Sunday, October 26, 2008

Round-up: Blog Action Day poverty posts (plus a free coffee coupon)

October 15th was Blog Action Day 2008, when more than 12000 bloggers of all sorts wrote about the topic of poverty (2007's topic was the environment.) Below are some great posts, mostly from the personal finance blogosphere. But first, I wanted to point out this coupon for a free hot drink (coffee, cappuccino, tea, etc) at Barnes and Noble through Oct 31st.

Now, on to the posts:

Enjoy! (By the way, my Blog Action Day post was Debunking the scapegoating of low-income homebuyers.)

Monday, October 20, 2008

Fair Trade Month: Sales, tastings, Halloween, and a clip from John Oliver!

It's Fair Trade Month!

  • If you need a refresher on what fair trade is, click here-- the short version is that it's about ensuring decent wages and working conditions for the people who make/grow the things you buy.
  • From New York to North Carolina to California to Milwaukee, there are fair trade events going on (including yummy tastings!)
  • Have a Fair Trade Halloween! Send the kids around to do reverse trick-or-treating: they can hand out fair trade chocolates and/or info sheets (print 'em here.) Find fair trade costumes and decorations here.
  • Global Exchange is giving away free chocolate with every order in October to celebrate Fair Trade Month. Divine Chocolate has a sale on their Halloween milk chocolate foils. And Sweet Earth Chocolates doesn't have a sale but their Halloween-themed chocolate is awesome.
  • Take a picture of what fair trade means to you and submit during October-- you could win a trip to meet fair trade producers!
  • And for a humorous take, here's comic John Oliver on fair trade. ("What is fair trade, when you boil it down, other than basic human politeness?… Rather than praising fair trade, we need to be demonising unfair trade. So, I suggest that from tomorrow onwards, all unfairly traded products should be forced to carry this logo: It's a cartoon of an international businessman urinating upon an African boy. I think that might really help nag at your subconscious when you're queuing up at the supermarket with a basket full of shattered lives.")

Wednesday, October 15, 2008

Debunking the scapegoating of low-income homebuyers (Blog Action Day 2008)

It's disturbing how often you hear people blaming the subprime meltdown and financial crisis on low-income homebuyers and their supporters. It's bad enough to single out low-income borrowers for the exact same thing that happened all across the income spectrum-- people borrowing beyond their means, taking out a larger loan than was prudent. But there's also a whole bundle of false assertions and assumptions bundled into the accusations:

Myth: Most subprime loans went to low-income borrowers.
Facts: More than two-thirds of high-cost loans went to middle or upper-income borrowers (80% or more of median income) in 2006, with less than 8 percent to the lowest income group (50% of median income or below.) The Wall Street Journal analyzed the last decade of mortgage records and found that "the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities. Although the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities."

Myth: Low-income borrowers end up with subprime loans rather than prime loans because of their poor payment histories and high risk.
Facts: That plays a role but is far from the whole story. For one thing, an estimated 50 million Americans have no credit score thanks to a thin or non-existent credit history, and low-income borrowers are disproportionately represented in this group, which means they're often denied for prime loans due to their lack of "official" credit history rather than a history of payment problems. Yet studies have found that alternative credit scoring models (incorporating information like payment history for rent and utility bills) are just as accurate at predicting risk as traditional credit scores; a study of the "FICO Expansion" score found that more than 50 percent of thin-file/no-file credit applicants had scores under the alternative model that would qualify them for prime interest rates. (Not to mention the whole issue of deceptive, predatory, and fraudulent lending that's targeted to low-income people and minorities... Countrywide recently agreed to a more than $8 billion settlement after being sued for allegedly hiding fees, marketing in deceptive ways, and encouraging its employees and brokers to make risky loans.)

Myth: Subprime, high-cost loans are the only way to increase low-income homeownership, and the high foreclosure rates are inevitable given the risks.
Fact: Lenders who make an effort to responsibly promote low-income homeownership (rather than focusing solely on turning a profit), and the borrowers they lend to, are weathering the "subprime crisis" remarkably well. NeighborWorks America is a network of community organizations which partner with local banks to promote home ownership in low-income communities; only 0.21% percent of their mortgages entered foreclosure in the second quarter of 2008-- far better than the 4.26% of subprime mortgages beginning foreclosure in that time period, but also better than the rate of conventional mortgages (0.61%)! And while I haven't been able to find more recent numbers, in 2006 community development financial institutions wrote off 0.45% of their mortgage loans, compared to 0.39% for conventional lenders. While there are many factors in this success, it's clear that a key factor is the way the loans are structured; a recent study which looked at outcomes for subprime borrowers found that "all other characteristics being equal, borrowers are three to five times more likely to default if they obtained their mortgages through brokers. When the feature broker-origination channel is combined with the adjustable rate and/or prepayment penalty, the default risk is even higher."

