Who Gets Protection?
Two numbers summarize US consumer protection policies for financial products: 1) The SEC is considering a modification of a rule so that hedge funds cannot sell their high-risk investment devices to 98.7% of all Americans. 2) An estimated one in five recent subprime home mortgage borrowers will lose their homes. There it is: When you might lose your investment in stocks, the SEC imposes suitability rules that prevent brokers from selling high-risk products to all but the most sophisticated investors. But when you could lose your home in a refinancing, federal regulatory agencies have largely left consumer to the wolves.
Investors get protection because the government decided a long time ago that there would be more confidence in the market if the repeat players (the brokers) bore some obligations to their customers not to steer them to high risk investments. Over time, the market has evidently agreed and regulations to protect consumer investors have been strengthened. But high risk mortgages reflect the opposite mindset. The home is the largest single investment the typical middle class family will ever make, but it's "buyer beware" in the subprime mortgage market.
Who cares if one in five subprime borrowers lose their home? The family cares, of course, because they lose everything they invested and many will end up with deficiency judgments that they can never pay off. CRL estimates that these families will forfeit $164 billion in home equity as these loans are foreclosed. Their neighbors care, because foreclosures depress everyone's home values. People who worry about racial inequality care because subprime loans are disproportionately sold to African-American and Hispanic borrowers, with the result that all their accumulated financial gains will be wiped out. Anyone with a job in the construction industry cares because foreclosures depress new housing construction. And all of us who have jobs that depend on a robust consumer economy care because of the potentail fallout from a housing market crash.
Should mortgage brokers have similar responsibilities to evaluate suitability as stock brokers? It isn't a complete solution, but it would go a long way toward ending the practices by which mortgage brokers steer clients to mortgage products that they know the customers are unlikely to be able to repay. If stock brokers must help investors with $100,000 to invest in the stock market avoid certain risks, should mortgage brokers be required to do the same for those borrowing $100,000 to buy a home?
As I understand it, subprime loans are designed for borrowers whose less than optimal credit ratings disqualify them for prime loans. If so, aren't you saying that mortgage brokers should steer borrowers away from the only loans they are likely to qualify for?
Maybe that is the right thing to do. And maybe it means the end of subprime lending, not just a regulatory slap on the hands of individual brokers who steer customers wrong.
December 30, 2006 9:47 PM | Reply | Permalink
I think you're overlooking something: most people should be able to understand subprime mortgages and the fact that "you don't get something for nothing." The folks on the housing bubble blogs smartly ask: "how does someone with a $20,000 salarly expect to live in a $500,000 home?"
Certainly, the dumbest amoung us should understand that simple fixed rate mortgages can more than double the price of "owning a home."
I would argue that investments are different.
For example, everyone at my office was excited about having a 401k with lots of options. However, now that we do, everyone I know has decided to defer "allocation choices" to the salesman who put the portfolio together.
As the "High School Musical" suggests, "We are all in this together." Of course, when Detroit's jobs went away, the housing market crashed and left people stranded-- should the workers have lived someplace with a more robust economy? Investments also have interesting intertanglings and some of the biggest money makers think that hedge funds will ultimately self destruct and we'll all be losers.
Anyway, maybe you'll agree that laws can't change the odds of the game.... in fact, many rich folks argue that if the laws were fair, nobody would play games!
December 31, 2006 10:53 AM | Reply | Permalink
"I think you're overlooking something: most people should be able to understand subprime mortgages ..."
Most people in your MBA class or most people who didn't graduate from their urban public school and can't read at the 6th grade level?
December 31, 2006 11:37 AM | Reply | Permalink
Those getting mortgages at least have the advantage that they could read the disclosure notices and know the risks if they chose to (or had someone knowledgeable explain the terms to them).
Those buying into hedge funds are the real suckers since most of the information that publicly held companies have to release is not required. Thus investors don't find out about the track record of the hedge fund management, nor do they find out about all the funds which have lost money or closed up. Hedge funds also take 1-2% (or more) of the funds assets as management fees and in addition take a hefty percentage of the earnings (10-20%) as well. People really have to be greedy to put up with such high expenses. A broad based mutual fund can easily have charges of under 1% and over the long time yield 6-8% returns.
