A financial security agenda?
A recent Los Angeles Times article began, “Americans don't have to worry that a $29 toaster could burst into flames, but the same can't be said for a $290,000 mortgage.” The article featured Professor Warren proposing a commission that would regulate financial products the way that the Consumer Product Safety Commission demands that all manufactured goods meet minimum safety requirements. This would represent a change from the current regime, which monitors industries instead of their actual products, resulting in significant and often devastating regulatory gaps.
Yesterday, a New York Times editorial appropriately railed against the “Myths Spun by Lax Lenders,” concluding that “It’s up to regulators and lawmakers to impose discipline when the market does not. The Federal Reserve, with authority over unfair and deceptive mortgages, should impose rules on all lenders — banks and nonbanks — deeming a mortgage unfair if it’s issued without evidence of a borrower’s ability to repay.”
While opponents of regulation argue that regulation undermines consumer choice, thoughtful intervention by government is necessary to make it possible for consumers have the information and product mix that they need to make good choices. Regulation is often labeled “costly” by conservatives, but no one talks about the Securities Exchange Commission as being costly because we know it is vital to a functioning marketplace. The trouble in the sub-prime mortgage market reveals that it is missing critical regulatory components.
It’s nice to see the mainstream press picking up on this in time for the presidential elections. How the current regulatory framework needs to be changed deserves attention and thoughtful debate. But do any presidential candidates have a real agenda for the financial security of middle class Americans? As Professor Warren pointed out here, John Edwards is the only candidate to have even offered up some reform proposals. Is Iraq drowning out discussion of America’s broken middle class?
I don't think it's consumer choice that's the issue so much as consumer access to the credit markets. If you implement the kind of regulations you want, it seems to me that you have to be willing to tell somebody who bought their first home during the looser credit years that, well, you wish they were renting.
What about the people who were maybe able to buy a first home because of the easy credit who haven't missed a payment or suffered a foreclosure? Wouldn't they justly argue, "those regulations would have prevented me from moving up in the world?"
thosethingswesay.blogspot.com
July 12, 2007 9:35 AM | Reply | Permalink
Actually, there's at least a forty year old tradition of blasting SEC compulsory disclosure for issuers of securities as unnecessarily inhibiting capital formation and imposing useless costs on issuers of securities. The exponents of this view are the same free market fundamentalist/neoclassical economics bunch who bash regulation of sub prime lending. They also share the same fantasy--the market will take care of any problems in the area--and tendencies to overestimate the costs of disclosure and underestimate its benefits. I agree with the thesis of your post. I merely wish to point out that it isn't really accurate to say that SEC regulation is universally accepted, and that the analogy to that form of regulation may not be convincing to those who are hostile to the regulation of sub prime lending.
July 12, 2007 12:29 PM | Reply | Permalink
"deeming a mortgage unfair if it’s issued without evidence of a borrower’s ability to repay"
"Unfair"? Stupid, maybe, but "unfair"? To whom? The borrower who gets more money than he or she deserves? Or the lender who ought to have made a more intelligent loan? What does "fairness" have to do with it? When the market slows down, sure, overlending and overborrowing look stupid. But when the market was going up for 10 years sraight and people were making double-digit profits, what was "unfair" about that? To anyone?
Who defines "ability to pay"? Jesse Jackson once said of his constituency that they got subprime loans because their "life was subprime." Do you define ability to pay so that they don't get credit? Redlining. Do you define it so they maintain the same access to credit as they have now? Then you get the same result and what's the point of the regulation? Plus, for a mortgage of more than a couple of years, who has evidence of their ability to pay the bulk of their mortgage? Who has a 15 year employment contract from an AAA rated credit?
There was a nice piece in the Chicago Sun Times a while back about the local subprime statistics. 54,000 subprime loans in arrears. Wow, sounds like a lot. Then you read on: 320,000 subprime loans not in arrears. Then you read on further: 15 years ago, no subprime loans outstanding. So 320,000 people have obtained loans that are doing just fine that they wouldn't have obtained under old paradigms. Regulation will do what to that? Protect them from exploding toaster mortgages? The toaster analogy was a bad one when made. I'm not going to repeat the analysis of it but it's in a comment under Professor Warren's original use of the analogy. Mortgages have one purpose - to help you buy a house. They fulfill that purpose 100% of the time. They don't blow up or burst into flames. Ever. Incendiary rhetoric may grab journalists'a attention but doesn't help fashion coherent policy. Would there were a regulation to protect us from misleading metaphors.
