On Monday, ProPublica, an independent non-profit investigative journalism outfit, published an inflammatory story against Freddie Mac, the government sponsored enterprise that facilitates the secondary mortgage market.  (Freddie was taken over from shareholders and placed into conservatorship in 2008.  It is currently being overseen by an independent agency called the FHFA.)

The ProPublica piece charged that Freddie took out investments which allowed the agency to profit from its own risk management policies that can prevent homeowners from refinancing into lower interest rate loans.  The investment vehicle in question is called an ‘inverse floater’, an instrument whose coupon rate is inversely tied to an interest rate.

The article suffers from a set of deeply contradictory assumptions. The authors expect Freddie to create liquidity, while minimizing its own risk exposure.  But Freddie’s very purpose in these markets is to deal with the prepayment (refinancing) risk associated to changes in interest rate, so that, in the words of blogger Matt Levine, “the banks don’t have to”. As Yves Smith points out “the GSEs have always engaged in hedging strategies to manage their prepayment risk”.

The most puzzling part of the article, however, is not in the technical argument which was rehashed in detail on several financial blogs, but rather the article’s prominent feature of the following quote: “We were actually shocked they did this,” says Scott Simon, who as the head of the giant bond fund PIMCO’s mortgage-backed securities team is one of the world’s biggest mortgage bond traders. “It seemed so out of line with their mission.””

Someone at the world’s largest bond investment company is expression shock (a moral sentiment of outrage) at another company’s investment strategy? Really? (Yves Smith wonders whether PIMCO has shorted the high yield coupon bonds that stand to loose the most if there is a wave of refinancing).

Freddie Mac has a difficult mission because it suffers, by definition, from a conflict of interest. It is supposed to make loans available to American consumers while at the same time maximizing return for its owners – at the moment, American taxpayers.  Seeking for fraud and corruption in how Freddie operates overlooks basic tensions in how the government and private capital have been draw together to funnel money into U.S. homeownership.  These deeply rooted tensions are part of how the system – for better or for worse – functions, and not, as journalists, politicians and pundits perpetually try to show, evidence that it is somehow working incorrectly.

The original ProPublica story is here.

A weak defence of the story by Felix Salmon on Reuters, here.

A detailed reply by Yves Smith of Naked Capitalism, here.

Further reply by Michael Olenick on Naked Capitalism, here.

Reply by Matt Levine at Dealbreaker, here.

According to this msNBC video and this CBS video report, with default rates on the rise, credit card companies are desperate to cut costs and reduce risk.  It’s called ‘balance chasing’ and it involves banks cutting credit lines, in one reported case from 19,000$ to 300$.  They can also unilaterally closing accounts to reduce open lines and cut managerial expenses.  By some estimates, 2 trillion dollars worth of consumer credit will disappear by 2010.

In this context, many actions that were once considered good credit practices have now become a burden. Merely having a card you don’t use, for example, has become a ‘risk’ to the individual’s credit security.  Here’s how: If a bank closes a card, a consumer’s overall credit limit is lowered.  This in turn lowers their FICO credit score, sometimes by more than 50 points.  Given the fine print in credit card contracts that allows companies to adjust their terms, the pitch down in score can trigger increased interest rates from as much as 7.99% to 28%.

What results is a severe disruption to a household budgetary routine.  Suddenly there is less credit available, increased payments on multiple cards, dramatically increased debt burden, and a reduced ability to command fresh credit to compensate because of a lowered score.

The downward spiral is caused by the feedback loop at the heart of the the credit scoring system which is designed to allow all lenders to simultaneously monitor a consumer’s behavior with credit. The problem is that although the scoring system is supposed to monitor the consumer, it is also responsive to actions taken unilaterally by creditors on consumer accounts.  The score does not only reflect the changes in the consumer’s behaviour.  It also reflects changes in bank policy. This means that one bank’s internal decision can trigger automated managerial responses in other banks that degrades the consumer’s credit rating, even though the individual’s behaviour has not changed.

In a crisis environment where banks are cutting back on credit lines, and the question of sustaining credit liquidity is of the utmost importance, the personal as well as economic results of this looping effect are devastating.