If the super rich want to gamble for the fun of it why not just go to Monte Carlo as those in Gatsby age did. Why people don't see the parallels to the 1920's continually amazes me. Investment choices over the past decade have become more and more disconnected from reality. Google has a market value of $141 billion. This is just not rational investing.
Where are the responsible business journalists warning of the glaring defects in our current economic structure?
--- Policies not Politics
Daily Landscape
January 1, 2007 6:58 AM | Reply | Permalink
I read recently that a strong majority of community college graduates cannot analyze a newspaper editorial and summarize the argument made; nor can they determine, unassisted, the unit price of items on a grocery shelf if not calculated by the merchant.
I also recall a recent survey asking economists to define 'opportunity cost,' in which a substantial minority of respondents could not.
When added to what we know of innate human patterns of risk identification and assessment, the idea that less educated folks can make an informed decision on subprime financing--well, it needs replacing with a better myth.
January 1, 2007 4:29 PM | Reply | Permalink
Suppose we changed things around a bit. Instead of the home buyer paying the home seller for both the house (which an individual created, and therefore is legitimately something one should own) and the land value (which all of us together create, and therefore is not legitimately privatized, despite our tradition of permitting it to be), we'd be far better off if we treated the economic value of the land as our common treasure.
Treating it as our common treasure would mean that the "owner" of a piece of land, instead of buying it from the previous owner, would pay his fellow human beings for exclusive rights to that land each year. THAT would be the primary tax base. Stop taxing sales. Stop taxing wages. Stop taxing even buildings. Just tax land value.
Land value is big, and would provide a lot of revenue, especially in our biggest cities. Small-town land would not provide all that much revenue. But we're used to sharing federal income tax revenue from urban wage earners to fund pork in small towns, so this wouldn't be so different.
But by taking the previous owner of the land out of the picture (he'd still be entitled to sell his house for its real value), we'd reduce the selling price of housing, and therefore the amount one would need to borrow. In big cities, the difference would be major. Yes, one would pay a tax on the value of the land one occupies, but for most of us, it would still be a net reduction in taxes.
The FIRE sector -- finance, real estate and insurance industries -- would not be enthusiastic about this idea. But for most of us, it offers a lot of benefits. Affordable housing. Less sprawl. Shorter commutes. Less energy usage. Less pollution. And, less obviously, higher wages, more jobs, more competitive markets, less wealth concentration, less income concentration.
Anyone interested? It sounds very appealing to me.
lvtfan
http://www.wealthandwant.com ... if you'd like to see an end to poverty
January 1, 2007 9:50 PM | Reply | Permalink
As you know Henry George proposed a variation on this over 100 years ago. The ideas had their moment on the stage, but ultimately were discarded. The problem is that the "big idea" which will solve everything never works well in practice. Changing the way real estate is taxed is a good topic for discussion, especially since the present system distorts school funding in much of the country, but hoping it will replace other taxes is unrealistic.
--- Policies not Politics
Daily Landscape
January 2, 2007 7:25 AM | Reply | Permalink
It works this way because it isn't about protecting consumers at all. It is about manipulating the economics of our society to benefit those who make the laws. Damn the long term effects. There is a LOT of money to be made in letting predators lend to people who will ultimately default. They justify it by touting the freedom of choice we have. However, most people, even attorneys, have difficulty sorting out the implications of some of the clauses in the complex mortgage agreements. Subprime lending creates poverty in our society at an accelerated rate. But it makes lenders very wealthy, and of course the legislators that represent them in Washington. What is illegal for most Americans is legal for lenders. Banks have the power to overthrow this country without firing a single gun. They can overthrow our government with the flick of a pen, the "loan default" weapon, because those who have been charged with representing the people have let themselves be corrupted with greed for excessive money and power.
Jim Anderson
The Truth About Credit
January 5, 2007 8:49 AM | Reply | Permalink