Main Street Greed

Today Obama reiterated his belief that banks are to blame for our current financial crisis. In my opinion, Main Street greed is just as much to blame as Wall Street greed.

Let’s look at the sub-prime mortgage situation that pricked our housing bubble. Using a supply and demand framework, Americans demanded more expensive homes and banks responded with a supply of sub-prime mortgages. In this context it was the common interest (greed) of both parties that created the market. Therefore, it is only logical that both parties should share the blame.

When trouble arises in markets, Americans generally blame the suppliers. In the 1970, when drug use was on the rise in the United States, we engaged in a War on Drugs with drug suppliers (cartels) in Columbia. As tobacco use rose, we fought the Big Tobacco industry. History has taught us that the war on drugs must be fought at home with drug prevention and education. Anti-smoking campaigns have been a huge success and tobacco use has declined accordingly. In both cases, the key to success was focusing on curbing demand with consumer education.

The regulation of credit card lending focused on the suppliers of debt (banks) and has been generally unsuccessful. The most profitable customers for credit card companies are still the individuals who make minimum payments, and generally make these payments after their due date. This market has become somewhat efficient in that several credit card counseling and debt consolidation services are now available. You may have seen some of their advertisements on television.

I think our regulation of the credit card lending is a good indication of what will take place on Wall Street. There will be more paperwork and disclaimers associated with high interest rate mortgages. This will certainly increase costs for consumers while providing some indirect education on the risks associated with high interest rate debt.

A more effective approach is to directly educate consumers on the risks of high interest lending. The US policy is that everyone should have the opportunity to own a home. If the path to home ownership requires financing with ARMS and balloon payments, we have an obligation as a society to offer education on these financial instruments. To the best of my knowledge, there is no large scale program in place to educate our citizens and students on home ownership.


  1. Jason says:

    Hi Bill – I think we talked about this briefly at my house on NYE. Hopefully you don't mind me stalking you on your new blog!

    From what I've read, the housing bubble was mainly inflated from the top down: foreign investment looking to real estate for better returns than 1% treasury bonds, which led to a relaxing of lending standards, which finally led to NINA loans for people who would have been thrown out of the mortgage office in 1998. So, an increase in supply of available money led to an increase in demand, and higher home prices as a consequence. I think main street gets the blame for pulling the trigger, but the financial players purchased and loaded the gun for them.

    I agree that greed and poor education led to a lot of bad mortgage decisions. Better education is the right path, but the cynic in me knows that we'll only get more regulation. I'm curious what you would recommend in the way of education.

    My first thought is that education should be more elemental: everyone leaving high school / entering college should understand the concepts of NPV, APR, opportunity cost, sunk cost, compounding, and the basics of a credit card or mortgage amortization schedule. This would give people tools for many other activities, such as starting a business, buying insurance, and evaluating short term vs. long term financial decisions.

    Secondly, people need to become better at educating themselves; this probably needs to be instilled at the grade school or HS level. We need to get better at recognizing when we are over our head and the steps to take to get more information. Mandated education on various mortgage products may solve this particular problem, but people will be just as helpless when the next exotic financial product comes along.

    • Bill Gray says:

      Hi Jason,

      I think you made some really great points which sharpened my own thinking on this issue.

      The perspective that foreign investment increased the supply of mortgages is probably the right way to frame the issue. Bernanke gave a speech on international investment back in 2005 under the title of The Global Saving Glut and the U.S. Current Account Deficit. (transcript) In my post I got the order of events a little backwards and should have written that a global savings glut resulted in the loosening of lending standards. In turn, Americans took on (demanded) more sub-prime debt.

      I like your analogy of banks purchasing and loading the gun. Using my earlier example, offering this toxic debt is like giving cigarettes away on every street corner. The best solution includes both regulation of lending (getting the cigarettes off every corner) and consumer education (cigarettes are hazardous to your health).

      The cynic in you is probably right, although I'm somewhat optimistic that part of the $142B for education in the latest stimulus bill will go towards 'financial education'. Staying in this dream land for a moment, I like the fundamental curriculum you proposed. Some practical lessons such as a housing rent vs. buy analysis could also be useful.

      As for teaching people to better educate themselves, maybe some 'soft skills' lessons on things like bargaining and negotiations or incentive structures would be helpful. With buying a house all the parties (realtor, mortgage broker, insurance agent, escrow company, etc.) are incentivized to close the deal, which might not be in the best interest of a buyer's financial future.