As CBS reports, new legislation preventing some of these card company practices, was passed in December 2008, but won’t come into effect until 2010.  In the mean time, credit counselors are suggesting that consumers change their user strategies in all kinds of creative ways.  Where consumers were once told to keep (the very) lines (that are getting them into so much trouble) open, in response to the sensitivity to line limits built into the FICO, they are now being encouraged to complexify their card use to make sure these cards get used each month.

Placing responsibility on the public’s shoulders to adjust to this flux of changing demands is an inefficient and disaggregated solution to what is a systemic problem. It also severely undermines the idea that the credit scoring system reflects consumer behaviour, when it is clearly shaping it.  The statistics of FICO have built into them them the rules of the system that generate the spiral.

There are elegant statistical solutions to prevent this problem from happening.  Statistical redesign of the score’s underlying algorithm could prevent unilateral decisions by creditors from affecting scores, at least so dramatically.  The problem could be avoided if FICO could distinguish between a line limit cut by blanket bank policy, and a line limit cut caused by a deleterious consumer action such as a default that triggers a behaviour responsive bank policy.  Once treated as separate events in the score’s underlying statistics the feedback loop that erodes credit quality would be greatly mitigated.

In this time of crisis, when will the ‘political will’ to stabilize the credit system be turned towards the design of hidden financial technologies underlying it, and not only towards the visible actions of people and institutions? This is something that we who study the social effects of financial technologies, sincerely wonder.

In thinking about financial innovation, retail banking is not the first thing that comes to mind. Derivatives, global deals, complex portfolios — yes. But ATMs? Bank branches? As an ex-banker from Citigroup used to say to me years ago, “branches are a dead weight.”

Branches, however, are what makes the work of Zsuzsanna Vargha so interesting. Zsuzsi is finishing her Ph.D. in sociology at Columbia, and her dissertation examines a massive shift that has occurred across the Atlantic. She writes

Banks, after pursuing electronic banking, are once again
investing in the face-to-face encounter. This re-personalization of
finance is particularly well observable in post-socialist Hungary.
Banks individualize services to keep their share of profitable
clients, and reach out to new populations in person.

What do these changes mean for the future of retail finance? To address that, Zuzsi conducted ethnographic research on the Customer Relationship Management (CRM) software used to recommend products to bank clients. She then examined a savings and loan-type bank that used a direct selling organization, not unlike the “thundering herd” of salespeople that Merrill Lynch used to have. Her first findings are available in the first paper to come out her dissertation, “Markets from interactions: the technology of mass personalization in consumer banking.”

Zsuzsi’s study comes at a particularly timely juncture. Now that proprietary trading no longer seems to an option for American banks, these institutions need to reimagine their identity as something exciting and innovative … but distinct from Wall Street. Zsuzsi’s conception of retail banking as a high-tech service could well be the way to go.

We’re lucky to have Zsuzsi as guest blogger at Socializing Finance for the coming week.

Download vargha-2009-markets-from-interactions

The $75 billion dollar Homeowner Affordability and Stability Plan announced by Obama today promises to relieve between 4-5 million responsible households who are facing foreclosure.  Included in the plan are provisions to work with mortgages that are not yet in default.  For some well framed examples of the types of calculations for refinancing the Administration expects the plan to enable see here.  It is noteworthy that the plan does not dispute the price of the house nor does it compensate owners who have paid down value that has now been lost; it simply permits the readjustment of loan amount, where ratio rules might have impeded modifications, to the current value of the property. In other words, it provides access to refinancing.

A key word in the plan is responsible which is repeated again and again in the Administration’s Fact Sheet.  There is a strong populist emphasis on demonstrating that unscrupulous speculators will not be rescued or rewarded.  We won’t know how eligable homeowners will be defined until guidelines are announced.  This is expected to occur on Wed. March 4th. In watch points, look for the use of FICO scores, in the the determination of individual responsibility…

Transparency, transparency, transparency: Obama wants it in government (he says), mortgage back securities didn’t seems to have enough of it, and many are yet to be convinced that the various bailouts will deliver it. As one recent sociological text on the subject puts it (in what, in light of the current context, now reads as something of an understatement), transparency is: ‘a concept that has gained increasing currency and favour as an organising principle and administrative goal’ [1] (you can also download a version of Fabian Muniesa, Emiliano Grossman and Emilio Luque’s excellent paper on the topic from the same book here).

