Strong opinions, weakly held

On fraud

Former bank regulator William Black names fraud as the cause of financial crisis. I really liked his definition:

Fraud is deceit. And the essence of fraud is, “I create trust in you, and then I betray that trust, and get you to give me something of value.” And as a result, there’s no more effective acid against trust than fraud, especially fraud by top elites, and that’s what we have.

My complaint about this is that it seems everyone involved was mostly deceiving themselves. People applied for subprime and Alt-A loans so they could move into houses they couldn’t otherwise afford (or to buy houses as investments in hopes of selling them at a profit). Banks sold those loans knowing that people would lie because there was insatiable demand for mortgage-backed securities. Investors bought these securities because they kept going up in value regardless of how crappy they were.

I feel like this was in many ways a fraud we perpetrated on ourselves. People believed what was going on was normal and somehow made sense, when it was clearly unsustainable. So while the fraud explanation sounds good, I think mass self-delusion better explains what occurred.


  1. Rafe, I see this situation as a cascading failure despite being preventable at every single level. Basically, you have to turn all of the safety valves off at once for this to happen, which is exactly what they did. There’s very little chance something like occurs at random.

  2. I agree with that, but everybody agreed to shut off the safety valve they were in charge of for their own short term benefit. I don’t think there was a conspiracy given that there were so many different players — the problem is that nobody was willing to put an end to the party because they were all benefitting in the moment.

  3. I disagree that everyone was mostly deceiving themselves. This would not have happened if at least some people had not made terribly greedy decisions at the expense of everyone else, fully understanding that they would profit whether things went well or things went wrong.

    Anyone who makes a risky decision without understanding it, in the hopes that they will profit from it, and with the knowledge that if things go wrong, they won’t suffer, has done something unethical. That is what many bankers did and that is what many homeowners did. And many people, particularly bankers, did indeed profit much more from the past 10 or so years by behaving unethically than they should have been able to earn in a lifetime of ethical behavior. They stole value from society, and they have come out ahead.

  4. In a recent blog post, Bob Sutton made an interesting related point: economists assume that all economic actors act with their own self-interest in mind. A possible next step is the following:

    One small way that business schools can contribute to the greed problem is to teach students — especially in economics classes — that self-interest with guile is a norm
  5. I agree with the mass self-delusion, but then, the delusion was encouraged by heavy lobbying, advertising, and PR from the big corporations. Joe and Jane Public were not leading the public discourse on the subject of whether house prices could continue to rise indefinitely; the corporate media were, as proxies of the lenders, builders, realtors, and other groups with a vested interest in maintaining that illusion.

    And pretty often the specific individuals who acted in ways that helped to cause the situation were not acting against their own self-interest and were also acting fraudulently. Fraud was rife in the subprime area, whether it was taking out enormous HELOCs with no intention to repay, inflated sales of junk houses to straw buyers, or just taking out a mortgage you can’t repay to speculate on further appreciation.

    I would say that virtually every actor responsible for the present situation knew that they were acting fraudulently to some degree or another. But I lay most of the responsibility on the executives who essentially robbed their own banks – albeit delayed a few years – so that they could have a few years of massive paydays.

  6. I think the self-delusion was abetted by people who were insisting, through marketing, that they had your back. I’m really uncomfortable with the “people bought houses they couldn’t afford” line.

    There were certainly lots of people who bought houses knowing they just didn’t have the income. Who knew they couldn’t prove or demonstrate means.

    But there were a lot more people who were told by the banks and mortgage-sellers that, despite what they personally thought, they could afford a house after all. And being unsophisticated customers they bought into it, assuming banks had to be responsible (they didn’t any more) and regulations were in place to ensure banks would be responsible (and those regulations weren’t there any more).

    Maybe a handful of people actually bought million-dollar homes on unverifiable income. But most home buyers, I think, were just trying to do the best they could in a market apparently crazy.

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