Myth: Efforts to promote low-income homeownership, such as the Community Reinvestment Act (CRA), played a significant role in increasing the number of subprime loans and creating the crisis.
Facts: Only one of the top 25 subprime lenders in 2006 was subject to the CRA. By 2006, about 3/4 of subprime loans were made through brokers not regulated under the act. And as the President of the Federal Reserve Board of San Francisco put it in March 2008, "There has been a tendency to conflate the current problems in the subprime market with CRA-motivated lending, or with lending to low-income families in general. I believe it is very important to make a distinction between the two. Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans, and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households." Besides, affordable housing advocates have been criticizing subprime and predatory lending tactics for years, not promoting them.

It would be a shame if the result of this crisis is less lending in the future to low and moderate-income families, especially considering that the crisis itself has had a devastating effect on many who refinanced with a subprime loand and are now losing their homes. Home ownership can be an important pathway to build wealth and improve quality of life for these individuals and families, and it seems clear that if it's done right it can be safe and profitable for lenders too.

I'm so proud that at a time when so many are running from low-income communities, my bank (ShoreBank) is using my savings account (with a healthy interest rate of 3.50% APY, by the way) to help struggling homeowners refinance their subprime mortgages and avoid foreclosure. If you want to fund responsible lending in low income communities, try banking with a community development bank or credit union (find one here.)

Sunday, October 12, 2008

Understanding the financial crisis: the basics

The causes of the current financial crisis are obviously complicated, but many of them are rooted in human nature-- the way people tend to think about decisions in general and financial decisions in particular-- and there are lessons from the crisis we can apply to our personal finances.

I've spent a lot of time lately reading about what has happened, and I've also had a fascinating time learning more about behavioral economics. (Traditional economics assumes that people always make rational decisions. Behavioral economics explores whether or not this is true-- and suggests that it often isn't.) In future posts, we'll look at some of the rationality-skewing factors that were at play. But to start, we need a basic understanding of what actually has happened. So here's the chain of events (to the best of my understanding):

