Repeat after me…

26 11 2007

more regulation is NOT the answer!

Now, I’m just a country lawyer, I don’t have a degree in economics, and I certainly don’t have the breadth of experience that pundits like Megan McArdle have. But be that as it may, I just don’t see the logic behind this statement:

We might create a new consumer-oriented regulatory authority, like the Financial Products Safety Commission that Elizabeth Warren, a professor at Harvard Law School, has been advocating. It would monitor financial products for consumers and draft regulations to prevent practices like the recent widespread issuance of adjustable-rate mortgages to low-income borrowers who couldn’t afford the rate resets.

Professor Robert J. Shiller, in his recent article “A Time for Bold Thinking on Housing” postulates the need for this new Commission to draft even more regulation for mortgage products.  Outside of outlawing ARMs completely, how would this work?  Intelligence testing of applicants?  Special counselors that sit applicants down and ask them “Do you REALLY understand that if interest rates go up, your payment will go up?”  ARMs are not, at their basic level, all that difficult to understand.

In fact, I would posit that the existence of ARMs is the reason for the housing bubble, allowing people of questionable credit to purchase houses beyond their means, driving prices ever higher.  If the lenders tighten up the approval process, the pool of questionable buyers shrinks, demand falls, and prices drop.  At that point, marginal buyers can now buy their houses with conventional lending options, stabilizing housing prices.

ARMs allocate risk to lender and the secondary market.  It then becomes incumbent on those players to take a closer look at the loans they make and buy.  If they don’t, they should bear the loss.  Recognition of that risk will make those loans less valuable on the secondary market, making lenders less likely to utilize them.

In short, the remedy for the sub-prime “crisis” is not more regulation, it’s more information.  If the problem is unqualified buyers, that information is readily available to the lender.  If the problem is fraudulent appraisals, that information should be available to the secondary buyer.  Rational allocation of the risk of loss will fairly quickly stabilize both the housing market and the mortgage market.  More regulation or guarantees will do neither.

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