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Plenty of Mortgage Blame to Go Around

On the eve of a holiday that celebrates the best in human nature, it's worth pausing to reflect that humans have spent the past 2,000 years struggling to live up to these lofty standards of the Golden Rule: "Do unto others as you would have them do unto you."

Is the Golden Rule suspended when it comes to money and investing and wealth? Surely, you'll answer with a resounding no. But that is not the way we behave. Perhaps because when it comes to financial decisions, human nature is ruled by two powerful emotions: fear and greed.

As economic events have recently displayed, those two powerful emotions can overcome both the good sense and the moral compass of even the most sophisticated, intelligent and responsible people.

How else can you explain the mortgage mess? At every level, greed held sway over the judgment, principles, and intellect of ordinary, moral people:

  • Ordinary, moral people believed they deserved to own a home without having either the money for a deposit or the income to repay the loan.
  • Ordinary, moral people believed that home prices would continue to rise, so they could always repay those loans.
  • Ordinary, moral people (bankers) believed it was all right to make those loans in spite of predictable consequences that violated the principles of sound banking.
  • Ordinary, moral people (investment bankers) believed they could "spread the risk" of those underlying mortgages by packaging them up, getting ratings agencies to evaluate them, and then selling slices of these packages to investors.
  • Ordinary, moral people at the ratings agencies gave some of these securities triple-A ratings, without looking closely at the underlying assets, while they earned fees for doing this work.
  • Ordinary, moral people running mutual funds purchased these securities because the higher yields made their performance look better to attract the retirement accounts of ordinary, moral investors.
  • And, ordinary moral investors never asked about risk, because they liked the higher yields in a time of low interest rates.

Who should have known better? Everyone!

But "everyone" was too overcome by greed to look at the evidence. Our most esteemed financial institutions, from Citigroup (C) to Merrill Lynch (MER) to Morgan Stanley (MS), have now taken multibillion-dollar writeoffs related to mortgage bonds. It's been reasonably estimated that by the time the process is finished -- something likely to take a few years -- the red ink could be as high as $300 billion.

But no one in a position to profit wanted to burst that bubble. (A few notable exceptions stand out in hindsight. Relatively unscathed at this point are JPMorgan Chase (JPM), which has not taken significant writeoffs, and Goldman Sachs (GS), which participated in the mortgage securitization but acted quickly to hedge its bets when prices started collapsing.

The others, now making headlines, were clearly blinded by greed.

Manias and greed-induced madness are nothing new. If you haven't read the classic book Extraordinary Popular Delusions and the Madness of Crowds , written by Charles Mackay in 1841 (and now reproduced in modern editions), it makes perfect holiday reading. Writing 150 years ago, this book documents the greed that made alchemists claim to turn lead into gold and encouraged ordinary, moral people to trade their farms and fortunes for one rare tulip bulb in the mid-1600s, and a century later to buy shares in the South Seas new world exploration company -- a classic bubble of the 1720s.

Even with the Internet and modern technology that allows us to easily study the history of greed as a human emotion, we fail to learn the lessons of the past. And so we repeat those scenarios. Neither time nor technology, it seems, can change human nature.

That's something to think about as we look at the state of the world this holiday season. And that's The Savage Truth.

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Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage's personal finance column in the Chicago Sun-Times is nationally syndicated, and she released her fourth book, The Savage Number: How Much Money Do You Need? in June 2005. Savage was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. A Phi Beta Kappa graduate of the University of Michigan, Savage currently serves as a director of the Chicago Mercantile Exchange Corp. She also has served on the boards of McDonald's and Pennzoil.

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