  • In the last few years, a significant number of mortgages were issued to people who were at risk of being unable to pay if housing prices did not continue to rise. Most of these were adjustable-rate mortgages, with lower interest rates in the first few years but the risk or certainty of higher payments afterwards (unless the mortgage was refinanced based on a higher home value.) These risky loans were not entirely subprime mortgages (mortgages where the borrower paid a higher interest rate than the prime rate), but there is a strong overlap, both because riskier borrowers are more likely to be charged subprime rates and because subprime terms themselves can make repayment more difficult for borrowers. Subprime borrowers were a wide-ranging group-- about 45% had bad credit, but the rest had credit scores of 620 or above; approximately 10% were investors or speculators, about half were refinancing their home "for cash-out purposes," and the rest were home-buyers; the majority were white and middle or upper-class, but blacks and Hispanics were twice as likely to have higher-cost subprime loans as whites with the same income and loan amount.
  • Most of those loans, and their associated risk, did not stay with the businesses that issued them. In many cases, commission-based mortgage brokers who never owned the debt were making the loans. And regardless of who actually issued the loan to the borrower, by 2006 75% of subprime mortgages were being "securitized"-- which meant the loan and the risk was not held by a single bank, but spread around by being made into securities in the financial markets.
  • Banks used subprime loans to create and sell complicated financial instruments. Financial institutions, especially investment banks, bought a lot of subprime mortgages and pooled them together into what are called mortgage-backed securities (MBSs), and then sold a few different types of bonds based on each pool, earning themselves big commissions and fees. The pools as a whole were considered somewhat risky because everyone expected that some of the homeowners would default on their mortgages-- but the banks segmented the risk by selling some people "super-senior" bonds and promising that they would be paid in full before anyone holding the more junior bonds got paid. This made the most senior level of bonds very safe, as long as mortgage defaults were within the range that people expected. It also made the highest-paying highest-risk junior bonds so risky that they actually call it "toxic waste." Sometimes they rebundled the medium-risk and/or toxic waste from a bunch of different pools into what's called a CDO (collateralized debt obligation) and re-sliced it, making new super-senior bonds out of the riskiest parts of a risky pool.
  • Ratings agencies gave super-senior bonds backed by subprime mortgages the lowest-risk rating. They almost always got AAA ratings, the lowest-risk designation there is, the same as U.S. government bonds. This was based on the belief, backed up by computer modeling, that it was extremely unlikely that enough of the underlying mortgages would default to cause super-senior bond-holders not to be paid in full. The computer models only included the worst-case scenarios that their programmers at the rating agencies thought possible: a relatively low level of mortgage defaults.
  • Some buyers of the bonds hedged their bets by purchasing credit-default swaps (CDSs), essentially insurance in case the bonds they bought didn't pay out. But because they thought the scenario was so unlikely, issuers of these CDSs (who ran the gamut from insurance companies like AIG to investment banks to other institutions) sold many more than they could actually afford to pay back, including selling many CDSs to people who didn't own any bonds and were just placing a bet that the bonds would default. And because many buyers thought default was unlikely, not all of them bought CDSs, especially on the highest-rated bonds.
  • The bonds, which paid higher interest than other options with the same risk ratings, were very popular and there was high demand for as many as could be produced. But to make more MBSs and CDOs, you needed more mortgages. The bond buyers made it very profitable for the investment banks to buy and pool and slice mortgages and they didn't mind (and sometimes preferred) high risk loans-- so the investment banks made it very profitable for the subprime lenders and mortgage brokers to make mortgage loans and theydidn't mind (and sometimes preferred) high risk loans-- so the subprime lenders and mortgage brokers did everything they could to push as many mortgages as possible, marketing their loans aggressively, steering borrowers towards bigger loans, and getting riskier and riskier with mortgages that sometimes didn't require any verification of income or assets. (This chain of supply and demand also sometimes led to deceptive and predatory practices by lenders and brokers.)
  • And then the "unthinkable" happened: home prices fell and many more people defaulted on their mortgages than expected. I won't go into all the details of why and how it happened, but suffice it to say, it was a bubble and the bubble popped-- and as home values began to fall and people began to lose their homes, the problem fed into itself, leading to bigger drops in value and more non-paying borrowers.
  • Because there were so many defaults on mortgages, the value of the bonds fell. This was/is partially because that they're paying out less than expected and are thus actually worth less than initially thought-- but also because they're so complicated (after slicing and double-slicing) that no one knows what they're actually worth, so they fear the worst and won't buy except at rock-bottom prices. Yet another reason for falling prices is a much higher supply to go along with that low demand: along with those trying to sell the bonds because they wanted to get rid of them, were many institutions who had to sell the bonds once they were no longer rated low-risk AAA (since investors like pension funds are required to hold only AAA bonds.)
  • Banks were especially exposed to these risks, and things have been going downhill for them over the last year or two, with a sharp acceleration recently. Banks held a lot of these bonds (ones they bought from other issuers and/or the risky parts of their own that they couldn't sell) and sometimes they had to buy back bonds from their buyers because they'd guaranteed to do so if things got bad. And because they had used the bonds as collateral to take out loans for investing purposes, when the value of the bonds fell they often had to sell (even at rock-bottom prices) in order to somehow come up with enough cash to pay back the loans. They were also hurt by the CDS situation in several ways-- sometimes banks had issued CDSs which they now had to pay out on; the prices of CDSs on their bonds went up now that it was clear how risky they were; and the issuers of the CDSs on their bonds (often banks or insurance companies who'd issued many more CDSs than they could afford to pay back) were often struggling financially, raising fears that they would not be able to pay out to the banks.
  • Banks got pushed towards collapse, which began to snowball. As banks' situation got worse, their share prices fell and investors in their financial products pulled out their money, worsening their financial condition. And as each bank (or insurer) collapsed or came close to collapse, it raised worries about how a collapse would affect the finances of all the other banks, increasing the nervousness still more.
  • Banks are now much less willing to lend out money because they're worried about having enough cash to keep themselves afloat. They can't sell their mortgage-backed securities to raise cash, and they don't know if they'll get payouts from any CDSs they have. And banks now think that lending to eachother is too risky, which is a problem for everyone. Interbank lending is important because the timing of banks' income (payments from loans) and the debt payments they pay out don't always match perfectly; typically this is solved by banks making short-term loans to each other. But that process has frozen up because banks are afraid that if they lend to another bank it might collapse before they get their money back. That makes banks reluctant to lend the cash that they do have to people or businesses, because they don't know if they can get an interbank loan to make up for it if needed. And when businesses can't get loans, that slows down our economy.

