StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



Mortgage Politics: Policy By Anecdote

26 Dec 2007
Posted by Stan Collender

One of my biggest concerns about the ongoing mortgage situation is the continuing (or even growing) use of anecdotes about what brokers and lenders did to excuse homebuyers from taking any responsibility for their actions.

I have no doubt that some buyers were talked into loans they shouldn't have had and that others were offered loans they couldn't afford. But other homebuyers also bought homes that were larger than they knew they could afford or did nothing to determine whether what they were thinking about doing was prudent. They didn't read the materials, didn't hire a buyers agent, didn't think to ask the right questions, etc. Some of these buyers might have been duped or didn't know enough to do these things, but not all of them. My guess is that it may not even be most of them.

Via Greg Mankiw's blog, An op-ed in today's New York Times continues to propagate this guilt-by-anecdote form of policymaking. With absolutely nothing to prove their case, the three authors -- Michael S. Barr, Sendhill Mullainathan, and Eldar Shafir -- lead the piece by saying:

WHILE the causes of the mortgage crisis are myriad, a central problem was that many borrowers took out loans that they did not understand and could not afford. Brokers and lenders offered loans that looked much less expensive than they really were, because of low initial monthly payments and hidden, costly features. 

Families commonly make mistakes in taking out home mortgages because they are misled by broker sales tactics, misunderstand the complicated terms and financial tradeoffs in mortgages, wrongly forecast their own behavior and misperceive their risks of borrowing. How many homeowners really understand how the teaser rate, introductory rate and reset rate relate to the London interbank offered rate plus some specified margin, or can judge whether the prepayment penalty will offset the gains from the teaser rate?

(Note: The italics in both paragraphs above are mine.)

The op-ed then goes on to use this unsubstantiated and unquantified claim to justify a solution that, not surprisingly, requires nothing of the borrower but demands "honest and comprehensible disclosures" from brokers and lenders. The policy would put no burden on the borrower.

...the borrower could raise the lack of reasonable disclosure as a defense to bankruptcy or foreclosure. If the court determined that the disclosure would not effectively communicate the key terms and risks of the mortgage to the typical borrower, the court could modify or rescind the loan contract.

Let me see if I've got this straight: a borrower who has nothing to lose by claiming that she or he didn't undertand the standard documents when she or he bought the home only has to make that case to a court.

 

Several questions:

  1. How will that lead to anything different that the current situation?
  2. Will that require that all closings be videotaped so that a judge or jury can see that the homebuyer was asked reopeatedly if she or he understands?
  3. Will this increase closing costs because of the need to record the closing and have a copy of the DVD on file?
  4. Will that create a new job: closing videographer?
  5. How many homeowners in this situation will have the resources to defend themselves in this way?
  6. Why does anyone thiink that policymakers won't intervene instead of allowing this process to unfold?

Most important:

  1. Do we really know (or will we ever try to determine) how much of the problem is caused by unaware homebuyers
  2. Why hasn't someone asked GAO to do a quick study to make this determination?
  3. Does anyone understand that a solution to this situation that  doesn't hold homeowners at least partly responsible for their actions will be a nonstarter with the much much larger group of borrowers not in trouble unless there is some definitive information that shows the first group really isn't to blame?

Lose-lose

When a family takes out a good loan with a solid lender, they both win. When a lender makes a shaky loan to a family that can't afford it, they might both lose, and they are both behaving irrationally. The thing I don't get is why did the lenders make these shaky loans? Is it a problem of diffusion of responsibility? That is, the loan broker isn't going to be the one holding the loan, so he doesn't care so much about whether it works in the long run? I don't have the data, but that's where my suspicion lies. When a family takes out one of these loans, I can think of a few things they might be thinking: "I love this house!" "Well, if they are willing to make this loan to us, we must be able to afford it. And if we can't we can just flip the house." "I'm gonna get that raise next year, and everything will be fine." "Man, that bidding war was brutal, but we WON!" Morally, it's hard to say who's at fault. But systemically, the long-term holders of these loans clearly had inadequate policies to ensure solvency. One way of looking at this is that the rules under which a loan qualified to be packaged into a bundle had loopholes, and loan brokers and families jumped through them with both feet. I don't mean that's as an imputation of evil so much as, "the rules say we can do this, and it's to our advantage, so let's do it." A loan broker is absolved of responsibility for thinking about whether it's a good loan by the existence of the rules, and by having no financial interest in the long-term viability of the loan.

While I will readily

While I will readily acknowledge that many home buyers are responsible for the mess they are in, my understanding of the bankruptcy laws and the way they suborn predation of young credit card useres inclines me to be extremely skeptical regarding the ethics of many housing lenders.


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