve, or the appropriate governing body forces them to move the nonperforming asset. Banks are banks, not real estate companies, they want to lose as little money as possible… but their governing bodies are not there to maximize banks profits, but protect investors and depositors. What is in the bank’s best interest is not always what’s best for stakeholders.
I can’t stand this SAP feature..is there a way to turn it off…so annoying.
Yeah,
Hover over a link. In the top right corner, there is a “Disable” right below options. Click that and it disables it on your browser.
Chuck Ponzi.
Very interesting post. It reminds me of a program I saw on traffic safety. An engineer explained that the safer they constructed cars the more risky people’s behavior invariably became. He suggested the only way to construct a safe car was to attach a knife to the steering wheel - aimed directly at the driver’s heart. The driver would be compelled to drive very carefully.
I think these are typically called Malthusain problems.
Populations expands till it can’t. People drive to a certain level of risk.
Lend to a certain level of risk.
Work the system to the extent of law allows… or they can obviously get away with.
Murphy’s Law - a euphemism for the curse that man will live by his sweat.
Why, because man has a sinful nature. This truth is borne out in every exploitation of man by man for selfish gain.
If we want to have better lives we cannot exploit others. We cannot flaunt God’s perfect laws that warn us of the destruction inherent in “sinful” behavior. People who exploit others are not happy and always lose in the end. O, yes, for a short time it appears that they are untouchable. History is packed with examples. From Hitler, to Stalin, to false prophets, tele-evangelists, politicians, Ponzites, and the list goes on and on.
Jesus shows us the greatest path in Mark 12:30-31,
And thou shalt love the Lord thy God with all thy heart, and with all thy soul, and with all thy mind, and with all thy strength: this is the first commandment. And the second is like, namely this, Thou shalt love thy neighbour as thyself. There is none other commandment greater than these.
Our problems is the sin nature and our legacy of sin. Jesus took care of both of these by dying to pay for our sin and by promising to complete the good work of transformation began in giving those who trust in Him a new nature.
Politicians and laws will not prevent the sin nature from carrying out its destructive behavior… it will find a way. The solution is to be transformed within. That is accomplished by asking Jesus to save us.
I realize many will attempt to write this off as fanatical and discount it by disparaging comments and references to the false prophets and televangelists, but they aren’t the real issue. Jesus is the issue and He is the way, the truth, and the life. Not those who merely purport to follow Him and exploit people in His name. He will bring them to justice for their sins.
It is Jesus that has the answer and not men or religion or denominations or cults. If you look you will see lives changed, transformed, for the good of all. Yes, you will see false teachers that do evil to others too, but they will have their end.
Jesus is incomparable in history and He came and died that we might have life. He is not some man made false so-called god, but the Creator and Savior of mankind.
The problems that we encounter in our world may be euphemistically called “Murphy’s Law”, but they are the direct result of rejecting God’s perfect way and pursuing our own selfish way. This sin is the cause of all the sorrows of mankind and the more we sin the greater the suffering will be. Just as a loving parent sets of boundaries for their child to protect them knowing that certain paths will lead to their suffering or destruction, so God in His love sets up boundaries. We always seem to think we know better.
This whole neg. am. debacle had a predecessor several decades ago. We were warned by the experience of previous generations, but each generation is “wiser” than those before it. Just like Adam and Eve were “wiser” in their own eyes than God and manifested their wisdom in rejecting God’s way.
We are all guilty of it. Somehow it is different for us and our generation. Somehow …
First of all, this was an excellent post. More people need to read this and digest it.
These advocacy groups, which I understand include The Leadership Council on Civil Rights, and The National Council of La Razza, are proposing “special circumstances” (6 month stays of execution) for their constituents. But as you correctly indicated, such advocacy group actions will only plunge the real estate sector into further chaos.
Mortgage brokers will be clamoring for prospective clients, all of whom must be super-humanly qualified, with lily-white credit histories. The market will grind to a proverbial halt. And all will be shackled.
Those who were dumb enough to sign sub-prime mortgages must face the consequences, i.e. stop spending money, contact their lenders, sell assets, and sell or foreclose on their homes.
It is a sad story - if you only watch the last 5 minutes of the film.
But when you rewind to the beginning and observe financial illiteracy in action, you start to appreciate the simplicity of what has really happened.
These people were not duped. They simply failed to take 10 minutes and ask themselves “what if”.
Just found this site. Well-written and thoughtful analyses. I hae intuitively been thinking for some time what Chuck lays out methodically and quantitatively. I am a new fan.
[...] As lawmakers are considering reform, it appears that they are at least considering our concerns about unintended consequences… how lending reform often makes it harder to borrow, not easier in the future. Attempts at helping borrowers most often hurts them. It’s the Chuck Ponzi Law of Unintended Consequences. [...]
How about this plan - the owners lose their house, and are given the option to rent that house at the prevailing market rate. They rent from the lender, who now owns a house they couldn’t sell anyway.
(I posted this elsewhere.)
[...] Chuck Ponzi Law of Unintended Consequences is alive and in full force. I had to whip it out another time when Congress started considering [...]
[...] Home Owners Tips and Info, Mortgage and Finance, Rants and Musings, Seller Tips and Info The Chuck Ponzi Law of Unintended Consequences is alive and in full force. I had to whip it out another time when Congress started considering [...]