The Credit Crisis*

*AKA “Crunch”, “Meltdown”, “Debacle”, “Catastrophe”, or--heck--make up your own horrific, hyperbolic noun!

Someone with access to Nexis-Lexis ought to research which story got the most ink (real and cyber) in the month of August, Michael Vick or the “sub-prime fallout”. I hate to keep harping on this myself, but as long as the press keeps telling this story, I feel compelled to tell it accurately.

Workaday journalists are pecking away on the story du jour and scaring the daylights out of the public with all the hand-wringing. Not that it isn’t scary, mind you. But it’s made much worse and self-perpetuating by the often lazy or sensationalist press who give the phenomenon a name, but do very little to break down the systematic reasons it took place.

Things haven’t changed all that much in the 700 years since the Black Plague. We know now that it was caused by a bacteria in rats. Back then, though, they were fairly convinced that it was the work of the devil. Or the Jews. Or the Muslims. Or that scary looking woman down the lane who yells at your kids to quit playing on her front porch. They didn’t have a clue as to what was causing it, but they gave it a catchy name, eh?

The story that ought to be written now isn’t about “How did this mess happen?”, but rather about “How could we have thought anything else could have happened?”

I don’t want to oversimplify this, because nothing in economics is simple. (Think about that Econ 101 class you suffered through. If you weren’t one of the 99.4% of us who were completely bewildered that first semester, then I don’t want to sit next to you on a long flight. Then again, you’re probably sitting in first class these days while I’m back in coach.) But the number one cause of the Sub-prime Credit Fiasco (oh, look, another slick name!) was lenders giving mortgages to folks with no business having mortgages.

It was pedal-to-the-metal. As bad as no documentation loans (basically, a “We’ll take your word for it that you can pay this back” situation) were, the 100% financing (no money down) loans were worse. The combination of the two has led to the current foreclosure rates. When someone has neither the means (not enough substantiated income) nor the motivation (with none of their own money down, they’ve got nothing to lose by defaulting) to pay a loan back, take three guesses as to what they’ll do.

So after 2-3 years of whooping it up with other people’s money and partying hard—business-wise—the lending community finally woke up with the current default hangover. Rubbing their eyes, and clearing the cobwebs, they found themselves wondering what happened last night and whose cat is that in the kitchen.

More accurately, the lenders didn’t wake up until the investors whose money was being used started looking more closely at their returns. It’s like your parents returning early from a trip after you’ve already invited half the senior class over to your house for a big party.

This current problem in real estate isn’t unprecedented* and it isn’t permanent. Nor is it as bad as it seems. There are still many investors out there with lots of money to responsibly loan for mortgages. Things will (and already are) beginning to change. And we’ll all get through it if, as Rudyard Kipling advised, we keep our heads when all about us are losing theirs.

*Read "Funny Money" by Mark Singer if you want to read a hair-raising, but hilarious account of a similar banking disaster (for eerily similar reasons) back in the early 80s.