The Savage Truth on Money by Terry Savage

Dear Terry: (This is an excerpt from a note posted on my blog.) We are grateful to have wonderful jobs and don't ever want to be viewed as complainers. However, I have to admit I am frustrated and perplexed at what I am hearing lately in terms of the financial behavior of some associates, even family. I know of people walking away from their mortgages and pocketing the monthly cash in anticipation of a foreclosure. I have seen people run up extremely irresponsible credit-card debt and declare bankruptcy, yet retain their home and cars and have money for vacations and investments. I dutifully pay off my debt, and in spite of a terrible year for my husband's company, we still pay all of our bills. I almost feel like a fool watching other people play the system (legally) and walk away in better shape financially. Can you cheer me up? — Patty

Yes, I think I can cheer you up — because I have a basic belief in both the intelligence and the moral compass of the American people.

Personal responsibility is at the heart of a democracy. We know that self-interest ensures survival. If a society creates perverse incentives, individuals are certain to be motivated to act in their own best interest. So we must fix the financial incentives to make sure that self-interest and social responsibility once again coincide.

Let me give you one quick example of a very perverse incentive. Let's assume you are one of millions who has a mortgage and are barely making the payments. You'd like to refinance at today's lower rates, but your house is worth less than the mortgage. You want to do the morally and financially correct thing: keep paying your mortgage and keep your home. Yet when you go to the bank, you run directly into the most perverse incentive.

The bank says you have to be behind at least three months in your payments before it'll consider refinancing your loan. But if you comply, once you've ruined your credit to get the bank's attention, there's no guarantee you'll get a new, more affordable loan. And then, because you're behind on your payments, you might get foreclosed out of your home.

Even worse, those perverse incentives to walk away from personal responsibility demoralize people like you. No one wants to feel like a sucker.

These perverse incentives apply on a national scale, as well. In fact, they're what created the housing bubble in the first place.

When Congress decided to subsidize low-rate mortgages through Fannie Mae and Freddie Mac, it was not surprising that mortgages were pushed out the door to all who applied, regardless of qualifications. After all, any losses would be "insured" by these "quasi-governmental" agencies that had lines of credit with the Treasury.

Why did Congress take it upon itself to push home ownership to such new heights? You don't have to be cynical to understand that the illusion of prosperity buys votes.

With Freddie and Fannie throwing money at the mortgage market, brokers got huge commissions to find borrowers, banks made money-selling loans in the secondary markets, and Wall Street made money securitizing the loans and selling them to investors.

And ratings agencies made money giving junk mortgages top ratings.

The incentives to expand home ownership worked — until the bubble inevitably burst.

Let's look at Wall Street's bad behavior. Much of it has been spurred by the same perverse incentives. Wall Street climbed aboard the mortgage boom, created by a Congress that urged Fannie and Freddie to make mortgage loans available to less-qualified buyers in the name of "community reinvestment."

These investment banks that securitized those mortgages knew they were "too big to fail" — until one of them, Lehman, did fail. Then they immediately rushed overnight to become "traditional banks" instead of investment banks. Thus they were covered by FDIC insurance — and the government could not let them fail.

That perverse incentive of "too big to fail" has underwritten their current risky activities, making today's huge bonuses possible. The incentives are simply too powerful to resist — even though the profits and bonuses must be embarrassing to them.

Our government created those misleading incentives that have resulted in activities that destroy our economy. So perhaps we should be asking, "What are the incentives for our government?"

You don't have to look far to find those incentives. They're in the money that comes from special-interest groups and campaign contributions that "buy" their votes — on both sides of the aisle.

Maybe our founding fathers anticipated this problem. They gave each and every one of us something more powerful than money. They gave each of us a vote.

And that's why I can offer optimism. Americans have not lost our moral compass. We recognize the perversity of so many proposals coming out of Washington. We have big hearts and a generous spirit. But we also have an enlightened self-interest that will not accept the theft of our hard work for any immoral purpose.

If enough Americans of all political persuasions are morally outraged by our government's actions, we will gather that outrage and vote them all out. Looking around at the mess they've made, I think we finally have that incentive. And that's The Savage Truth.

Terry Savage is a registered investment adviser and is on the board of the Chicago Mercantile Exchange. She appears weekly on WMAQ-Channel 5's 4:30 p.m. newscast, and can be reached at www.terrysavage.com. She is the author of the new book, "The New Savage Number: How Much Money Do You Really Need to Retire?" To find out more about Terry Savage and read her past columns, visit the Creators Syndicate Web page at www.creators.com.

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