 So there's a lot of different consumer protection issues where people are being given loans that they can't pay back and that are actually designed to fail and they anticipate a car will be repowed several times over the life of the loan. And then each time that happens and each delinquency you can extract fees out of the borrower in that sense. And so you can kind of make more money by designing a loan to fail than for it to succeed. My name's Thomas Herndon. I'm an Associate Professor of Economics at the City University of New York, John Jay College. Kind of my heuristic for whether a project is important or not or it's worth doing and that it should scare you a little bit. Typically like, you know, our emotions and our fears and things like that, they're a good, you shouldn't make like decisions necessarily based on emotion or fear but they can be a good indicator for things that are important. And something that scares you a little bit or even terrifies you is probably something that means a lot to the world, not just to you but to the world. That's usually why you're scared of it, right? It's you're scared that you're on a big story and you're excited and it's a mix of like fear and excitement and the most meaningful projects I've ever been a part of, they've always scared me a little bit because, you know, they were finding things that really mattered to key debates and some of the key issues of time. So for example, when I worked on the Reinhardt-Rogoff paper, that was terrifying. I was trying to replicate a major famous paper by very high profile, high status economists from Harvard and it wasn't working. And at first I thought that, you know, maybe I was just, you know, it was just me being kind of newer to econometrics and empirical research, right? I thought I was kind of just kind of like an idiot. And I think actually one of my professors thought that after one of our discussions, right? I remember some of the initial problems I had on that data, working with that data and reproducing the average, I walked out of like my advisor's office hours once and he was like, come on, Thomas, you have 20 countries and you're taking an average. This shouldn't be that difficult. And I was like, oh no. But, you know, I kept working on it and it didn't work and I gained confidence in my skills. But even when I knew I was right, you know, especially once we found the spreadsheet error in that paper, it was terrifying. We went public with it. I was scared. I didn't have any idea that the paper would have the viral impact that it did that be picked up by all of the world's media from, you know, Krugman, The New York Times, The Wall Street Journal, BBC, lead article of Rolling Stone, and certainly the Colbert Report. Those, you know, I had no idea that was gonna happen, but I was still terrified because I figured in the community of economists I respected the word was gonna get out. And, you know, it's a scary thing. One, the paper that I was critiquing was supporting really controversial austerity policies in the US and Europe that had caused a lot of misery to a lot of people. So it really had a high impact. And then two, I was finding mission critical errors with us on a spreadsheet and then other kind of bogus assumptions. And so, you know, that's, it's a scary thing, but that was because it was important. And then my other work, you know, I started looking at the role of mortgage fraud in the Great Recession. And when you're trying to estimate how the most powerful financial institutions in the world committed fraud that caused massive losses for, you know, households and investors, that's a big story. It's scary. It matters to millions of people the world over. And it's always kind of dealing with elements of power too. So yeah, that's kind of my heuristic for something that matters. I mean, certainly like you can run, you know, the nth regression of schooling or earnings on schooling. And, you know, I mean, even if you have a really interesting method and stuff, I'm not sure if that's gonna, that wouldn't personally like scare me per se, right? It doesn't mean it's not necessarily important, but it's something that we know pretty well already. We've ran a lot of regressions of earnings on schooling, right? To kind of back out a little bit, a lot of my research has been on topics connected to the political economy of financialization. So issues about distribution and instability relating to the growth of the role of financial institutions in the economy. Of course, there's a whole literature about deregulation and the growth of the financial sector and how that contributed to 0809. I think what, you know, a lot of my work on housing showed is that, you know, very much like the classic Minsky model, large expansions in the supply of credit can mask underlying conflicts, right? Such things like insiders ripping off outsiders, other forms of fraud, et cetera. And then also just asset bubbles and cause asset bubbles. These things have a huge relationship to economic stability, but because debt itself is also a distributional contract, when these things, right, debt, debt contracts specify that the borrower takes the first losses. And so whenever these problems associated with the expansion of the supply of credit, like bubbles or fraud, et cetera, when these things, when those bubbles pop and the supply of credit like has a sudden stop, it's always the borrowers in the households that are gonna take the big losses and they're often the agents that are least able to bear those losses as we saw with subprime lending in the housing thing, but also in the auto market. And when we concentrate losses on those that are least capable of bearing it, it has bad macroeconomic consequences as well. But the problem is that, you know, a lot of economists in the back of their head believe the self-correcting mechanisms of the market will get rid of these principal agent conflicts and things like securitization will actually, you know, distribute risk among those most capable of bearing it, who want it the most. We can chop up the collateral and interest rate risks and give it to different parties who all want that. But, you know, what I've found and really what I think the study of history shows is that the self-adjusting mechanisms of the market are a lot less powerful than advertised, I guess. They're not really capable of self-correcting this. So what we found with mortgages, right, is that, you know, across three easy to measure measures, you know, like whether it's LTV, appraisal value, inflation, unreported second liens on the home or misreported owner occupies in these status, half of the loans that were bundled in packages and securities from O2 to O6 had one of those three flags and we're not even talking about income overstatement yet and really there was a whole cottage industry of finance professors who was able to identify fraud at the loan level. That's what my research was one of many papers in this but a good overview of that is a John Griffin paper asking, was fraud a force in the financial crisis 10 years of evidence? And so there's been a decade of empirical research that