I agree that regulation is necessary, though one of the major problem with regulations is writing and implementing them without the to-be-regulated industry co-opting the process to their own benefit. For examples, see practically any federal regulations introduced or rewritten during the Republican domination of Congress, as well as far too many previous to that.

I'm kind of with you in that we have suitability laws for stock, bond and private placement investments so it seems we should have them for mortgages too.

But, what will you say when some one is denied a loan to buy a house on statutory grounds? Won't these regulations basically create another hurdle that new home buyers will have to clear?

Isn't it somewhat awful for the law to stand in the way of a citizen's home purchase?

thosethingswesay.blogspot.com

I think the analogy oversimplifies the issue. You needn't be an electrical engineer to understand how a toaster works: Electricity is turned into heat and the bread browns. Mortgages, however, are very complex financial instruments. Pension plans, and to a lesser degree 401(K)'s are regulated, because the consumer is not expected to have a nuanced understanding of the financial markets that grow the value of the consumer's investment. So too with a mortgage, it's hard to believe that most people understand the financial instrument much beyond their monthly payment.

I recall when I got my first mortgage I had a call with the mortgage broker to go over the six inch pack of papers she had sent me. By the end of the conversation I was explaining to her what each document represented and why it was required. She had no idea how COSI works, or any other such pricing index. Her comment to me at the end of the call was that I was her first customer in 12 years who had actually taken the time to read and study the whole package.

Perhaps a different approach to the solution might be regulating risk. Rather than a pure truth in lending statement, maybe the market should have minimum risk requirements and risk control. This would eradicate subprime loans, negative equity and shady balloon payments--all things that can sink a borrower quickly.

I would suggest that if such regulations prevent someone from getting a loan, perhaps he/she shouldn't be buying the house in the first place. Foreclosures hurt both consumers and lenders, but lenders only a little.

We're doing no one any favors by selling mortgages to cosumers who cannot afford them, no matter how much we pervert the repayment terms.

/c

In the blogosphere every one is an expert, so no one is an expert.

MCS is quite right. The exploding toaster analogy is very misleading to the debate. CPSC regs address the function of the toaster, not the price or availablility of toasters to individual consumers. Mortgages perform their intended function quite well - they help buyers finance an asset that would otherwise require a lifetime of savings. They do not "explode"; the only thing about them that might justify the "exploding" analogy is the price and even there only of a small, small subset of them. The vast majority never explode in price or anything. Whether the percentage that does is a social evil that needs to be fixed or whether it is simply a statistically likely fallout of credit risk, we probably differ on. There are already disclosure, foreclosure and bankruptcy laws that regulate how the ones where the credit risk materializes will be handled when it does. The proposed regulations appear to be ex ante regulations of price and credit for home buying. While I am glad to see the proponents of credit regulation being candid about that fact, instead of being disingenuously vague or pointlessly incremental, the experiences of the last two centuries if not millenia teach that the price and availability of credit are for a market, not fiat, to manage. While price and credit controls have been implemented from time to time, they have never been effective on an extended basis. Eventually the harm they do exceeds the perceived benefit. In a regime of strict credit, whether the availability is regulated by law or banking, there will always be someone who in hindsight would have been better off getting a loan who couldn't, and in a regime of easy credit, the converse will be true. Then there is the problem of enforcement and evasion - using leases, etc., etc. It is important to the efficient allocation of credit in the future that persons who take risk suffer losses from time to time.

A final point - so many persons who complain about the consequences of subprime lending for borrowers fail to admit the extent to which political pressure on Fannie Mae, Freddie Mac, banks and bank regulators to see that more credit was extended to risky borrowers is responsible for the loosening of credit standards in the last decade. The proliferation of various subprime loan products and of the computerized credit analyses that are so often fooled and defrauded leading to origination of those loans were generated in significant part in response to those pressures. When money was cheap and housing prices rose, the risks politicans and interest groups encouraged failed to materialize. All that is happening now is that with those props gone, the consequences of politicized redefinition of credit risk are becoming evident. The lesson that should be learned is not to politicize / regulate credit risk.

Well put. Regulation is a product of elected officials, it's one of the primary tools we use to shape the marketplace in a democracy. Government is 80% taxes and regulations. Of course, if you don't like taxes and regulations, you might not be very good at running a government. Like a certain business-friendly, socially conservative political party who will remain nameless.

Re: That's why these sleazy mortgages didn't exist before Bush.

ARMs have been around for a long time. Bush did not originate them (come on, we can't blame the guy for everything). What changed is that as the cost of housing skyrocketed people who could no longer afford a 30 year fixed mortgage were placed in ARMs which they could initially afford, but then could not when the rate reset and housing prices slumpeed, closing off the chance of refi.

The lesson that should be learned is not to politicize / regulate credit risk.

I recently read that Wells Fargo and ACORN were working together to adjust the terms of toxic mortages because the banks don't want a firesale! That event would hurt everyone: homeowners; local tax receipts; banks; etc...

So, essentially, the market is responding by sending out replacement toasters that actually work.

To boldly go...

