The Similarities Between Foreclosures in 2007 and the South American Debt Crisis

It was easily predictable that at the end of the housing bubble, we’d see a lot of homes getting foreclosed. But there is nothing inherent in the end of a bubble that requires vast numbers of foreclosures. The reason we see them is that lenders made imprudent loans, and of course, that many people took those imprudent loans.

Regular readers may recall that I mentioned growing up in South America in the 1970s and 1980s, when much of the continent was going through high inflation. The high inflation itself was caused in large part by massive foreign debt, which consumed much of South American tax revenue, meaning those revenues couldn’t get used to pay for other things – roads, teachers salaries, or even soldiers. And since the latter, at least, have to be paid no matter what (or the government falls), well, it makes printing money look a bit more attractive.

So how did South American countries get into debt? Well, big American (and they were mostly American) banks loaned them lots of money. And loaning “them” money was easy – “them” were basically dictators who were happy to take the money. This was because with no checks and balances (one of the cool features of being a dictator), the money could then turn around and be deposited (often in the same bank that made the loan), this time in the accounts of the dictator, his kids, his mistress, etc.

So Brazil or Argentina or wherever would borrow a few billion to build a road, but the road would never get built because the money would never be used to build a road. The economic development that the road was supposed to foster would never occur, and thus neither would the extra tax revenue, and thus, the money to pay back the loans would never materialize.

But this went on for decades. So why did the big American banks make these loans? The answer is simple – they didn’t. Individuals in the banks made these loans. They got promoted for making loans. Twenty years later, when the loan came due and wasn’t paid – well, the guy who got promoted for making the loan wasn’t in the same job any more. He might not even be with the company any more. If he was with the company, he’d be much higher up – too high up to pay a price, even if he somehow was associated with the loan he originally made.

So what does this have to do with foreclosing homes these days? Everything, I think.