basically shows that every way a mortgage application could be falsified it was and then those falsifications were then concealed from all the major investors by every single one of the reputable financial intermediaries. And so the idea that the reputation of a Wells Fargo or a Goldman Sachs or a J.P. Morgan, they would be scared of their reputation so that they wouldn't commit fraud that just that mechanism was not strong enough and there was a Gresham's dynamic where everyone committed and the problem is the more the bad practices spread the more everyone has to do them to be competitive. There's that old saying there's nothing worse than being an honest card player in a crooked game, right? And that's very much the style. And so I think understanding this noir side to our economy and the limits of the self adjusting mechanisms and how serious problems can happen is very important. The principal agent models give us those tools but oftentimes economists have been scared to point those tools at the most powerful institutions in our society. And I think that level, I think that level of fearlessness is required by honesty because oftentimes with the most powerful institutions they have the most capacity to do harm as well. And certainly there's large histories of them always influenced by the work of Upton Sinclair quite a bit. So it's kind of taking the same noir muck raking approach but with empirical methods. The auto market, there's a lot of different elements in supply. So on the one hand following 0809, a lot of capital flowed into a securitized auto loan. So we see the same huge expansion of credit there. I think this is one of the things that has helped drive auto prices up that combined with the shortage of used cars due to 07, the big financial crisis. There was like a blip in demand. So cars from that era, which would be the affordable used cars now just weren't made. And this has masked a lot of problems. Now these problems are slightly different, right? The issues with misrepresent, so when you understand the originate to distribute supply chain with securitization, there's capabilities to misrepresent things at all stage. In mortgages, a lot of the fraud was committed by loan officers and underwriters at origination. And then in distribution it was concealed from the end investors. To a certain extent, it's not clear that, so there's a lot of fraud in origination going on. If you look at this market, almost none of the incomes are verified, employments aren't verified. There's a lot of issues with inflating the value of the car, because when you have a loan to value ratio, right? You want it to be lower. So the loan is a lower part of the value, but there's two components to that. There's the loan and then there's the value of the car. And if the value of the car is based on the sales price of the car, there's all sorts of ways to bundle in all the little dealer markups and the dealer at different packages to get that value up in the LTV to a low level. There's a lot of other real huge issues at origination, especially disparate interest rates charged along racial discriminatory lines. And so there's a lot of different consumer protection issues where people are being given loans that they can't pay back and that are actually designed to fail and they anticipate a car will be repowed several times over the life of the loan. And so each time that happens and each delinquency, you can extract fees out of the borrower in that sense. And so you can kind of make more money by designing a loan to fail than for it to succeed. That's really bad for the consumers. It wrecks their credit. These are folks that are on the margin and if they were given a lower interest rate, they wouldn't default on the loan, but then they're given these ridiculous interest rates, way past state, usury limits, et cetera, in the 30% range, et cetera. And if they just had even a more modest 10% interest rate, which is still outrageous, they would be able to pay the loan off, but it's not there. So there's the consumer protection issues. And for me, I think those are the biggest issues in this market. In terms of distribution, the reason there was fraud in home loans was because there was very strong representations and warranties in the loan prospectuses. Like when you bundle a bunch of loans into a security and then you sell that security, you have to disclose the asset quality. You have to say that this asset is X amount of good. So it'd be very much like you're going to Whole Foods in the bulk section or just buying bulk rice and if you're gonna buy a pound of rice, you put it on the scale, it says a pound. But if the scale was short or something and you got like 0.8 pounds, you'd be like, that's not right. Well, the same thing when you buy securities based on assets, you gotta say how good the assets are. And then that's the representations part. And then they had strong warranties too that if these representations were wrong, like there was inflated borrower income or something like that, concealed second leans, then you would have to repurchase that loan. And actually in auto loans, even though there's probably more bogusness happening at origination though, it's hard to say that because there's a lot of bogusness in the run up to 0.708. I mean, the competitions, the race to the bottom, it's hard to say who wins, but certainly auto loans now are competitive in that race to the bottom. But the representations and warranties are also a lot weaker. But it's still not clear what degree of concealed risk are in the loans and it doesn't appear that they're being priced into the securities either. And so even if it's not the same type of fraud problem, the same type of concealed risks and uninsured risks, they can add up quite big, right? Really big, especially as more and more capital is poured into the securitized auto loan market. It's the same dynamic of very much concealed risks that can then happen later and have stability issues. Now, of course, auto loans aren't the same size as say the American mortgage market. And so it's not systemic in that area, but you still see large buildups of risk. And with the rapid growth, these things can get out of control soon. And so it's not clear. I mean, certainly the bogusness and falsification and origination that there are a lot of lines crossed there. It's not clear in distribution if the same lines are crossed, but there's still the same economic problems of concealed risk that's being concentrated on those least able to bear it. It's building up. And these things can get out of control pretty quick too. And then the consequence of this is there's just a lot of your normal working class folks whose lives are gonna be a lot harder because they can't get a decent interest rate to get an affordable car and so they can't go to work. Cars are very important. A lot of studies show that people default on homes before they default on cars. As you can sleep in your car and at least you can still get to work, right? Whereas if you lose your car, you lose your job, you lose your house as well. These things are really first-rate issues for working class folk.