In relation to my own research into consumer credit, the attempts to perform transparency (as with many other financial products) have to somehow manage and contain the inherent uncertainty and opacity of the unknowable future. In other words, consumer credit has to contain mechanisms that in some way render the future a little less opaque, even if achieving complete transparency is, by definition, impossible.

In the UK, part of this task has been recently undertaken by an ongoing review of the regulatory framework in relation to which consumer credit sits, principally oriented around an updating of the Consumer Credit Act (first drafted in 1974). This review has a stated aim of achieving a ‘fair, clear and competitive’  consumer credit industry; in other words, transparency (clarity) sits in relation to two perhaps conflicting requirements: ethical (fairness) and market openness (competition). Part of my research examines how these categories are performed in and through the operations of consumer credit in the UK. Just to give an idea of how achieving these aims are attempted, requirements on regularity of credit statements have recently been strengthened and, within those statements themselves, there are precise requirements for the ways in which the balance, interest payments, and default charges are displayed (this includes a requirement to provide a clear ‘Summary Box’ detailing the particular product’s key features, both pre- and post-contract – a similar scheme operates in the US, I understand).

I’m not going to focus here in detail on the role such ‘market devices’ play in relation to contemporary consumer credit. Instead, I want to sit these attempts to devise a contemporary regulatory framework in something of a long historical context. For, it was in a period when I was actively considering some of the issues that I have sketched above, that I visited Salisbury Cathedral in the UK and encountered one of their venerable ancestors: the Magna Carta, the document that is widely held to provide many of the founding principles for British jurisprudence, written in 1215. This is what (in translated form), it states in the ninth of sixty-three points:

‘9. Neither we [the King] nor our officials [in some versions ‘bailiffs’] will seize any land or rent in payment of a debt, so long as the debtor has movable goods sufficient to discharge the debt. A debtor’s sureties [guarantees] shall not be distrained upon [seized] so long as the debtor himself can discharge the debt. If, for lack of means, the debtor is unable to discharge his debt, his sureties shall be answerable for it. If they so desire, they may have the debtor’s lands and rents until they have received satisfaction for the debt that they have paid for him unless the debtor can show that he has settled his obligations to them.’

It then continues, in points ten and eleven, to lay out further attempts at establishing what are clearly intended to be the ‘reasonable’ responsibilities that should be held by others (in particular heirs and wives) towards the repayment of any debts owed to moneylenders should a debtor die. The Magna Carta is then, not only the first (well, to my knowledge – perhaps a legal scholar will correct me if not) attempt at a credit act, but also the first attempt at achieving ‘fairness’ and ‘clarity’ in relation to borrowed sums and to bring some measure of ‘transparency’ towards a financial instrument that depends on an inevitably opaque future. Unsurprisingly, the desire to couple these two aims with achieving market ‘competitiveness’ is absent – although, that being said, the document as a whole was produced in a context where a group of barons were attempting to circumscribe King John’s (seemingly unfettered) power, deemed to be a threat to the pursuit of their livelihood. So perhaps a proto-market imperative is there after all.

Apart from wanting to simply draw attention to this, to my eyes anyway, compelling historical artefact, one perhaps quite simple point here (and this relates to previous posts here and here), is the historical persistence of controversy around forms of borrowing, as well as the need for material devices that attempt to contain these controversies. Forms of lending, in their need to stretch an economic transaction across time, and in their ability for debts be transferred from one party to another, tie together actors often wholly disconnected from the original moment of exchange: in this example, there are not only borrowers and lenders, but also potentially bailiffs, wives, heirs, barons, Kings, and their various assets. The Magna Carta is an attempt to ‘frame’ or stabilise the potentially unpredictable and variable interactions that could occur between these parties. Performing transparency in relation to financial instruments is thus not solely a contemporary phenomenon, but as old the legal system itself.