Well, I didn't promise it would be an uplifting story! But by taking a closer look at how we got into this mess, we can think about how to avoid dangerous, irrational decisions in our personal finances (and about what policies and regulations in the financial system can prevent against future disasters like this on a larger scale, too.) And that's what the other posts in this series will be all about.

Tuesday, October 07, 2008

Five great posts from Lazy Man and Money

Baseball's regular season is over, which means fantasy baseball is over too. Nine of us personal finance bloggers squared off against each other in a league this year, and in the end, Lazy Man and Money came out the winner. (I'm just proud that I ended up in second place after spending much of the first half of the season near the bottom!)

As his prize, here are five posts of his that you should check out:

Thursday, October 02, 2008

10 great socially/eco-conscious companies: vote for your favorite!

Co-op America is running their annual People's Choice Award for Business of the Year, which means they're featuring ten great companies and taking votes for a winner through October 9th. They're all listed in Co-op America's National Green Pages (along with thousands of other businesses) which means they've been screened and verified as socially and environmentally responsible and values-driven; they also all have many fans who made them the top 10 nominees for Business of the Year.

Here are the ten nominees, in alphabetical order, along with descriptions from proud customers:

Alter Eco (San Francisco, CA)
"They are 100 percent committed to Fair Trade, and use responsible practices throughout their company, like employing disabled workers to package products, and running a green office."
--Carlota O., Dallas, TX

Babyworks (Portland, OR)
"They provide a wonderful assortment of cloth diapers and organic baby clothes. They also have wonderful toys that are not made of plastic, not to mention the fantastic service that you recieve from them."
--Mari W., Vancouver, WA

Frontier Natural Products Co-op (Norway, IA)
"They are a cooperative committed to helping the planet and its people through renewable energy, carbon neutral shipping of their organic products, and their commitment to educating their custormers and the public through their Tall Grass Prairie Project."
--Carol M., Sioux Falls, SD

Gaiam, Inc. (Boulder, CO)
"This company offers responsible choices in many areas-- from cleaning products to linens to solar and wind power systems. Even their own green buildings promote responsibility to our earth."
--Ellen R., Wilmington, DE

Kate's Caring Gifts (Fremont, CA)
"Kate, who owns the business, is one of the most sincere and selfless people I know. She gives so much more to the community with little thought of gain to herself. I truly respect her and what she is accomplishing with her green business!"
--Lin-Lin O., San Jose, CA

Mountain Rose Herbs (Eugene, OR)|
"All herbs are organic or ethically wildcrafted, they support students with a 10 percent discount, their products hold to the highest standard, and their customer service is amazing!"
--Julie C., Madison, WI

Mountains of the Moon (Chicago, IL)
"Not only do they provide eco-friendly and organic hemp clothing, but it's sophisticated and wearable in the real world! I get so many compliments from non-green people, and that opens up the conversation on the benefits of going green!"
--Druanne M., Elkins Park, PA

Pizza Fusion (Fort Lauderdale, FL)
"They practice what they preach! As the first franchise restaurant to be totally green, they cook organic, recycle, and drive hybrids to deliver. Their slogan, 'saving the world one pizza at a time,' is right on the money."
--Lisa N., Thompson Station, TN

We Add Up (Mentor, OH)
"We Add Up has continued to support the green rebuilding in New Orleans, and promotes education on the everyday things that we can all do to turn the tide on climate change. They are social greentrepreneurs with heart!."
--Cristal W., Slidell, LA

West Paw Design (Bozeman, MT)
"Great and innovative dog products using recycled/reclaimed materials. All products show great durability and design and they are made in the US with fair labor practices."
--Beth F., Indianapolis, IN

Enjoy these ten socially/eco-conscious businesses and the thousands of others featured in Co-op America's National Green Pages-- and don't forget to vote for your favorite!