Serious Money - Part II

$41,000,000 buys a lot of advertising. 

We could ask, “How bad must your product be that it requires $41,000,000 in advertising?”  But the unfortunate reality is that the $41 million is a very good investment for many of those donors, even if it is not that great a deal for the rest of us.

 

To give you an example, let’s take one issue from the Texas Constitutional Amendment Election this past November.  I mentioned this election in my Fidelity Contract post, so remember we had a turnout of 5.77% of voters.  The issue I want to focus on is Proposition 2, the language on the ballot read as follows:

 

“The constitutional amendment to establish a lower amount for expenses that can be charged to a borrower and removing certain financing expense limitations for a home equity loan, establishing certain authorized lenders to make a home equity loan, changing certain options for the refinancing of home equity loans, changing the threshold for an advance of a home equity line of credit, and allowing home equity loans on agricultural homesteads.”

 

And because I live in Flower Mound, my representative Tan Parker, who sponsored this change, was kind enough to send me a flyer and tell me what it means.

 

“This would ease restrictions on borrowing and increase accessibility of home equity loans.”  

 

So, let’s start by asking how will this Amendment increase accessibility? Well, banks didn’t like dealing with “little” home equity loans under the current system because they could only charge you 3% for fees and they had to pay for stuff like appraisals, surveys, title insurance, etc.  So, the new amendment lowers the cap that they can charge you from 3% to 2%, BUT they are going to take out some fees from the cap. So now they get to pass on to you the fees for stuff like appraisals, surveys, and title insurance.  So you may actually have to pay more than 3%, but the lenders will only make 2% on those fees.  This may seem fair, but remember those banks didn’t want to lend to you, because they knew their cost to take on “little” loans was over 3%. To put it differently, if a bank knows it is going to cost them say 5% or more to set up a small loan, and they can only charge you 3%, they lose 2%.  On the other hand, if they can earn a 2% fee and pass the other fees on to you, they have figured out a way to go around the cap and can charge you a solid 2% fee while not having to pay for any of that other stuff. (There is history here and I will link an article below.) Ok, so let’s assume a conservative example and do the math on a $100 loan just to make it easy.

 

 

From the Lender’s Perspective:

Old: Charge a fee of $3 – Pay for closing stuff $2 =  Amount of fee bank earns $1

New: Charge a fee of $2 – Pass on closing stuff to borrower $0 = Amount of fee bank earns $2

 

From you the Borrower’s Perspective:

Old: Pay $3 in fees (some will go to banks some to other costs)

New: Pay $2 to bank + Pay $2 costs (or more) = Pay $4 in total fees

 

Bottom line, the bank makes 1% more, and more importantly it can now make small loans for smaller properties.  So maybe Tan was right, it increased the “accessibility” to unknowing borrowers for fee hungry lenders.

 

Now, stay with me.  Let’s say this new amendment will allow these lenders to conservatively generate $1 billion dollars in new loans across the state.  That would generate ($1,000,000,000 x 1%) = $10,000,000 in new fees to the lenders.  So according to balletpedia, $1,038,025.44 was spent on campaigning FOR this amendment.  And unfortunately, a whopping $0 was spent campaigning AGAINST this amendment.  So now let’s run the very conservative return on investment for these campaign funds.

 

Investment: $1,038,025

Return: $10,000,000

Return on investment: 963%

*Note this assumes only $1 billion in new loans are created over all time. The reality is that as long as this new law is in effect, fees will be generated as more little loans are created and the return keeps growing.

 

So now do me a favor and scroll back up and reread the amendment language…do you feel that this issue was adequately described to you?  Did you hear a thunderous chorus of “resist” and “don’t tread on me” politicians telling you about this amendment? 

 

Let’s pause to give good reporting here a pat on the back… Lydia DePillis was all over this and other issues related to Proposition 2 in August.  For legal junkies, click on her “overturned interpretations” link to understand the persistence of our banking community.

 

So, coming full circle, again we have a Principal Agent problem.  The truth is, you do need a large advertising budget because the product is that bad for the average voter. The problem is this advertising budget is easy to raise because the return on investment is so good to the donors.