But more than that, it is often too easy to forget the material labour that goes into establishing these ‘transparency enacting’ framing devices: in that respect, the Magna Carta serves as a good reminder. Painstakingly etched, in tiny script, into durable vellum, the Magna Carta is a device that was written so as to both endure and to be (to again recall a Latourian concept) an ‘immutable mobile’, to travel both across time and space, without losing its agential potential, its ability to ‘act’ and be mobilised when, and where needed. Achieving transparency through the regulation of contemporary financial instruments may well be dependent on a far greater range of material processes, however this greater complexity should only increase our attention to the way they combine with people and other material processes across a varied range of highly situated social settings.

[1] Garsten, C., de Montoya, L. (Eds.) (2008), Transparency In A New Global Order: Unveiling Organizational Visions, Cheltenham, UK: Edward Elgar, p. 1.

What is a controversy? And what is the nature of the publics that are involved in controversies? These are some of the questions that were posed by Bruno Latour on Saturday, at a highly engaging event organised by the Columbia Communications School PhD programme (many thanks to Rasmus Nielsen in particular). Publics are, argued Latour, not a singular pregiven entity (‘The Public’) that we can assume to simply exist, ready to be consulted when, and if needed, but an entity whose visibility is variable and intermittent: blinking into view only when, and if, the lighthouse beam of a controversy falls on them, or to use a different metaphor, when finding themselves entangled within one. And we should be careful, continued Latour, to assume that these publics are necessarily the same as those who are spoken for, whether by governments, companies, activists and NGOs. Because publics ‘blink on’, only when a particular controversy escapes the ability of these very spokespersons to adequately resolve them. Part of our job as researchers becomes to remain attentive to the ‘coarse signs’ that signal towards the existence of, or transformations in these controversies.

What consequences might this apparently abstract debate (whose detail I have only sketched) have for the objects we study? I want to open up this question by looking at my own object of study, consumer credit, and how its visibility, and its publics, may have changed over period over which my attention has been directed onto it, beginning in late 2004.

As a researcher, one very coarse ‘coarse sign’ of the visibility of your object of study is others’ reaction to you when introducing your topic. In that respect, there has been a broad (I should say, this is purely anecdotal – as this is a blog, I feel I can be a bit more methodologically loose) shift away from seeing consumer credit as private attachment, usually manifest along the lines of ‘oh, consumer credit, interesting. You should definitely speak to me / my best friend, I have / s/he has loads of credit cards’, and towards attaining the status of a Public Issue: ‘oh, consumer credit, interesting. That’s very topical’.

So, consumer credit has become topical, a Topic, an ‘argument suitable for debate’. In other words, consumer credit appears, in the popular (I hesitate to say Public) imagination at least, to have achieved the status of a Controversy, a subject upon which divergent opinions exist, to which academic expertise can add its own, but upon which agreement is, it seems, unlikely.

But what then, was it before? The object certainly exhibited some of the coarse signs of controversy. Take the following headlines in the UK from 2004:

‘CREDIT KILLS A FAMILY MAN: … father of two committed suicide over £70,000 debt from 19 credit cards … ’ (The Daily Mail, 11/04/04)

‘CREDIT CARD MADNESS: Spend spend Britons run up 75% of Europe’s entire debt on plastic’ (The Daily Express, 17/04/04)

‘CREDIT CARD MELTDOWN: Spend now, pay later binge may force interest rate rise’ (The Daily Mail, 04/05/04)

In addition to these high profile news stories, academics, economists, politicians, activists, particularly in the US and the UK, were certainly all debating the rights and wrongs of consumer credit, some highly presciently (the now much lauded UK opposition politician Vince Cable is cited in the last of these articles, warning against the crash). And yet, did this controversy really have a public? It is tempting to say that, to a ‘large’ (I’ll come back to the importance of scale) extent it did not. The case referred to by the first headline is a tragic one and did not exist in isolation. Yet, as a coarse sign, this and other similar cases blinked only infrequently. The remaining two are more peculiar, in their very attempt to speak for and to a public that appears not to be listening: ‘experts have warned that Britain’s reliance on credit card borrowing is spiralling out of control’ continues the Daily Express. But are experts’ warnings signs of controversies?

