The Psychology of Subprime Mortgages

The Psychology of Subprime Mortgages

via Boing Boing

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Posted on: August 9, 2007 10:19 AM, by Jonah Lehrer

The poo is hitting the fan: all those sub-prime mortgages given out so recklessly over the past two years are getting their interest rates re-adjusted. And that, of course, is when the foreclosures begin.

By most measures, sub-prime loans are a bad idea. Look, for example, at the popular 2/28 loan, which consists of a low, fixed-interest rate for the first two years and a much higher, adjustable rate for the next twenty-eight. Most people taking out a 2/28 loan can't afford the higher interest rates that will hit later on. It's not unusual for interest payments on a 2/28 loan to double within four years. (That's why you're seeing such high foreclosure rates in the sub-prime market.)

So why do people take out sub-prime loans? Don't they realize that they won't be able to afford the ensuing 28 years of mortgage payments? I think a big part of the reason sub-prime loans remain so seductive, even when the financial terms are so atrocious, is that they take advantage of a dangerous flaw built into our brain. This flaw is rooted in our emotional brain, which tends to overvalue immediate gains (like a new house) at the expense of future costs (high interest rates). Our feelings are thrilled by the prospect of a new home, but can't really grapple with the long-term fiscal consequences of the decision. Our impulsivity encounters little resistance, and so we sign on the bottom line. We want the house. We'll figure out how to pay for it later.

The best evidence for this idea comes from the lab of Jonathan Cohen. Cohen's clever experiment went like this: he stuck people in an fMRI machine and made them decide between a small Amazon gift certificate that they could have right away, or a larger gift certificate that they'd receive in 2 to 4 weeks. Contrary to rational models of decision-making, the two options activated very different neural systems. When subjects contemplated gift certificates in the distant future, brain areas associated with rational planning (the Promethean circuits of the prefrontal cortex) were more active. These cortical regions urge us to be patient, to wait a few extra weeks for the bigger gift certificate.

On the other hand, when subjects started thinking about getting a gift certificate right away, brain areas associated with emotion - like the midbrain dopamine system and NAcc - were turned on. These are the cells that tell us to take out a mortgage we can't afford, or run up credit card debt when we should be saving for retirement. They are our impulsive pleasure seekers, the hedonists inside our head.

By manipulating the amount of money on offer in each situation, Cohen and his collaborators could watch this neural tug of war unfold. They saw the fierce argument between reason and feeling, as our mind was pulled in contradictory directions. Our ultimate decision--to save for the future or to indulge in the present--was determined by whichever region showed greater activation. More emotions meant more impulsivity.

This discovery has important implications. (A more recent paper by the Cohen lab extends the theory.) For starters, it locates the neural source for many of our financial errors. When we opt for a 2/28 mortgage, we are acting like experimental subjects choosing the wrong gift certificate. Because the emotional parts of our brain reliably undervalue the future - life is short and they want pleasure now - we end up delaying saving until tomorrow (and tomorrow and tomorrow.) George Loewenstein, a neuroeconomist at Carnegie Mellon University and a collaborator on the Cohen paper, thinks that understanding how we make decisions will help economists develop better public policies: "Our emotions are like programs that evolved to solve important and recurring problems in our distant past," he says. "They are not always well suited to the decisions we make in modern life. It's important to know how our emotions lead us astray so that we can design incentives and programs to help compensate for our irrational biases."

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Analysis: New Law Gives Government Six Months to Turn Internet and Phone Systems into Permanent Spying Architecture - UPDATED

By Ryan Singel August 06, 2007 | 2:11:02 AMCategories: Surveillance

A new law expanding the government's spying powers gives the Bush Administration a six-month window to install possibly permanent back doors in the nation's communication networks. The legislation was passed hurriedly by Congress over the weekend and signed into law Sunday by President Bush.

The bill, known as the Protect America Act, removes the prohibition on warrantless spying on Americans abroad and gives the government wide powers to order communication service providers such as cell phone companies and ISPs to make their networks available to government eavesdroppers.

