Wednesday, October 01, 2008

Personal Financial Responsibility

There is a group of people among those whose morally culpable behavior contributed to the current meltdown in the financial markets whose blameworthiness is being swept under the rug.

We have heard people putting the blame on greed and irresponsibility on Wall Street. those few highly paid wall street executives who can drive a company into the ground and then retire with a multi-million dollar “golden parachute”.

We are missing is any discussion of the contribution that came from the greed and irresponsibility on Main Street.

Politicians, certainly, cannot deliver the message. They need to tell the voters, “This is not your fault. You are the victim. They did this to you. Vote for me, and I will make sure that they pay for their crimes.”

The fact of the matter is that some of the culprits are probably in the audience at every political rally. The honest politician would have to look out into that audience and say, “Given the way some of you have run your household finances, you have made your contribution to this. If we have a right to be angry at the prospect of bailing out greedy wall-street executives, we have just as much a right to be angry at the prospect of bailing out the financially irresponsible homeowner.”

A lot (though certainly not all) of the moral responsibility for the country’s current financial mess rests with those who took out loans that they could not afford. These people received a package in the mail or saw an advertisement on television from somebody promising to lower their monthly payments by hundreds of dollars, or to get them into a house that was larger than they dreamed they could ever afford, and the leapt at the opportunity. Or, they refinanced their homes in order to cash out some of the equity built up by rising home prices. Or both.

They were greedy. They wanted things, and they were not going to let a little issue like fiscal responsibility prevent them from satisfying this hunger. They went into debt – more dept then they could afford.

When the grace period on these loans ended and the value of their payments went up, they found that they were now being asked to pay more than they could afford. Some went into foreclosure. The bank seized the property and then sold it. But, with a lot of property being sold, the prices started to drop.

Others tried to sell their homes to get out from under their debt, but their homes were now worth less than the debt they needed to pay.

The world is full of risk. Often even the most responsible person will find herself the victim of a universe that cares nothing about his or her happiness delivering random blows that force them into bankruptcy. The most financially responsible person cannot guarantee financial solvency. So it is not the case that everybody who lost their home is to blame. At the same time, some of them could have acted more responsibly than they did.

If we are going to get angry and say, “Why should we bail out wall street?” then we should be equally angry and say, “Why should we bail out financially irresponsible homeowners?” In both cases, they could have helped the nation avoid this mess if they had only acted responsibly.

Ultimately, I do not advocate the type of cold callousness of refusing to help those who have gotten themselves into this kind of bind. We would be worse off living in a society where everybody was that callous. However, this does not change the fact that many of the people who took out loans, the people now dependent on our aid, put themselves in that position. They created a burden for us, and this should be figured into our response.

We have reason to turn to our neighbors and demand some measure of fiscal responsibility, to offer praise to the financially responsible neighbor, and condemnation for those who are financially irresponsible. We certainly have many and good reasons to promote financial responsibility in the community at large.

Here are some of the rules for financial responsibility.

(1) Create a savings account that you can draw on in case of emergencies. Instead of depending on other people to rescue you from some financial setback, give yourself the tools you need to rescue yourselves. Keep yourself in a financial position where you can say, “Don’t worry about me. Go help those who really need it.”

(2) Put a substantial percentage of each paycheck away in savings. If you are accustomed to living off of 80% of your income, and you have no debt, then you will be better off than you would be if you are living off of 110% of your income and this includes $200 per month in interest payments on credit card debt.

I constantly hear from people, “I cannot cut my expenses. All of the money that I get goes to essentials.” This is nonsense (in most cases). If you are making anything above subsistence level, then you can save money.

(3) Avoid debt. You do not need credit cards. Next time you put some debt on a credit card, think of it this way. That new purchase is going to go to the bottom of your debt pile. You will pay for that movie, game, tool when it reaches the top of your revolving credit list. How long will that be? And how much will it cost you when you add on all of the interest payments from the time of purchase until the time it reaches the top of the credit card list.

If it currently takes you 6 years to pay the current principle on your current debt and you have a 12% interest rate on your credit card, then the $50 dinner you buy today will end up costing you $100 by the time you actually pay for it. You can either pay $100 for a $50 night out, or you can buy two nights out (by not having any debt).

(4) Buy things that you can afford to keep if something goes wrong. It turns out that, in this housing crisis, it is the price of high-end houses that are dropping. People who bought modest homes well within their budget are not only staying in their homes, but their homes are not dropping in value either. People who are foreclosing or trying to get out from under staggering debt are selling larger homes and buying more modest homes. So, while the price of high-priced homes has dropped, the price of modest homes has stayed steady (depending on location).