By the same reasoning, no customer should be forced to read the fine print in 30-plus-page...

I think you're a lawyer and understand that size doesn't matter!

My grandmother had to choose between fixed rate; capped fix rate; and market rate for her heating oil last winter. If you remember, the price of oil dropped. Thus, the market rate became the best option. In a sign of goodwill, the oil company didn't hold my grandmother to the fixed rate pricing option she chose.

Of course, the story could have ended differently: the price of oil could have shot through the roof!

For all we know, the price of homes could start climbing again-- I don't believe this, and the usury fees won't look so bad.

To boldly go...

Many states have gotten tired of legal disputes over the terms of things like living wills or affidavits, and have simply published the language in a statute for all to use if they wish.

Mortgages should not require a microscope or a law degree to read. I suggest states publish fair, consumer-friendly standard deeds, deeds of trust, etc. in their conveyancing statutes (again, without mandating their use), which could be incorporated by reference into vastly simpler documents. Any mortgage company that thereafter wanted to impose its own subvariant documents on a consumer would have to expect questions, resistance, rancor, profanity, etc.

Let's not throw the baby out with bath water!

Much of the objection to subprime mortgages is related to mortgage company fraud -- that is, inducing folks to take teaser ARMs without telling them that they qualify for cheaper and/or more sensible mortgages.

Make doing so illegal, the penalty being the cancellation of the reset clause and the awarding of lawyers' fees.

As for mortgagors' knowledge, a simple disclosure statement signed by the borrowers which sets forth the monthly cost after reset* should be adequate.

Those who think they can handle the reset or will be able to sell the house before reset or think living in a nice house for a few years at 2.9% is a good deal should be allowed to make those decisions for themselves.

Note: This argument does not address a separate issue of realtors using subprimes to "churn" a neighborhood to the detriment of long-term owners who will see their home values crash when the subprime borrowers later default.

*  Yeah, I know. So use the average (LIBOR, UST, whatever) over the prior five (ten) years.

I think Ms. Warren raises the most important political question of the past 25 years with “The 'R' Word.” Going back to Reagan, the first chief executive to trash the entire enterprise of governance (and why wouldn’t we lowly plebians believe the guy who sits atop the heap and sees everything?), regulation has become an almost universally reviled word, on a par with the term “liberal.” If there were a single concept that governs the conservative mind, it would have to be aversion to regulation. Sadly, much of the American public has bought into the utterly immature notion that no one should have to submit to the humiliation of regulation, America is about is freedom (from regulation).

The sheer mindless idiocy of this aversion to regulation has yet to be examined seriously in public. Government is entirely about regulation, and the determination of which regulations yield the most benefit for the most people is in fact the most basic democratic function. Aversion to regulation is equivalent to aversion to government, and conservative antipathy toward both regulation and government has climaxed with the current nightmare (for representative democracy) of the Bush Administration. And it’s not just Bush, but his legions of doctrinaire fools in office throughout the federal bureaucracy who think regulation is a curse.

It is a human tendency to highlight aversive consequences of governance (ie taxes, speed limits, costly environmental regs, tort laws) while downplaying the benefits that directly and indirectly accrue from submitting to governance (such as moderately functional institutions of society that are created, financed and run under government regulations incorporating certain societal values such as fairness, safety, openness, uniformity and dependability into policy). Ronald Reagan and his conservative heirs have made a political movement out of denigrating government, promoting a childish fantasy that freedom means we don’t have to worry about anyone else. Meanwhile they have eviscerated the ideal of the common good while sucking dry the institutional reservoirs that have been slowly filled over generations and maintained in the public interest.

I see regulation as a personal civic responsibility. As a concerned and participating citizen of our democracy, it as my civic duty to regulate my behaviors for the common good. I largely abide by laws and regulations in part because I see them as an affirmation of the democratic process. Sure there are some that chap my hide, but does it make sense to trash the entire enterprise of democratic governance because there are some regs I don’t like? As long as regulations are forged in the public interest, I willingly, perhaps even enthusiastically, submit to them.

Democracy is a process by which the concerns of all citizens are taken into consideration and hammered into policy, law and regulation. Concern for all is the defining principle of democracy, and regulation is the expression of that concern. Perhaps the day will come when the American public re-evaluates its commitment to the common good and re-engages with the imperfect, often frustrating and ponderously slow process of democracy. For now, we seem unconcerned about the drastic changes wrought by the government-hating conservatives who have been busily disabling the instruments of regulation, and in the process redirecting our institutions away from the principles of democracy.

While it is important to evaluate the particulars of such regulations as lending rules, etc. as seen in posts above, at this point such fine-grained analysis is a distraction from a much more important issue. It is urgent that we now debate the essential function of regulation and government before conservatives have so thoroughly undermined them that we are unable to re-establish a credible democratic system.

Americans need to decide whether they are willing to participate in the work of democracy, deciding which rules (regulations) are appropriate for maintaining a civil society dedicated to the principles of democracy and public welfare. Simply demonizing regulation, as conservatives love to do, is both childishly simplistic and profoundly damaging to our democracy.

