What have you got to lose?

The FT carried a report suggesting that the American financial psyche has changed, with the result that the credit markets were caught unawares in the subprime fallout. In other words, again, the financial press is blaming the consumers, who were led like donkeys with a carrot dangling from a stick by the banks and mortgage merchants, rather than the asses sitting on the mortgage cart.

As the authors, Krishna Guha and Gillian Tett, put it:

As the credit squeeze persists, ratings agencies are being forced to downgrade thousands of securities, after failing to foresee the recent wave of defaults, particularly in subprime loans. On Wednesday night alone, Standard & Poor’s downgraded more than 8,000 residential mortgage-related securities worth some $534bn (£268bn, €360bn).

But the downgrades have also left policymakers and analysts scrambling to determine what has gone so badly wrong. As this search intensifies, some economists are starting to suspect that the answer lies in a striking recent change in American household choices – a shift that could have important implications for policymakers and investors alike.

In particular, it seems that mathematical models used to predict future default rates, based on past patterns of losses, have gone wrong because they did not adjust to reflect shifts in household behaviour.

The issue at stake revolves around so-called delinquency rates, the proportion of people who fall behind on their debt repayments. When American households have faced hard times in previous decades, they tended to default on unsecured loans such as credit cards and car loans first – and stopped paying their mortgage only as a last resort. However, in the last couple of years households have become delinquent on their mortgages much faster than trends in the wider economy might suggest.

As a result, mortgage lenders have started to face losses at a much earlier stage than in the past.

One possible explanation is that it has become culturally more acceptable this decade for people to abandon houses or stop paying in the hope of renegotiating their home loans. The shame that used to be associated with losing a house may, in other words, be ebbing away....

In earlier credit cycles, micro-level changes in household behaviour would probably have been spotted by bankers at an early stage, particularly if they had personal knowledge of their clients. But because banks have securitised mortgages in recent years, this contact between lender and borrower has shrivelled. “Nobody has stepped into the gap in terms of monitoring the quality of the loans,” says Walter Kielholz, Credit Suisse chairman. Or as George Soros, the billionaire investor, puts it: “Securitisation had the effect of transferring risk from people who are supposed to know risk and know the borrowers to people who don’t.”

Investors have tried to fill this information gap by turning to ratings agencies. But these agencies have typically predicted defaults by using macroeconomic models that essentially extrapolated past trends into the future. Thus they have been ill-equipped to spot shifts in the fundamental economic drivers of delinquency or that loan underwriting standards had been collapsing to a point where fraud was often creeping into the mortgage chain.

In a sense, then, the securitisation industry has been fighting the last war, tracking the issues that created delinquencies in earlier recessions. Thus mortgage lenders and investors have been filtering loans in recent years on the basis of Fico scores (which measure cash flow management) rather than loan-to-value ratios (which denote exposure to house prices). While some officials inside the ratings agencies have tried to point out these shortcomings, the sheer volume of business that has engulfed the agencies has given them little opportunity [Guambat reckons "incentive" to be more appropriate word] to rethink their approach. “Ratings agencies have been very keen to rate things because they got fees,” says Mr Kielholz.

Guambat recalls the days of yore (as in "yore ain't gettin' any of this bank's money lessen you puts up a hefty downpayment and throw in yore first born to boot"). In those circumstances, where your actual savings from past labors were at risk, you fought like crazy to keep from losing the house.

Now, with no-down low-down mortgage pushers and Wall Street securitization/derivativization framing the game and the credit melt-up preceding the recent credit crunch, no one has anything to lose, so why not gamble on the house? Nothing ventured, nothing lost.

Guambat doesn't reckon human nature has changed one iota. What has changed is the slap-happy way the money chutes and ladders game is now being played.

Don't blame the consumer; human nature doesn't change. The blame rests with the guys making the rules of the game, who got strung up on their own petard and unintended consequences. And on the folks in central banks and other places of responsibility who should have restrained some of the wild antics in the sandbox.

See, Just walk away, Renee