Who’s Fairer, Chimpanzees or Mortgage Bankers?

In this corner, Pan trogolodytes, or common chimpanzee. In the other, the average American mortgage banker. Which has a more highly evolved sense of fairness? Thanks to a combination of psychological experimentation and economic happenstance, the truth can now be known.

In effect, both chimpanzees and bankers have been made to take to a test called “The Ultimatum Game.” Commonly conducted in behavioral economics research, the procedure involves giving the first of two players a certain sum of money to divide. This person can keep as much of it as he wants, and pass the rest along to the second player. The second player can either accept what the first player offers or cancel the whole deal, in which case neither player gets anything.

In strictly rational economic terms, the second player should be willing to accept any amount of money that the first player offers. Even one penny, after all, is better than zero. But human beings are not strictly rational. Millions of years of evolution as social animals has left us with a deeply ingrained expectations of fairness. So most people react to an offer of one cent with indignation and reject the deal as unfair.  Realizing this, most first players tend to offer splits that are at least moderately fair — 60/40, say.

Neither bankers nor chimpanzees conform to this rule of thumb, however.

A team of evolutionary anthropologists in Leipzig, Germany recently carried out an experiment with captive chimpanzees that was essentially an ape-friendly version of the ultimatum game. They seated two chimps in front of a device that allowed the first one to pull a rope attached to a tray containing raisins. The further the first chimp pulled the rope, the more raisins it got, leaving the rest for the second chimp. For either to get any raisins, though, the second chimp had to pull on a rod to bring the tray forward.

The researchers found that 95 percent of the time the second chimp was willing to accept a deal in which it got 2 raisins while the first chimp got eight – an 80/20 split. In other words, chimpanzees don’t seem to have the same expectation of fairness that normal humans do. As a result, the first chimp can be much more greedy. Even a small, unequal reward will be enough to convince the second chimp to sign off on the deal.

Now, how would a mortgage banker perform in this experiment? Thanks to the collapse of the real estate market, we now know. As a great number of homeowners have begun defaulting on their mortgages owing more than their homes are worth, banks are increasingly willing to allow so-called “short sales,” in which the mortgage holder allows the property to be sold for whatever it can fetch. The bank takes a loss, but it stands to recoup more than if the buyer trashed the house and walked away.

Complicating many short sales is the fact that many of the homeowners in these cases are also delinquent on a second mortgages as well. Also known as homeowner’s loans, they are considered subordinated debt, meaning that they are second in line to be paid off after the first mortgage holder. But they are also a lien on the property, so that they can prevent the property from being sold.

Imagine, for instance, that a homeowner takes out a $240,000 mortgage to buy a $300,000 house. Then he takes out a second $60,000 loan to cover the down payment. Before he pays down much of the principle, he defaults. By now, the market being what it is, the house is only worth $200,000. If the property goes into foreclosure, it will be worth even less — says, $160,000. The bank that owns the first mortgage will get all of that, and the bank that holds the second mortgage will get nothing. But if the first bank arranges a short sale, it will get the full market value of $200,000, less whatever it has to offer the second mortgage holder to go along with the deal.

In essence, it’s a classic ultimatum game setup. So how do the bankers fare?

Not that well. According to short-sale broker Jeremy Brandt, bankers holding the first mortgage are typically offering the second mortgage holders only a pittance — about 10 percent of the value of their loans.  In the case outlined above, that means they get $6000 to go along with a deal that will save the first lien holder $40,000.  In ultimatum-game terms, that’s an 85/15 split – a deal that would appeal to a chimpanzee but not most normal humans.  In conclusion,  you could say that bankers behave in a more economically rationally manner than either human or chimpanzee test subjects in a lab. Or, alternatively, you could say that bankers are greedier than jungle animals.

However, there’s a twist in this story. CNBC real estate blogger Diana Olick reports that some second mortgage holders are finding ways around the strictures of the Ultimatum Game. Before they’ll sign off on the deal, they’re demanding kickbacks from other interested parties: the prospective buyers or from the real estate agents who stand to pocket a commission on the deal.

Explains Brandt, “The second lender’s position is that $6,000 doesn’t go very far towards recouping the value of the loan, so they’ll see if they can get another $10,000 or $20,000 from someone involved in the transaction.”

This extra money has to trade hands under the table, because if the first mortgage holder knew about it, they would simply kill the deal and let the property go into foreclosure. Brandt says: “The first lender’s perspective is, ‘If we foreclose, you get nothing, so if there’s another $10 or $20,000 floating around, it should go to us.’”

The equivalent, in arthropod terms, would be for a chimpanzee to try to bribe lab assistants to release extra raisins. So far, no such behavior has been described in the scientific literature. A reasonable conclusion, then, is that while chimpanzees are more fair-minded than mortgage bankers, they are also less devious.

[Note: this essay originally appeared on The Big Money.]

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