Monday, May 31, 2010

Memphis mortgages, complexity attacks and long term consequences

Times are bad in the subprime mortgage neighborhoods of Memphis, home to recession wracked FedEx...

The black men and women interviewed by the NYT seem remarkably stoic about it all. Two aspects of one story caught my attention ...
... To turn into Tyrone Banks’s subdivision in Hickory Ridge is to find his dream in seeming bloom. Stone lions guard his door, the bushes are trimmed and a freshly waxed sport utility vehicle sits in his driveway.
For years, Mr. Banks was assiduous about paying down his debt: he stayed two months ahead on his mortgage, and he helped pay off his mother’s mortgage.
Two years ago, his doorbell rang, and two men from Wells Fargo offered to consolidate his consumer loans into a low-cost mortgage.
“I thought, ‘This is great! ’ ” Mr. Banks says. “When you have four kids, college expenses, you look for any savings.”
What those men did not tell Mr. Banks, he says (and Ms. Thomas, who studied his case, confirms), is that his new mortgage had an adjustable rate. When it reset last year, his payment jumped to $1,700 from $1,200.
Months later, he ruptured his Achilles tendon playing basketball*, hindering his work as a janitor. And he lost his job at FedEx. Now foreclosure looms....
Mr. Banks leveraged the real estate bubble to pay off the costs of the the higher education bubble. The real estate bubble burst, leaving him underwater. Now the higher education bubble is bursting, leaving him with high tuition loans for a product of declining value.


We might ask, however, how the heck Mr. Banks didn't realize he'd changed to an adjustable rate mortgage. I can't tell from the brief story, but I suspect that minor detail was omitted from the phone sales spiel. Later, when he signed the papers, he might have spotted it -- but by then he was well along the commitment path. It can be hard to back out then.

I'm betting he fell victim to a form of complexity attack, the same form of emergent fraud that defeated my family when assessing our health insurance options [2]. The resources of banks, mobile service providers and insurance companies ensure information asymmetry -- they can play the game much better than we can.

Complexity attacks have obvious direct costs to the "Marks" (which, in the GR, was most everyone). They also have less obvious long term effects that may be underappreciated.

Once buyers become aware of complexity attacks, they become far less trusting. Modern markets run on trust; when trust is lost markets suffer. Our bank recently hounded us to sign up for a lower fixed rate mortgage that should save us tens of thousands of dollars. As best we can tell this is motivated by a federal program; they need us in a bundle they can sell to the feds (we're "low risk"). It seems a no-brainer, but we delayed our decision because of deep distrust. Finally, when the Euro crisis dropped rates even further, we signed up [3]. We still wonder what the catch is.

The Great Recession will linger for a very long time. That is ... assuming it's really over ...

[1] If he was taking a quinolone at the time he might want to sign up with one of the class action suits.
[2] My brightness might be debatable, but I know some brilliant folk. None of the very smartest claim to understand our coprorate health insurance options.
[3] The bank wanted us to commit over the phone lest we lose the "incredibly low rates". We refused of course, which was easy since we know Greece isn't getting better any time soon. When we got the paper work it was remarkably clear and simple -- far more straightforward than the near-market-peak paperwork we completed when our home was rather more expensive than it is now.

Update 6/30/10: I wrote about our "no-brainer" refinance option. Even though it seemed simple, we were suspicious. Justifiably as it turned out. After our initial paperwork we received much more, then they bungled a prepayment of ours, then they stopped returning calls. Based on their recent share price, I'm guessing their coming apart. So we may still refinance, but probably with a different bank.

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