The best regulator of bad lending and bad borrowing is losing money. It has a way of burning the lesson into one's brain.
July 12, 2007 12:52 PM | Reply | Permalink
The criticisms of the post leveled in the comments by dstor23 and mt57 are simplistic. First, the criticism that no standard exists for determining one's ability to repay is pure fantasy. Every professional lender has criteria and guidelines for ability to repay. If they didn't, they wouldn't be in business for long. Second, the criticism that no one can guarantee one's continued ability to repay is true, but totally irrelevant. Contingencies such as a loss of job, or uninsured medical expenses can wreck anyone's finances. They are, in fact, the leading precipitators of consumer bankruptcies. No one is suggesting in any way penalizing the lender who makes a loan to a credit worthy borrower who later loses the ability to repay because of a misfortune. Third, both posts suggest that many sub prime borrowers will be unable to purchase a home because they will not be granted a loan under new regulatory standards. This is a distortion.
Not all sub prime loans are the same. Sub prime simply means that the interest rate is higher than normal because there is more risk the borrower will not repay. It does not mean that there is a likelihood that the borrower will default. The problem with some sub prime loans is not the interest rate. It is that they are made in instances where, going in, a likelihood of default exists. Many of the proposed regulations are targeted at the latter practice, not the former. Thus, when mt57 points out that in the Chicago area "only" 54,000 sub prime loans were in arrears whereas 340,000 were not you have to ask two questions (1) how many of the other loans will eventually go into arrears, and more importantly (2) what percentage of each of the two groups were made to persons who, under normal underwriting standards, faced a likelihood that they would be unable to repay? I suspect that many of the group of 340,000 loans not currently in arrears would not have been affected by any of the proposed regulations because while they did carry an above prime interest rate, they were made to persons who, while carrying a greater risk of default, still did not face a likelihood on non repayment based on a lack of ability to repay (actually some studies indicate that as many as 25% of the borrowers in sub prime arrangements can actually qualify for normal mortgage loans). I also suspect that a very large percentage of the 54,000 sub prime loans in arrears were made to people who could be predicted to be unable to repay based on their finances at the time of the loan.
Finally, the claim that no unfairness exists because the borrower got what they bargained for by getting the loan blinks at reality. The truth is that many of the abusive sub prime lending arrangements are characterized by huge fees which the borrower must pay up front. The end result is that the borrower winds up bereft of his or her savings, without her home, a blemished credit record and a potentially crushing future debt burden thanks to the recent bankruptcy "reforms." Some bargain.
July 12, 2007 2:19 PM | Reply | Permalink
What's funny is that we don't disagree much. Though I take issue with being accused of being simplistic. The Subprime market, which is new, has helped people who ordinarily couldn't buy homes buy homes.
Through terrible laws like the bankruptcy reform and through securitizations, lenders have avoided taking their fair share of the risks. That's a problem that should be addressed.
I never called these loans a bargain, by the way. And abusive practices should be curtailed by capping and waiving fees. Courts should force lenders with borrowers who have fallen behind to renegotiate their terms. Something which is very complicated because of securitization and the secondary mortgage market.
What we don't need, though, are laws that say "Person A can't take this loan if they want to." More disclosure? Sure. Fee caps? Sure. A bankruptcy system that protects rather than punishes the borrower in trouble? Of course.
