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Have We Learned Nothing??? A Bedtime Story, by Me…

March 11th, 2009 · 7 Comments
Incentives · Markets · Policy

Since people seem pretty set on trying to place blame for this whole housing/credit debacle, I figure it is my patriotic duty to add an anecdote to the fray:

Last summer I got a call from the lovely people at Wells Fargo financial. Apparently the lease on my last car was through their company, so my name was in a database somewhere. Anyway, the sales guy explains to me that it looks like I have a lot of revolving debt (which I do) and that he could offer me something to consolidate said debt into a fixed-term loan. I explained to him that the vast majority of the debt was a home equity line of credit and therefore I doubted that he could get me a better interest rate than what I currently had. He then asked if there was any debt outside of the HELOC, and I said that I had a few credit cards where I had taken advantage of the 1.99% and 2.99% APR offers, which remain in effect until the debt is paid off. (Keep in mind that I am technically still a student here.) The rest of the conversation went something like this:

Sales Guy: “Yeah, but are you just making the minimum payments on the credit cards?”
Me: “Of course. At 2.99% and lower APR, why would I be doing anything else?”
SG: “That’s going to take you forever to pay off.”
Me: “Correct, until I decide to just pay it off in a lump sum.”
SG: “I can offer you a product that would get all of this debt paid off sooner.”
Me: “If I consolidated with you, the overall interest rate you could give me would be higher than the average of what I’ve got going on now.”
SG: “Yes, but it would get paid off faster.”
Me: “Tell me if I am mistaken- the only reason the debt would get paid off faster is because the lender would require it to be paid off faster. If I were to make the same payments on what I currently have as the new loan would require, I would pay off my debt just as quickly if not quicker.”
SG: “Well, yes, but what if you didn’t do that?”
Me: “So what you are trying to sell me is a commitment device that isn’t going to actually save me money.”
SG: “It’ll save you money because you’ll pay it off faster.”

And so on…I might have gone off on the guy with some rant about how it was people like him and the grey areas of being fraudulent and misleading that got us into the housing loan mess in the first place. I certainly wasn’t going to fall for this, but can you imagine if this guy was talking to my grandmother or something? The words “pay off debt sooner” are so appealing to a lot of people that they likely wouldn’t pay attention to anything else. (Luckily, a. my grandmother doesn’t have any debt, and b. most people probably are paying sky high credit card rates and could stand to benefit from this type of consolidation. But still…)

The moral of the story? Take a second to stop and do the math rather than just believing what the sales guy tells you. As usual, a little bit of economic knowledge can be a powerful thing, both in terms of being able to do the math and also in understanding that the sales person has an incentive to sell you a product and has little consequence to bear if that product is not ideal for you, or even for the ultimate lender of the money.

The best part of the story? After I threatened to call the Better Business Bureau on the guy, he called me back the next week to see if I had reconsidered on the loan.

Also under the heading of have we learned nothing, I saw the following the day after the original bailout went through:

Housing Rescue Bill Passed!  We now have the liquidity to sell more idiotic mortgages!

Way to go, people. Perhaps next time we can think about addressing the underlying problem rather than just throwing some money at it. (Admittedly, the money was arguably necessary. That said, I would argue that the market IS thinking about the underlying incentive problem now, and the newfound awareness has potentially made new regulation less necessary, since people aren’t going to try to sell stuff that no one is willing to buy. Unless you’re GM. Hmmm…)

Tags: Incentives · Markets · Policy

7 responses so far ↓

  • 1 judgeetox // Mar 11, 2009 at 8:17 pm

    That example has more to do with common sense 🙂 Love it.

  • 2 Michael Lumley // Mar 11, 2009 at 8:51 pm

    That’s hilarious. I wish I had been on the line to listen in on that conversation, or better yet, that he had called me instead. One of my favorite things in the world is talking to people who just don’t get it…

  • 3 WhartonMBA // Mar 12, 2009 at 1:14 pm

    Nice, although the better business bureau isn’t much of a threat. Really, the FTC is the only consumer protection agency that has any enforcement authority and to have any real impact you have to go directly to the Office of the Comptroller of the Currency, WF’s banking regulator. Also, keep in mind that for most people are generally better off refinancing credit card debt into a fixed rate loan, even if it didn’t make financial sense in your case. Plus, a sales guy with a high school education doesn’t have a chance going up against a woman who is getting a PhD in Economics because her computer science masters from MIT wasn’t challenging enough….

    You did hit on a good point though, which that even the most libertarian amongst us must admit that the average person’s financial literacy is fairly limited. A lot of people therefor make economically bad decisions in the face of good marketing. That said, I’m not sure if the cure to that is better than the disease. Do we prohibit innovation of new financial products just because some not particularly sophisticated people make the wrong choice? Take for example the market for no-doc loans (aka “liar loans”). They were designed for people who are self employed or have highly variable income, many of whom would be economically better off with an Alt-A mortgage rather not having a mortgage at all. They were also misused by people who were perhaps fraudulent or maybe just plain dumb.

    So, I toss the question back to you…as annoying as that phone call was, do you have a policy suggestion to address it? Do you limit marketing of financial products? Do you create rules that require financial services firms only to offer products that make their customers financially “better off” (and if so, how do you define it and how do you enforce it)? Thoughts from anyone?

  • 4 ECS // Mar 12, 2009 at 11:25 pm

    When you think about it, this pitch was not only marketing- which is bad enough, as it has a powerful effect on human thinking, and not in a good way– it was fraud. The debt would NOT be “paid off faster” it would be transferred to a new creditor and be larger.

    So I think credit card interest rates should be MUCH lower, FICO should die, there should be NO cold calls to consumers and fraud should be easily actionable.

    Oh– and executive compensation in ALL areas should be in proportion to “worker bee” wages. and there should be MUCH MORE profit sharing.

  • 5 Frederick // Mar 15, 2009 at 11:14 pm

    I take issue with WhartonMBA. Having been in the financial field for over 26+ years, it is a rare thing to mix short term debt into a mortgage.

    As far as marketing goes, this guy couldn’t follow his script, as you took him off of it.

  • 6 Patrick Kilhoffer // Mar 21, 2009 at 6:49 am

    ECS,

    It wasn’t fraud. You could call it misleading. It WOULD have paid off the debt faster in the sense the debt would have been paid off in less time.

    FICO made it possible for banks to compete on a regional and national level, that’s a good thing.

    If you think credit card rates are “too high”, start a bank and offer credit cards. You’ll find that people get charged rates that for the most part make sense for that person.

    Actual fraud is very hard to prove in court.

    And finally, people pretty much get paid what they are worth. Many people and many jobs just aren’t worth much. If you disagree, start a business and pay them more. If you are right, you will make a profit and be able to hire more people. The reason that doesn’t happen often is that in general people are getting paid about what that person doing that job is worth.

    Your ideas are great…as long as you are using your own money. If you actually did them, you wouldn’t have money for very long.

  • 7 rich p // Mar 22, 2009 at 9:35 pm

    We all want to believe that bankers have some higher understanding of the world and the money that flows through it. However, the reality is a bit different. Banking is about sales. Retail banks SELL loans the retail market. Asking a banker if his his loan product is the best isnt any different then asking a car dealer if he sells the best priced cars. Buyer Beware!

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