An epidemic of lying
Meet WMALT 2007-OC1. W, for short, is a pool of mortgages collected by Washington Mutual and sold to investors in May, 2007. These were not subprime mortgages. The average credit score was 705. But something has gone very wrong. At the end of April, less than a year after the pool was created, 29 percent of the borrowers were badly delinquent. Six percent already have lost their homes to foreclosure.
The story of W has been carefully tracked by a blogger named Mike Shedlock, of Mish's Global Economic Trend Analysis. Shedlock writes that W has one determining feature: 88 percent of the borrowers were allowed to state their income. That is, instead of asking the borrower to bring in a paystub, or a W-2, or any proof of income, the lender simply allowed the borrower to write down a number.
The industry has a nickname for such stated-income loans. They are called "liar's loans," because most people lie.
In a recent piece on Slate relating the history of the liar's loan, Mark Gimein recounts that an examination of 100 "liar's loans" in 2006 found that 90 borrowers had overstated their actual income. About 60 borrowers inflated the actual number by at least 50 percent.
People who made $3,000 a month were getting loans based on a supposed income of at least $4,500 a month.
Gimein calls this epidemic of lying "an astounding breakdown of social norms."
I tend to agree. It is the part of the mortgage crisis that I least understand.
The reason is that the American economy generally has little tolerance for lying. In economic terms, lying is inefficient, which means it is expensive. Lying increases costs. One hallmark difference between first-world and third-world economies is the relative absence of lying.
"The evolution of capitalism has been in the direction of more trust and transparency, and less self-serving behavior," then-Forbes columnist James Surowiecki wrote in 2002."Not coincidentally, this evolution has brought with it greater productivity and economic growth."That evolution, of course, has not taken place because capitalists are naturally good people. Instead, it's taken place because the benefits of trust--that is, of being trusting and of being trustworthy--are potentially immense and because a successful market system teaches people to recognize those benefits."
And then there's the liar's loan: In places such as San Diego, at the peak of the boom, more than half of all mortgage loans were based on a stated income. In Massachusetts, the numbers were slightly more modest. Federal Reserve data shows that 46 percent of outstanding non-prime loans were based on a stated income.
As Gimein notes, one result of income inflation is that prices got so high that many people couldn't buy a home unless they lied, too.
That point is important. A great deal of social science research shows that people are only honest so long as they believe other people are behaving honestly. Our tax collection system, for example, depends on this principle. If people become convinced that their neighbors are successfully withholding money from the government, they will start underpaying, too.
Or in this case, if people become convinced that others are lying about income to buy homes, they will start lying too.
Which returns me to my original question: How did we get to that critical mass? How did lying become so acceptable?
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