During the subprime meltdown of 2007, many mortgage brokers and LOs defended their decision to sell subprime loans saying “The lenders were the ones that provided the loans. We were only selling what we were told to sell.” As wholesale lenders fell, the blame shifted to Wall Street. “It was Wall Street’s fault for creating those toxic mortgage products.” Now the Wall St investment bankers are failing and the blame continues to shift. This blog post is not about who is to blame. I’ve already blogged about blame in other places.
This blog post is about the Milgram Experiments. For some background, read/view the following:
ABC News: Basic Instincts; The Science of Evil
VideoSift: The Original Milgram Experiment
Wikipedia: Milgram Experiment
The nature of Milgram’s experiments were challenged as being unethical because of the emotional trauma experienced by the real “subject” of the experiment .
Reflecting on the Milgram experiments, how would you now explain the blame shifting that took place earlier in the subprime meltdown? (To some extent, it’s still taking place today.)
How would go about obtaining consent from your mortgage lending clients before recommending experimental mortgage products?
I am fairly new to the industry and I didnt really participate in much of the subprime market, so I will do my best in discussing this topic.
I honestly don’t know how to answer these questions. I do feel that the reason behind some of these loans being sold is greed. I dont think it is fair to say that loan originators were only being told what to sell. I believe that everyone needs to be responsible for their own actions and in some aspect everyone is guilty who participated. Just because a product is offered, doesnt mean it is right for your client. This is a hard subject to touch on with out pointing blame to any party.
I am not sure I would feel comfortable recommending experimental products. If I did have a client who was interested, I would be sure to provide them with research on the particular product, showing pros, cons, worst case scenario’s, etc.
I am interested to see how others feel about this. Although the study was in the 60’s, I belive that if it were conducted today, we would se similar results.
If you replace the authority figure in the Milgram Experiment with the US government in pushing lenders to produce more loan programs to qualify more borrowers to meet the government’s statement of affording the American dream of homeownership for all, then I guess you see why the industry is in a mess. However, lenders received financial reward from the loan products as well as LO’s, so there was a huge element of greed on their parts as well. And of course, borrowers are not to be excused as they were willing to accept loans they knew they could not afford because they wanted the house without having to put out much effort (i.e. saving for deposit, building good credit, proving stable income, etc.).
Regarding recommending exotic loans or experimental loan products to my clients, I would make sure that they fully understand the loan including the exit strategy for getting out of the loan should it have an adjustable rate and/or balloon payment. I would disclose the worse case scenario and that should be what the borrower can qualify for, not the teaser rate. I would provide the borrower with a plan for changing his financial situation so that he/she would be in a position to refinance into a better loan at a later date. And lastly, if I cannot understand the loan product, then I would not sell it.
Hi Leslie,
Yes, however the government did not “force” loan originators to put clients into unaffordable home loans. There were many LOs who chose to push people into a subprime loan or an ARM loan in exchange for a higher broker fee or YSP instead of keeping the client in a 30 year fixed vanilla loan.
I’m not sure the millgram experiments are relevant to the blame shifting. Greed is what’s at the core of fraud and unethical practices. The reward wasn’t acceptance or approval by authority, though it could have been a secondary motivator for those looking to advance in mid to large sized organizations, it was cash.
The blame shifting behavior seems much better explained as passing the buck, and it reminds me of the behavior of children who are unable to accept any blame for their part in a wrong doing, but saying that does not automatically paint all brokers who sold sumprime loans as having done wrong. The way this is being portrayed is that fraud and unethical behavior is/was so widespread as to be unavoidable. In reality, I’m believe we’ll end up discovering that the mess was caused in large part by a concentration of bad apples throughout the system, and that the whole bunch of us involved in the mortgage lending industry are not rotten.
I’m not sure what an experimental mortgage product is, but I agree with Leslie that I would not sell a product I couldn’t understand or explain, and that I couldn’t compare and contract against other related products.
Loan Originators sell loan products to their clients based on their clients qualifications and the availability of the loans. If lenders knew that the subprime loans will meltdown I don’t think lenders would make subprime loan available. Now most people blame the economy. It’s harder for clients to qualify for mortgage loans.
Before clients signs mortgage loan documents I would encourage them to seek second opinion so they could make the right decision on what best suites their needs.
I don’t know what’s a milgram experiment either. But I agree with Shawn and Leslie that I would not sell a loan product that I couldn’t understand or explain.
