Greed and Capitalism
As everybody knows capitalism is based upon the apparently simple transaction of borrowing money from a lender who is confident the borrower will pay back the same amount (the principal) plus a certain premium (interest). For centuries the transaction was morally questioned by religious moralists (first Christian and later Muslim) who objected to the central idea of making money out of lending money to others. Lenders who charged an excessive interest were generally condemned as money mongers. Eventually –at least in the western world—the operation became not only fully legitimate, but the driving force of modern capitalism.
Borrowing and lending are closely linked with buying and selling. Most borrowers use the money they borrow to buy what they need or what they want. Lending itself is a kind of selling. Sellers sell the use of the money they have to earn more money for themselves.
People borrow money to buy big items they could not otherwise pay for in cash, such as automobiles, and, far more importantly, the houses they plan to live in. Buying a house is for most Americans the biggest monetary transaction of their life, almost always eighty times bigger than buying a new automobile. In most cases, buyers do not buy directly from the owners of the house, but through real estate agents who act as brokers between the buyers and the owners and the banks.
In our days buying a house involves a number of professionals and public agencies that expect to make a lot of money for themselves. Here is a simple list:
A real estate agent who is in most cases obliged to share the opportunity with other members of the same profession in the same locality. This sharing greatly expands the publicity of the possible transaction. Real estate agents try to sell the house at the highest but realistic price. Setting the house’s price is the first opportunity for human greed to make its presence felt: it combines the greed of the seller and the greed of the real estate person, whose fee is normally 6% of the price of the house sold. The first people to benefit from an inflationary rise of housing prices are the real estate agents.
-Agreeing on the price of the property to be sold involves two other professionals: a licensed appraiser of its value, and a public inspector who guarantees that the property complies (or not) with all the local construction codes. The activities of appraisers are barely regulated by local or state laws; inspectors are much more regulated. The more people are involved in the deal, the more room is opened for questionable conflicts of interest. If the appraiser is a friend of the seller, he or she will be tempted to overestimate the value of the property. In the same situation, the inspector might become blind to the deficiencies of the building, to the repairs that are imperative before the sale takes place before the first big rain comes along or the first strong earthquake pays a visit to the town.
Up to this point the self-interest of all the participants tends to safeguard in most cases the basic impartiality of the whole deal. In fact, early capitalists wrote about “an invisible hand” that maintains in equilibrium the interplay of the selfish motivations of all the individuals involved. This manner of thinking was later raised to the point of professing an almost unshakable faith in the liberty and self-regulating character of the markets, a character that abhors the unwarranted intrusion of the state regulatory power. To conservative economists a regulated economy necessarily brings on an unwarranted diminution of individual liberty.
The sub prime mortgage crisis of 2008 – one of the mot serious crisis in American financial history—has forced us to reflect on its dynamics. The Bush administration has always believed that the vitality of the American economy depends basically on the willingness of the consumer to spend, in most cases by borrowing money. The mechanisms of borrowing have multiplied with the use of credit cards, equity loans, the normal buying of stocks, bonds and other securities, or by paying installments. No other society in human history has borrowed more money than America today. As a result, the accumulation of debt at all levels (individual debt, local debt, state debt, national debt, foreign debt) has reached numbers that simply defy the imagination.
The American housing industry was no exception to this trend, in fact it was a trend setter. When President Bush spoke in glowing terms about “a national culture of ownership,” he meant mostly housing ownership. Soon the boundaries between people trying to find a home for the family and rich speculators (who had already one or two mansions) trying to invest in houses became very fuzzy. The “hot” housing industry gradually moved from the offices of real estate agents, mortgage lenders, and local banks, into the halls of Wall Street. Buying a house was the investment of the day. The housing prices kept spiraling up. Home owners found themselves with huge home equities inviting further loans. With home equity loans they bought houses that had been poorly maintained, bought them at a bargain price, refurbished them with new kitchen counters, fixed up the modest bathrooms, hired up an illegal immigrant to embellish the garden, put in some copper pipes, and quickly put the house up for sale. They bought cheap and sold high. Although this housing bubble showed the unequivocal signs of an “irrational exuberance” (as the chairman of the Federal Reserve Bank confessed), nobody moved in a significant way to provide the needed restraints. The ambition of the buyer/investor ran amok.
Soon the borrowers who had exaggerated their incomes or their hopes of job promotions, found themselves unable to pay their mortgages. Few of then plainly admitted that the house they were panning to buy was not a primary residence for themselves, but a second (or third) house, most likely to be rented or sold as quickly as possible. Lenders exploited all the possibilities of “teaser loans,” loans with and adjustable rate of the interest. Few borrowers were transparently told that “adjustable” meant in most cases, that the rate of interest was “raised.” Rating agencies concealed the weaknesses of the borrowers’ credit, a rating that was nothing but a statistical information about the paying back the debt of a pool of investors in similar conditions. The rating grade was clearly more than information for the possible buyer; it became a marketing or even an advertising device, an open recommendation to buy. The approval of the loan by a bank was the ideal time to share some champagne for bank managers, the real estate agents, and the more or less “innocent” buyers. People of modest income who badly needed a home were not able to play the game; they just went back to their one-bedroom rentals and felt sorry for themselves. I know of many families who were forced to move to another state simply because they could not afford housing in California.
President Bush’s “pride of ownership” was painfully limited and artfully concealed to a small group of older home-owners who were mortgage-free, only 30% of the so called “home-owners.” Most American houses, like most SUV’s, belonged to the bank.
In trying to find the causes of the immense credit crisis that has brought a serious slowdown to markets everywhere in the world (not in the same degree) one should try to find who were the people or institutions who benefited most from the “irrational exuberance” of the uncontrolled expansion of credit, and who were the people who suffered most from its demise. Banks and lenders have lost millions; individual home-owners have lost or are losing their homes. Banks and lenders were the big powers in the game; the owners who had to sign the foreclosure on “their” homes, were the pathetic victims. This final judgment should not surprise any one who has observed the Bush administration or the final decisions of today’s Supreme Court: the real losers are in most cases the weak parties to the conflict.
No wonder that young new voters in the presidential election stand firmly on the side of those who demand real change at all levels of our national life. By instinct they know that a sober amount of greed is essential to the survival of democratic capitalism. But they also know that “irrational” greed can bring about the doom of the entire system. America will survive the present recession only if economists admit that irrational credit expansions can and must be controlled by reasonable “regulatory intrusions.” An irrational expansion of credit threatens its very existence and reliability. An excessive pride of ownership can bring about the demise of liberal capitalism as we know it.