Alex A. Hutnik

A really interesting interview with Warren Buffett:

Underground Value: Notes From Buffett Meeting 2/15/2008

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Jeff Frankel (via Greg Mankiw):

“Despite the EITC and child credit, the poverty trap is still very much a reality in the U.S. A woman called me out of the blue last week and told me her self-sufficiency counselor had suggested she get in touch with me. She had moved from a $25,000 a year job to a $35,000 a year job, and suddenly she couldn’t make ends meet any more. I told her I didn’t know what I could do for her, but agreed to meet with her. She showed me all her pay stubs etc. She really did come out behind by several hundred dollars a month. She lost free health insurance and instead had to pay $230 a month for her employer-provided health insurance. Her rent associated with her section 8 voucher went up by 30% of the income gain (which is the rule). She lost the ($280 a month) subsidized child care voucher she had for after-school care for her child. She lost around $1600 a year of the EITC. She paid payroll tax on the additional income. Finally, the new job was in Boston, and she lived in a suburb. So now she has $300 a month of additional gas and parking charges. She asked me if she should go back to earning $25,000. I told her that she should first try to find a $35k job closer to home. Also, she apparently can’t fully reverse her decision to take the higher paying job because she can’t get the child care voucher back (the waiting list is several years long she thinks). She is really stuck. She tried taking an additional weekend job, but the combination of losing 30 percent in increased rent and paying for someone to take care of her child meant it didn’t help much either.”

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Recently, there has been a lot of press coverage (in between clips of Paris Hilton going to jail) about something called subprime lending. I’d like to explain what the current problem is to aid anyone trying to better understand the articles about it.

There is one basic banking idea you should understand for this post: the most common way banks make money is by charging people interest on loans, credit cards, mortgages, etc. The interest that they charge depends a lot on how comfortable they are with whether or not you will be able to pay back the loan. The more risk you have, the higher the interest.

So, about 10 years ago, banks started to feel pressure from their owners to be more profitable. In order to do that, the bank had to either charge more interest on loans or find more customers to apply for loans. Some banks chose the latter, and began to take on riskier customers. These customers are known as ’subprime’ customers, because their credit ratings are not the greatest. These subprime loans typically had low interest rates at first and were attractive to people with low credit scores (indeed, low interest rates are attractive to anyone regardless of credit rating). But the banks still consider these customers risky, so they charged higher interest rates. Nothing unusual here, except that many banks fully expected customers to default on the loans. Real estate prices were rising so the bank could either make money when the customer paid back the loan, or they could make money by foreclosing on their house and selling it. They were making money coming and going: both money from the customer until he defaulted and money from the sale of his house too.

If a bank knew that a borrower was going to be unable to repay his loan but lent him the money anyway, the bank would be guilty of what’s called ‘predatory lending’. This is something that is forbidden by law. In fact, there is a federal investigation going on to determine if any laws were broken.

So why so much press coverage? Because hundreds of thousands of people are facing foreclosure on their homes.

You can read more about this on the wikipedia article: http://en.wikipedia.org/wiki/Subprime_meltdown.

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