The Administration pushed for passage of the changes to close what it called a "surveillance gap," referring to a long-standing feature of the nation's surveillance laws that required the government to get court approval to capture communications inside the United States.

While the nation's spy laws have been continually loosened since 9/11, the Administration never pushed for the right to tap the nation's domestic communication networks until a secret court recently struck down a key pillar of the government's secret spying program.

The Administration argues that the world's communication networks now route many foreign to foreign calls and emails through switches in the United States.

Prior to the law's passage, the nation's spy agencies, such as the National Security Agency and the Defense Intelligence Agency, didn't need any court approval to spy on foreigners so long as the wiretaps were outside the United States.

Now, those agencies are free to order services like Skype, cell phone companies and arguably even search engines to comply with secret spy orders to create back doors in domestic communication networks for the nation's spooks. While it's unclear whether the wiretapping can be used for domestic purposes, the law only requires that the programs that give rise to such orders have a "significant purpose" of foreign intelligence gathering.

The law:

• Defines the act of reading and listening into American's phone calls and internet communications when they are "reasonably believed" to be outside the country as not surveillance.



• Gives the government 6 months of extended powers to issue orders to "communication service providers," to help with spying that "concerns persons reasonably believed to be outside the United States." The language doesn't require the surveillance to only target people outside the United States, only that some of it does.



• Forces Communication Service providers to comply secretly, though they can challenge the orders to the secret Foreign Intelligence Court. Individuals or companies given such orders will be paid for their cooperation and can not be sued for complying.



• Makes any program or orders launched in the next six months perpetually renewable after the six month "sunset" of the new powers last for a year after being authorized



• Grandfathers in the the current secret surveillance program -- sometimes referred to as the Terrorist Surveillance Program -- and any others that have been blessed by the Foreign Intelligence Surveillance Court.



• Requires the Attorney General to submit to the secret surveillance court its reasons why these programs aren't considered domestic spying programs, but the court can only throw out those reasons if it finds that they are "clearly erroneous."



• Requires the Attorney General to tell Congress twice a year about any incidents of surveillance abuse and give statistics about how many surveillance programs were started and how many directives were issued.



• Makes no mention of the Inspector General, who uncovered abuses of the Patriot Act by the FBI after being ordered by Congress to audit the use of powerful self-issued subpoenas, is not mentioned in the bill.

In short, the law gives the Administration the power to order the nation's communication service providers -- which range from Gmail, AOL IM, Twitter, Skype, traditional phone companies, ISPs, internet backbone providers, Federal Express, and social networks -- to create possibly permanent spying outposts for the federal government.

These outposts need only to have a "significant" purpose of spying on foreigners, would be nearly immune to challenge by lawsuit, and have no court supervision over their extent or implementation.

Abuses of the outposts will be monitored only by the Justice Department, which has already been found to have underreported abuses of other surveillance powers to Congress.

In related international news, Zimbabwe's repressive dictator Robert Mugabe also won passage of a law allowing the government to turn that nation's communication infrastructure into a gigantic, secret microphone.

UPDATE: This analysis originally said that the orders entered under the new rules could be renewed indefinitely. That is not accurate. I conflated the ability of the government to continue indefinitely the programs under way under FISA before the law was signed, with the section that says that the programs under the new law go for a full year, despite the 6 month sunset.

That said, if a future bill includes the same grandfather clause that this bill has, the spying outposts could easily permanent.

Those interested in seeing how I made this mistake, look at Section 6 of the bill. I regret the error.

UPDATE 2: James Risen, the New York Times reporter who broke the story of the warrantless wiretapping program, has an analysis piece here.

See Also:

• More Known Unknowns in NSA Spy Controversy: Secret Appeals Courts, Tea Leaves and the Mineshaft Gap



• Bush Administration Reportedly Rejects NSA Spying Compromise Bill



• Democrats Halt Move to Revamp Spying Laws



• Patrick Radden Keefe's Slate piece Wiretap at Will

Photo: Room 641A at AT&T's internet switching facility in San Francisco. Former AT&T technician Mark Klein says the room is a secret internet spying outpost for the government.

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