-Ted Bucklin

Ellen, you know a whole lot more about this than I do

So I'm coming to you with a grovel... could you give me a quick rundown on what LIBORs and USTs are?  Also, another commenter here makes the remark that ARMS (I know what those are) are much older than Bush, but there seem to be some newer wrinkles...like 0 money down mortgages and interest only mortgages.  Do you know when (about) these instruments were invented.  If you're ever feeling in an essay mood, something on these and their history would be very much appreciated.  Math is scary.  I have to take off my shoes to count to 20.  :-)

aMike

Wish I could tell you that Karl Rove and George Bush cooked up the ideas in 2003, but I can't.

The first emergence of no money down, balloon payments, negative equity, over capitalization, etc. show up in the "manufactured home" (read, trailer park) financing world back in the late 80's, just after the deregulation crusade. Greentree Financial became synonymous with these practices after capturing 25% of the market. Greentree also lead the pack for repackaging their mortgage portfolios and trading them in secondary markets. This pushed the usury interest rates higher to maximize the backend securitization. Not long after perfecting this practice other financial firms noticed and emulated these innovations. By 2000, even buyers of McMansions could find a host of shady mortgage deals that allowed folks who could not otherwise afford McMansions to buy them with money at closing for buying leopard print furniture and mega playsets for the kiddies in the backyard. Of course five years later the balloon comes a calling and suddenly the middleclass is feeling the pinch of living beyond their means.

I feel terrible for people who know little about finance and mortgages and who sign into these loathsome financial structures. But the group I sympathize most with are the young couples who are in the market post-credit bubble, who cannot qualify for even a reasonable mortgage because the banks are is reaction mode and tighten their credit requirements. Basically the banks did this to themselves and their customers, and now the next generation of first time buyers are made to pay.

I think you can throw all sorts of caveats into the home buying mix, but all they do is thicken the already ungainly stack of paper required to close. They might as well be invisible the way they get lost in that pile. I believe the solution resides in how the mortgage market is regulated. Firm risk requirements could eliminate many of the iffy loans, or shed light on those who construct portfolios that were meant to fail

Look, creative payment structures can be lifelines to consumers who come into hard times. It’s when these tricks are used to suppress the monthly cost for the first five years that should raise the hackles of a regulatory board. We could get this fixed with regulation. Maybe we ought to insure mortgages via the FDIC? That way lenders can be assured that they will be audited three times per year.

Thanks, that was really helpful. 

I can blame it on Reagan and George Bush, Senior.  That's almost as good.  <snicker></snicker>

aMike

Very interesting -- that Greentree Financial Redux.

GF was financing the sale of manufactured housing (sometimes known as "trailers" which are highly depreciating personalty not much different than passenger cars) to people who often didn't even own the land on which they were parked. Income of the purchaser rather than value of the asset purchased was the real security for the loan (drive a manufactured home around the block and it loses half its value).

How -- if it did -- did GF's model morph into subprime mortgage lending which really does employ asset value as a very significant part of the security behind the loan?

I need to posit this, and I suspect I'm going to get killed, but I'm not convinced that financial markets dislike regulation, or some regulation at any rate. Poorly worked out regulation, like SOX for example, causes some discomfort, but more so because it introduces uncertainty--something markets hate. SOX also provided no value to the financial sector--or any I guess sector really.

Well worked out regulation, such as Basel II and some of the FSA requirements in EU and Far East, provide enough guidance and measures that financial institutions can adapt to them quickly and even identify opportunities for competitive advantage--certainly makes funding such initiatives easier.

This comes to mind as I review the thread and some of my musings about putting mortgage loans under FDIC and SEC oversight. Such moves would be applied marketwide and afford the smarter firms an opportunity to be more competitive. It could act as a disincentive to conjure up crap loans and an incentive to craft more risk averse programs.

Go ahead, kill me.

/c

In the blogosphere every one is an expert, so no one is an expert.

"If they can get 6 and 8 points over prime . . . ."

And after some percentage of those loans go bad, the average portfolio return may be only a couple of points over prime -- cf., Mike Millken's insight into the average return in the junk bond market being better than the return on investment grade bonds.

Is there an issue of social fairness, here -- that decent, responsible mortgagors are paying for the ne'er-do-wells?

And if so, since at the outset the two classes of borrowers are indistinguishable, how do we weed out the bad without harming the good?

My apologies.

SOX= Sarbanes-Oxley
FSA= Financial Standards in Accounting

I'm a finance geek.

/c

In the blogosphere every one is an expert, so no one is an expert.

First, one can live without a toaster or without owning the dwelling, and for many people that can be a preferable option (I lived for many years without either, although in a country where un-toasted bread is perfectly edible).

Second, for a mortgage to be like "rent that you pay yourself" it should be a predictable and affordable; otherwise you "surprise yourself with a rent hike" that leads to the loss of whatever equity you amassed so far -- which may turn to be an illusion.

People who cannot afford payments larger than "teaser rates" would be much better of using affordable rental dwellings.