I did see alot of sub-prime AE’s come into our office back in 06 and 07. The programs that they offered the borrower was almost appealing and comparable to the 30 year fixed rate but it was a 2/28 arm product instead. I did see LO’s from other companys put a good borrower into these loans for their gain. The lender offered very appealing rebate. generally 1-2%. I never had a huge sub-prime pipeline. Now I’m glad. Alot of finger pointing and blame now. I never thought I would see such an awful sub-prime meltdown. I don’t think they did either. Now loans are back to basic as when I started into the mortgage industry about 8 years ago.
In the Milgram experiment, the participants, who knowingly and openly acted in a manner that they believed was causing pain and suffering, shifted blame for their actions onto the experiment itself or the observers who told them that the experiment must go on. It’s amazing the extent to which our minds will allow us to deny our own responsibility given even the flimsiest prospect of shifting the blame. So it has been with a great number of mortgage brokers and their LO’s. They often repeat that they were not to blame for originating bad loans – it was the lender’s fault for making such loans available. While there seems to be a natural tendency for this sort of behavior, it is no less inexcusable. The bottom line is that brokers and their LO’s work for the borrower. They always have, in spite of the claims by industry leaders that they work for neither the borrower nor the lender. If a broker oversold a loan to a borrower for whom it was inappropriate, or if a broker knowingly submitted a loan application that did not accurately reflect the borrower’s financial situation, then the broker ought to be held accountable for the problems that result.
The article poses the question, “How would go about obtaining consent from your mortgage lending clients before recommending experimental mortgage products?” The reference to some creative products as “experimental” is, I believe, another example of what the Milgram experiment shows us. We are able to distort facts in an effort to mitigate our blame. The reference to these products as “experimental” seems to be baiting the question about who is to blame. While these products may in fact have been “experimental” from the standpoint of lender risk analysis, that fact is not relevant to the roll of the broker. In every case, the terms of these loans were explicitly stated. Any competent loan officer or broker could read and understand those terms and could reasonably project the probable changes to payments over time. Any competent loan officer could reasonably foresee worst case scenarios and the potential harm posed to borrower. The issue is not whether the lender was experimenting with its own risk exposure, the issue is due diligence on the part of the broker or his LO in serving the interests of the borrower. No one can see the future. But any competent practitioner can read the terms of the note and see what the payment on a pay option ARM is likely to do when the loan recasts. If a borrower is barely able to make the payments at the introductory rate, one can reasonably foresee danger coming when that payment steps up by a significant amount at the recast trigger point. Even absent a sense of fiduciary responsibility, the competent loan originator, after having studied the loan he is selling, who has any sense of a minimal standard of suitability could not have sold these loans as they were too often sold. To pass blame to the lender for creating them, or even to mitigate blame by saying that these loans were “experimental” is irresponsible.
As for “informed consent”, where does that fit in? There is no need for or place for informed consent in an arm’s length transaction, and if we presume brokers to have been fiduciaries, no amount of “informed consent” can abrogate the fiduciaries responsibility to serve his client’s interests. If a proper (and fiduciarily required) due diligence process identifies a loan as inappropriate for a borrower, the broker must recommend against it. If the borrower insists on applying for such a loan even in the face of the broker’s recommendation, the broker should obtain a signed statement to the effect that the borrower is applying for a loan contrary to the recommendation of the broker. Under no circumstance should the broker encourage a borrower to proceed with a loan that the broker’s due diligence has identified as too risky for the borrower.
How to explain the blame shifting that took place early in the sub-prime meltdown? Human nature. As a society we have become quick to accept credit for positive results and even quicker to lay blame on someone else for poor results, even when we are clearly the cause of the poor results. That we are so quick to point fingers elsewhere when we are at fault is an indictment on our society. In my view, the responsibility lies where the rubber meets the road. The LO or broker who knew the loan was a bad fit for the client but did it anyway, for whatever reason. There is a military analogy here – the responsibility of a soldier to NOT follow the orders of a superior when they know it is not a lawful order. “I was just following orders” is not a clear defense. Likewise, in our case, I was just doing what the lender wanted is not a valid excuse for contributing to the crisis.