Part of my own interest in consumer credit at the time was that its use was, despite these headlines, for most, undeniably mundane, unspectacular, and ordinary. Consumer credit had become, for many, an everyday ‘fact’. And headlines, however prescient, foretelling a ‘meltdown’ or proclaiming the ‘madness’ of Britain’s spend spend spend culture did not, and perhaps could not, create the public that they wanted to. Warnings such as the above (themselves often highly internally contradictory) were, to a large extent, not heeded, spending continued, and real hardship for thousands is now a result (not, I should emphasise, ‘the’ result – its causes are too manifold for such simple narratives).

But, as I argue in my working paper, consumer credit does have, and has always had, controversy rolled up in it as part of its operations, particularly as translated through its processes of debt collection. These processes, which consumer credit depends on are, and always were, extant in the background of the operations of consumer credit, ready to be unfolded in relation to a particular debtor should their situation take a turn for a worse. And as such they are, I suggest mini-controversy generators. In making this claim, I do not mean to make a moral judgement, but an empirical one: debt collection is controversial, in the sense outlined above, because of its ability, in a highly localised context – often a family home – to render itself visible and to pose problems to an individual and those in his/her close proximity, which others (the state, activists, NGOs) cannot ultimately solve – partly because repaying consumer debt is, by definition, the responsibility of the consumer alone.

It may be, as I argue, and as Daniel commented on, that expert advice can help reframe a household-level controversy that results from technologies of debt collection, putting an individual in a position where economic calculations become relevant once again, back onto a path where the debt, or at least an agreed part of it, can be repaid. However, this expert knowledge – indeed it is not in their remit – deal with the various and complex ‘externalities’ of defaulting on debts, such as the worries associated with being overindebted, or its impact on the shape of a debtor’s relationships with others. Consumer credit therefore is and always was controversial, in Latour’s sense, not because newspapers headlines make it so, but because, even before the credit crisis, debtors were defaulting and being asked questions which were beyond the limits, or remits, of expertise to fully answer.

The transformation in its status to an apparent ‘Public’ controversy is as a result of these mini-household controversies have enrolled more actors to their cause: whereas before, in the above examples, newspapers were trying, and to a large extent failing, to attach the dangers of consumer credit to actors such as a potential immanent (0.5%) rise in interest, or to experts’ macro-economic worries, or even to isolated personal tragedies, now, struggling with consumer debt can with some ease be tied to the consequences of house price deflation, job losses, high inflation, to name a few. Moreover, the current crisis also meets another of Latour’s coarse signs: the state, NGOs, experts seem, by and large, to unable to agree on what to do about it. What was a series of highly affecting household mini-controversies have therefore ‘gone big’, and ‘gone visible’, becoming connected to the global spectacular, incorporating a vast range of actors, that is the current economic crisis.

However, the scale of controversies alone should not determine the direction in which our attention is focused (even if the way a controversy attains this scalar reach maybe should – I argue something similar elsewhere). This is because, for the individual defaulting debtor, the questions being asked of them may still be very similar in 2009 to 2004. For some controversies do not ask for engagement, they demand it: Noortje Marres [1] argues of the productivity of the term, borrowed from Science and Technology Studies, of ‘attachment’, which attempts to capture an ambiguous relationship of ontological commitment and dependency in relation to some controversies. This does I think speak well to the experience of being a defaulting debtor, which is one of being in a state of deep ontological (and, as I argue in the paper, bodily) attachment to debt: a debtor has to constantly interact, and become committed to, a variable network of financial institutions, advisors, and services, whilst constantly facing the implied wholesale threat to, or endangerment of, her existence if she opts out interaction with them. This personal controversy may not be global, but it is a controversy nonetheless. That is, in Latour’s terms at least.

[1] Noortje Marres (2007), The Issues Deserve More Credit: Pragmatist Contributions to the Study of Public Involvement in Controversy, Social Studies of Science, 2007; 37(5), p.774. Available online here (if you have access to a subscription).

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