Here’s one paper suggesting that regulation doesn’t necessarily solve current problems:
We find that most aspects of mortgage broker licensing systems, such as mandatory professional education, do not have a significant and consistent statistical association with market outcomes. However, one component — the requirement in many states that mortgage brokers maintain a surety bond or minimum net worth — does have a significant and fairly consistent statistical relationship with both labor and consumer market outcomes. In particular, we find that tighter bonding/net worth requirements are associated with fewer brokers, fewer subprime mortgages, higher foreclosure rates, and a greater percentage of high-interest-rate mortgages. Although we do not provide a full causal interpretation of these results, we take seriously the possibility that restrictive bonding requirements for mortgage brokers have unintended negative consequences for many consumers. On balance, our results also seem to support theories of occupational licensing that stress the importance of pure entry and exit barriers over those that focus more on the human capital effects of licensing.
Get that? Tighter regulation does mean fewer subprime mortgages, but also higher foreclosure rates and higher interest rates on the mortgages. This paper is hardly the final word, if only because broker licensing is not the only possible means of regulation. But in the meantime caution is in order; don’t be attracted to the idea of tighter regulation simply because you feel we haven’t had good enough regulation so far. Regulators are famous for fighting the last war, not preventing the crisis to come.
So far I’m not finding an ungated copy of this paper.
How about this solution:
1) Define some kind of “safe mortgage” that has characteristics likely to make it avoid foreclosure
(20% down, fixed, less than 30 years, less than 35% of initial gross income, no prepayment penalty).
2) If the mortgage offered to a client differs from the safe mortgage, require him to fill out a pointless
form and get (guaranteed) approval from a pointless bureacracy a week later. This creates a psychological
barrier to taking a non-safe mortgage, while still allowing people really intent on getting them for a good
reason, to get them.
3) Since non-safe mortgages will appear to have a lot more “hassle”, people are more likely to avoid them
but they are still legal.
Thoughts?
The paper makes sense. Fewer brokers mean they don’t have to scamper as much, and so they are less likely to be desperate enough for volume to have done a lot of subprime.
But if there’s less competition for customers, interest rates are likely to be higher.
I’m not sure why foreclosure rates would be higher; this might depend on the measurement used. I will note the WSJ earlier this week noted many home equity loan issuers (2nd mortgage) are NOT foreclosing on mortagees because foreclosing doesn’t pay for them. [first mortagee gets paid first, of course]
Get that? Tighter regulation does mean fewer subprime mortgages, but also higher foreclosure rates and higher interest rates on the mortgages.
Well, I haven’t read the paper, but that’s a pretty misleading summary of the section you quoted. It doesn’t draw any conclusions about tighter regulation in general, just bonding requirements, and it specifically says, “we do not provide a full causal interpretation of these results.”
Answer: But if there’s less competition for customers, interest rates are likely to be higher.
Question: I’m not sure why foreclosure rates would be higher;
Sorry I haven’t read the paper, but this sounds like a huge con. Why do we assume regulation is the independent variable? This might just explain the ebb and flow of policy reactions: Subprime mortgages and deliquincies rise, creating demands for more accountability in the regulatory regime. Or not. Regardless I would prefer a natural experiment, not a pure explanation of variation.
Why not “do nothing”? The major problem was that investment houses were mispricing the default risk for subprime borrowers, as mentioned above. The solution to this problem has already been seen – investment houses want a higher interest rate to take on these riskier loans. The result: less mortgage availability and higher rates for risky borrowers, which is entirely sensible given that we now know these borrowers are in fact higher risks when house prices are not increasing quickly.
I see some role at the margin for (for instance) documentation requirements, and securitizer liability rules, but the basic system has already self-corrected itself, has it not?
Usually I would agree with the idea that the market would eventually align the incentives (as stated in the last post), and that risky brokers would be weeded out naturally. The only issue is that in the banking system, it isn’t just the “lenders” who get hurt.
Banks are just more or less like a consignment shop, paying you a low rate for your deposit and lending it out for a higher rate. They are, in general, more highly leveraged than most other entities in the economy. To be considered “well-capitalized, they only have to have a 10% ratio of equity to assets. That means that any major or widespread losses (like are feared from the sub-prime mess), could mean that depositors suffer losses.
For many reasons, depositor losses are bad, so some fix would theoretically be needed. The other option would be to require higher capital levels for banks so that they could absorb more losses, but that may have an ever greater impact than tightening broker requirements in reducing the availibility of credit in the market. So I would think regulation of brokers might be a good way to start, but as the original article mentions, is not without its drawbacks.
Easy credit means easy bankruptcy. But the current scam in subprime mortgages is only a variation on the HUD scam of the 60s and 70s. However, in the earlier period, the taxpayers were left holding the bag. This time investors got burned. But basically the same thing happened. The real estate brokers and people who packaged the loans got their fees up front, then dumped the load on the suckers, I mean investors. The brokers have gone, the mortgage companies who packaged the loans are gone, only investors and those who lent to them are left. The same thing happened a few hundred years ago in tulips. However, the consequences are nobody wants to lend and credit dries up. People with legitimate needs can’t credit. In this case, the housing market is dead. People who should have known better were asleep at the switch.
thank you for this excelent article
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