The people who obeyed these basic principles of financial responsibility are not the ones who got our country into this mess. If everybody had behaved like them, then there would be no mess for us to dig our way out of.

It’s the moral difference between being a part of the problem, or being ready to be a part of the solution.


Burt Likko said...

Alonzo, while I think your advice about debt-free living is well-taken, I do not see it as an ethical imperative. There are two issues that you ignore.

First, the ability to borrow money and pay it back later is something that is both necessary to the building of wealth for society as a whole. Money is not created when the government prints dollar bills. Wealth is created when people add value to goods or services, and they do so in order to get money and they are only able to do so after they make an investment of money. So if your advice were universally followed, we would be a less wealthy society as a whole. It would be better if banks charged consumers lower interest rates for credit, and consumers repaid their debts more aggressively. But while the numbers may need some tweaking, the basic mechanism of money-making is for a bank to lend out more money than it has on deposit, and be repaid all of that money over time, distributing the resulting profits to its stockholders.

Second, you lay blame for fiscal irresponsibility on individual consumers who bought more than they could afford to repay, who voluntarily entered into credit transactions that they knew or should have known would be beyond their means to handle. I agree that there is a significant ethical issue here. But the ethical blame may not lie with the individual credit consumer here, but in quite a few cases -- a large number of the problem cases at the flashpoint of our current financial woes -- rests not with the consumers but rather with the professionals who gave those consumers bad advice. Mortgages and credit are complex things for a lot of people and it is not easy for people who are not educated or sophisticated to understand what they are getting into. It is not unreasonable or ethically blameworthy for someone who lacks expertise in a particular field of knowledge that is very complex to rely on an expert's advice. Some of these people were tricked by mortgage brokers, bankers, stockbrokers, financial advisors and in some cases even lawyers, who told them that the smartest thing they could do with whatever money they had was to buy a house so they could start riding the wave of equity appreciation, and that in two years when their mortgage rates adjusted up sharply, simply refinance. They relied on that advice not out of greed but out of a healthy desire to accumulate wealth so as to improve their circumstances in life, and they relied on that advice because it came from people who they reasonably trusted. I would excuse someone in that situation from moral blame.

Alonzo Fyfe said...

transplanted lawyer

Your statements are substantially correct.

I do not believe in universal prescriptions. In desire utilitarian terms, morality (being ultimately concerned with promoting and inhibiting desires) have weight, and can be outweighed by other concerns.

My concern here is to distinguish the current crisis situation from one in which the economy ran smoothly.

When the economy runs smoothly, there is still certainly some borrowing for the reasons that you describe, and some borrowing turns into bad debt.

The current crisis, on the other hand, was caused by a widespread lapse in fiscal responsibility on the part of home buyers. I don't see any serious objection to the claim that if borrowers had been more responsible in the past five years, that the current situation would not have existed.

Yes, the people who created and packaged these loans - and who sold them - are culpable as well. I discussed their culpability in the post The Bail-Out.

Here, I wanted to make clear the case that the problem was not 100% Wall Street and 0% Main Street. (Nor is it 0% Wall Street and 100% Main Street as some free-market purists would claim.) Both share responsibility.

anton said...

Transplanted lawyer:

"So it would be a less wealthy society as a whole."

So what?

When I was a child in the North our family played checkers that my father had made by sawing a shovel handle into disks and using beet juice to color one set. Our board was made from the inside of a cardboard box. We enjoyed this family experience regularly. We only found out that we were "under privileged" when we came south. We continued to play checkers.

How many "wealthy" American families play checkers anymore? How many families even spend time "quality" together?

It would appear that US Americans are searching for the "joy" of a well-played game of "checkers" but never play the "game".

Anonymous said...

Recently an insurance company nearly wind up....

A bank is nearly bankrupt......

Who fault?

The top management of the Public listed company ( belong to "public" ) salary should be tied a portion of it to the shares price ( IPO or ave 5 years ).... so when the shares price drop, it don't just penalise the investors, but those who don't take care of the company.....If this rule is pass on, without any need of further regulation, all industries ( as long as it is public listed ) will be self regulated......

Sign a petition to your favourite president candidate, congress member again and ask for their views to comment on this, and what regulations they are going to raise for implementation.....If you agree on my point, please share with many people as possible....