But you didn't really answer my main objection which is that if the limits suggested in the main post were put in place you'd really have to look a homeowner in the eye and say "If I were in charge, you'd be renting."
thosethingswesay.blogspot.com
July 12, 2007 3:36 PM | Reply | Permalink
First, the criticism that no standard exists for determining one's ability to repay is pure fantasy. Every professional lender has criteria and guidelines for ability to repay. If they didn't, they wouldn't be in business for long.
what about the S&L crisis? the government bailed them out. what would have happened if the government let them fail? would banks have become smarter?
there is more risk the borrower will not repay. It does not mean that there is a likelihood that the borrower will default.
seems like you're contradicting yourself here since "not repaying" == "default."
actually some studies indicate that as many as 25% of the borrowers in sub prime arrangements can actually qualify for normal mortgage loans
and 75% of the kids who eat crap, like coca puffs for breakfast, would be just as happy-- and better off, with a better breakfast. but humans, being humans, often make non-optimal choices.
Finally, the claim that no unfairness exists...
certainly $2.89 for a box of coca puffs IS fair but the long term health consequences are the result of many bad decisions.
To boldly go...
July 12, 2007 10:09 PM | Reply | Permalink
True, someone might misapply micro thinking to a macro problem. But the mortgage bubble threw housing prices completely out of whack, so who really knows whether Bill from Phoenix got a nicer house than he otherwise would have.
Maybe Bill only paid $265,000 for his $180,000 house because his mortgage broker convinced him he'd be able to sell it for $300,000 after 2 years. If his $180,000 house had really cost $180,000, maybe Bill would've been able to afford it. Or maybe Bill could've found an acceptable $140,000 house that really cost $140,000 instead of its bubble-inflated price of $195,000.
Bill's mortgage broker and real estate agent probably got paid more under bubble-inflated pricing. They'll undoubtedly trot out poor Bill when they testify before Congress why they need a new tax subsidy for beachfront timeshares in Alabama, or something. Nobody should be fooled for a minute.
July 13, 2007 6:32 PM | Reply | Permalink
Maybe Bill only paid $265,000 for his $180,000 house because...
it could be that Bill got $65,000 back in cash as a bribe to pay $20,000 over market...
BTW, does Professor Warren talk about Predatory Borrowing?
To boldly go...
July 13, 2007 11:22 PM | Reply | Permalink
Banks have very short term memories: they forget the lessons learned in the last real estate crunch quite quickly. That's why regulators need to keep them honest. New products like sub-prime loans open up areas for profit exactly by allowing some consumers to borrow where before they might not. That's healthy both for the banks and consumers. So knee-jerk criticism of lenders is unjustified.
BUT: predatory practice is abominable, more so than in most other products because of the dire consequences that financial failure can have on someone's life. A failed toaster is one thing, a failed mortgage is quite another. That's why bankers are supposed to be staid and boring, not flashy and aggressive. They have a fiscal responsibility that extends beyond normal economic criteria into social policy. Unfortunately most current banks seem to have forgotten that.
Plus the financial industry has rigged the bankruptcy laws to increase the harm on people who suffer genuine misfortune, so the emergence of new, aggressively designed products has come exactly at a time when consumer protection has been severely weakened.
Overall my prescription would be to make the financial regulators restrict sub-prime lending by enforcing the existing capital ratio regulations, and to undo the recently legislated bias in the bankruptcy laws. In other words insert discipline into the market and soften the consequences of misfortune.
Lastly: my observation is that many Americans have too little financial education to understand some of the nuances of the products now being pushed by lenders. This includes retirement products as well as credit products. I think there is a clear need for government to improve financial education: it would mitigate some of these problems in the future and would provide a better market for banks. I think that some states are already trying to do something in this field, but we need a coordinated national effort.
'All Life is Problem Solving'
July 14, 2007 10:56 AM | Reply | Permalink
No, they do not. Missing from this discussion is mention of the many subprime mortgages that have been extended to people who already own homes. In a phenomenon called "reverse redlining," minorities and elderly people who own homes are encouraged to refinance into new mortgages with worse terms. These deals are often presented as a way to get money to make home repairs, or to pay off debts. The terms are atrocious and designed to ensure the homeowner fails. Here's an example:
-- "Predatory Lending: Redlining in Reverse," National Housing InstituteThe purpose of subprime lending is not to help people own homes who couldn't own homes before. It's to strip as much equity as possible out of as many people as possible.
July 17, 2007 5:00 PM | Reply | Permalink