I think the Milgram experiment does not best represent the blame shifting between lenders, borrowers, and mortgage brokers. Milgram experiment was conducted under a controlled environment where the subject was informed of the consequences and the subject chose to participate. However, the subprime meltdown happened because each player was greedy to only benefit themselves and they did not think of the consequences. Since mortgage brokers and LOs are specialized in the programs offered by the lenders and our job is to understand the programs offerend, comprehend and able to present to the borrowers if they have any question. I believe in for us to sell the product (program) we, ourselve need to understand the product. Therefore, I do not think Milgram experiment best describe the situation we have.
@Yoshiho
“experiment was conducted under a controlled environment where the subject was informed of the consequences”
How do we account for the thousands of homeowners who claim that they were told that their interest rate would be fixed and they ended up with a pay option arm.
Too many homeowners were given a pay option ARM who did not fully understand how it worked.
Milgram did not fully explain all the possible consequences to his research subjects.
By nature people see what they want to see and hear what they want to hear to the extent it gives them their desired results. Prospective homeowners wanted to live the american dream. Subprime loans were offered like candy to borrowers who clearly did not or did not want to understand the implications of 2/28 ARM, POA, or other types of financing that didn’t include vanilla 30 yr fixed mortgages. I believe many simply did want to understand the implications of subprime financing believing their mortgage “professional” that they could refinance out of the loan in a few months. Were most of these loans sold based on greed? I believe so. The authority says sell it, if you sell it there will be profit and reward. That is the american way. Our society is programmed to follow authority. If you do what you are told you will be rewarded. You don’t have to agree with it but if the end result is reward in most cases we will do what is asked of us. I can count on 1 hand the number of subprime loans I have done and in all cases they were done in extreme cases where it was needed to save a borrower from losing their home. Each borrower had a plan of action and knew that the loans were short term and what needed to be done to obtain desirable long term financing. All but one followed the plan and were able to refinance. I met with plenty of borrowers who wanted the lowest payment, more house than they could afford etc., I wouldn’t offer the subprime loans and lost potential clients. I know they went down the street and got what they couldn’t afford.
I could not more agree with Jillanye here about ‘Too many homeowners were given a pay option ARM who did not fully understand how it worked. ‘ Again, I worked for ‘xyz’ and I could not count how many times my co-workers were placing homeowners in a Pay-Option Arm, and the co-worker would say ‘wow, just had another borrower sign a pay-opyion arm, and what they dont know, is that its adjustable’!! And to answer Pams question, ‘were most of these loans sold based on greed?’ FOR SURE! We were told to sell Pay-Option arms at all cost, for the benefit of our company and our pay-check! We were ‘programed by our managers’ to sell subprime and pay-option arms. I look back and I am glad that I am a LO/Broker. I beleive I am doing the right thing for my borrower. I will not originate a loan that does not benefit my borrower, and what is sad they will go down the street and get it somewhere else.
I don’t believe the milgram experiment compares to what we are dealing with in the mortgage industry. Sub prime loans were developed for borrower’s who could not qualify for traditional financing. They allowed for little to no downpayment for those families who could not save for the downpayment. They allowed for higher DTI’s so the borrower could get into a home they would not have been able to qualify for under traditional guidelines. They offered financing to people who had less than perfect credit.
The federal government mandated that they wanted every american to be able to obtain home ownership and yet they have not accepted the responsibility of their actions. What happened to “The buck stops here”?
A several years back, I worked in a loan call center environment.
I made sure every caller (that would listen) received a full explanation of the Option Arm, right off the bat. Most did not choose that loan, in fact, most did not do any loan with me, but I felt a certain satisfaction that at least they went away knowing the essential workings of an Option Arm, and would not as likely fall prey to the next LO they called, who would usually NOT explain all of the risks, only the reward (super low payment), and then collect a fat check.
In the rare case that they expressed an interest in the Option ARM, I had them state back to me the relevant risks. Unfortunately, at the time, neither I (nor any borrowers) foresaw the national collapse of housing prices.
I remember looking at 15 years of Puget Sound prices either staying stable or rising and thinking “continuously dropping house prices…that seems like a small risk..”
As an actuary friend of mine recently said about a pension fund he was managing risk for, “Collectively, we failed to account for, and insure against, what seemed at the time to be the most unlikely risk elements”.
When your judgment about the new loan products is clouded by the sweetness of the money your making can sure soften the reality of what you are doing to your clients. Commissions do have there dangers.
You just have to make sure they understand what they are getting to and if they don’t understand you have to stop the process. You don’t put a 6 year old behind the wheel of a car and tell him to go have a good time!!!
I can honestly say I did not participate in selling loans to homeowners that they did not fully understand, over my 20 years as an originator. I refused to put a consumer in to a loan that I clearly was aware that it was not an option for them. However, that is not to say that I did not sell a Pay Option ARM (although not too many!) These types of loans did have benefits to a sophisticated buyer that would invest the difference and were aware to pay the negative amortization before it rolls in to the principal balance. Greed from aloan officer and “the extreme desire” of a home buyer are not a good combination. I really have a difficult time believing a homebuyer thinks those 1.25% interest rates did not come at a cost when it’s easy to find out what the going interest rates really are for a home loan. Yes, I’m sure they didn’t receive full disclosure from the LO but they also chose to not ask the questions that they probably knew they should ask.
I became an LO in 2006, and had a wonderful manager who taught me how to be an honest, ethical LO. Prior to that, I was a notary signing agent, and went out to borrower’s homes and had them sign their loan documents. The fees that I saw on the HUD was astronimical, and is a testament to the way things were during the subprime mess. I also worked out of a branch signing their loans, and their LO’s had monthly quotas, and if they did not perform, they were put on notice, and eventually fired for not selling. Every loan was an ARM, and later when I became a broker I found out that the reason for that was because ARM rates were much better than a 30 year fixed. I could see where there was a lot of greed out there, with managers pushing their employees to sell sell sell, at all costs, much like the Milgram experiment. No one was accountable to themselves for the loans they were inflicting on borrowers.
What does Milgram Experiment & Pavlov”s Dog have in common…greed & ysp??
Scott,
Milgram didn’t tell his volunteers that they were the subject of an experiment. The volunteers thought that they were conducting the experiment on someone else.
Full disclosure; full informed consent of the possible consequences didn’t happen in Milgram’s days. Because of the outrage from the psychology community, we now have full informed consent with psychology research subjects.
Someday, we will have full informed consent owed to borrowers by mortgage brokers.
We are almost there.
J.
No one wants to be the “Bad Guy” especially when so much damage has been done to individuals and thier quality of life. I do think there was a certain peer presure behind most Lo’s closing the sub-prime loans, as Brokers would often and still do run contests to see who can close the most loans or the largest $$$ amount of loans closed. Most Everyone wants to be thought of as a winner not a loser. Those are the LO’s and Brokers that do not have “Clients” but just a number on a Point File and a Blue Folder to go with it.
Reflecting on the Milgram experiments, how would you now explain the blame shifting that took place earlier in the subprime meltdown? (To some extent, it’s still taking place today.)
A: Because the result of the meltdown was so staggering, everyone is looking to blame someone or something and since Wall Steet is the most visable, it is onlyl logical that this is where the blame is landing.
How would go about obtaining consent from your mortgage lending clients before recommending experimental mortgage products?
A: I think some of the newer state and federal disclosures that “dumbs down” the language will help tremendously. I also think that there should be a form that fast-forwards the loan to a scenario in the future that clearly shows what could ultimately happen to that individual on that loan
Reflecting on the Milgram experiments, how would you now explain the blame shifting that took place earlier in the subprime meltdown? (To some extent, it’s still taking place today.)
A: People will always feel guilty when some unexpected consequence of their own action takes place and the natural human response is to shift the blame from themselves to others. Of course, the natural tendancy is to say, I was told to do it. As if that makes it alright. Of course it doesn’t but it sounds better than “hey, I was in line to make A LOT of money. Why not do it? The loans were leagal after all.”
Admitting out own culpability is much more difficult than shifting the blame to others. Still gets back to what is right and wrong. How do you shock someone with 450 volts just becasue someone else tells you it’s part of the experiment? I would hope my son would never let things go that far. But from an early age, we are told that free thinkers and those that ask questions are bad, unrully, and trouble makers. So what are we to expect when those students grow up and become adults? That all of a sudden they have become the pinicle of free thinkers and have somehow learned that standing up for what they beleive rather than doing what they are told is the right thing?
How would go about obtaining consent from your mortgage lending clients before recommending experimental mortgage products?
A: Experimental mortgage products?? Like what? Tellme what it is, show me how it’s supposed to work, let me figure out what the worst case could be, and then I will let you know if i’d even bring it up to a client let alone try to figure out the disclosure for it. . .