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Austin Kelly

I'll note it again. The big issue in the mortgage debacle is not protecting the borrowers, but protecting the neighbors of the borrowers. When I presented my paper on zero down mortgages at a conference, someone asked me "so the lesson is to not buy a house with nothing down?" I responded "no, the lesson is to not buy a house where your neighbors have bought with nothing down."

The problem is that it is usually difficult to know the financing terms obtained by others in your community, and nearly impossible to get some sort of pre-commitment with respect to behavior of future buyers. Foreclosures have substantial spill-over effects. In condos and co-ops there are usually rules governing the financing of new buyers, but to the best of my knowledge nothing like that exists at the level of municipal government, and given federal lending pre-emption I would guess that it would be almost impossible to craft such a local solution.


Becker asks: How would greater regulation have helped when commercial banks, one of the most heavily regulated of all industries, did so badly during this housing bubble?

We learned in the 20's that banks have to be regulated and did OK until S&L's were "deregged" and the rubes that ran them began swinging for the fences, and perhaps from the chandeliers. Now, we've surely learned that despite having savvy economists and lots of computers the system will fail if the "lender" is able to pass his risk on to some other institution that also should know better but accepted the risk for an inadequate premium anyway.

There's a claim made here that had the banks lending standards been more stodgy during the creation of the bubble housing would have grown less rapidly and fewer would own their own homes, or at least a less expensive home.

Well here we are with a meltdown in the housing industry, a huge banking mess that could spread, and millions in foreclosure.

Had we held to more traditional lending criteria the industry would have grown more slowly but on a far more solid foundation and we'd still be building, lending and selling today.

Would the building of "too few" new homes have created inflation due to the scarcity of new homes? My guess is that because lending would have been constrained there would have been fewer dollars chasing the homes so house price inflation may have been a lot less than with the ultra-easy money scenario and that the whole getting rich by pyramiding home values would not have been such a lucrative game in most markets and the bubble might not have taken place.

I'd say that knowledgeable and disinterested regulators would have served us far better than those profiting mightily and making up even more profitable but risky rules for themselves as they went. And especially so as America is populated with so many who are child-like and have little idea what is going on in the economy that surrounds them.

Michael F. Martin

Three cheers for minimalism!

One minor dithering with Prof. Becker:

"How would greater regulation have helped when commercial banks, one of the most heavily regulated of all industries, did so badly during this housing bubble?"

The answer is not greater regulation, but smarter regulation. Regulators like all economists, are now trapped in a static world. We need to start thinking and modeling markets as dynamic. Even simple models would help.

One key observation that immediately comes out of a dynamic market analysis is that consumers need to pay price PLUS their share of negative externalities associated with each transaction for market prices to remain stable.


Government taxes are one mechanism for forcing consumers to do this. Berkshire-Hathaway's selling of 20-year puts on the market is another.


With Prof. Becker, I would much prefer to see government take steps to ensure that prices reflect the complete social impact of transactions in time (by requring consumers to pay for both personal value and negative externalities) than to move toward a command and control system as Judge Posner suggests.


I appreciate the views of Posner and Becker on this matter. However, I would note that information, in particular information asymmetries are what drives profit in many areas. In this respect, consumer information becomes a two edged sword. While Becker is right that information may be provided voluntarily, in the information age, there is always the temptation to posit (i.e. “spin”) the information so as to direct the consumer’s thinking a certain way. For example, Becker notes that some food companies provide information that “their cereals use oats that may be good for the heart.” However the quantity of oats included could be well short of the required intake to have any change, let alone a beneficial one. As a result, the food company provides a true statement to the consumer that implies this product will help the consumer. Yet the consumer does not understand that they would need to consume several servings of this cereal each day.

As companies seek profits, it is in their interest not to lie – which harms their reputation – but to provide information in such a way as to promote a particular mindset for the consumer. In such circumstances the food company and the grocery store that vets products lulls the consumer into believing that the product is more beneficial/less bad/worth more than other similar products.

The same is true for financial services.
Becker asked if greater regulation would have helped when commercial banks, which are already heavily regulated, did so badly during this housing bubble? My answer on this is no, in part of the other way the information sword cuts: information overload. Posner pointed out that requiring disclosures can lead to information overload, lulling of consumers, and “crying wolf”. In responding to Becker’s question, one of the contributing factors is that institutions which are required to provide information are generally permitted to provide the information how they see fit. Again psychology comes into play. Many people, when wanting to buy a house or undertake a stock transaction, feel that time is of the essence, and may not read over the contract in its entirety. Indeed, when I started to take the time to read my mortgage at the bank, the bank officer seemed fascinated that I read every contract before I sign it. While I understand that I suffer from micronumerosity with a sample of one, it illustrates that many people may feel too confident, too trusting, or too rushed when dealing with long, complex contracts in fine print.

As a result, banks can provide the required information littered throughout the document, in such a way that the consumer needs to get independent advice (which they may not be likely to do) or spend hours reviewing in order to understand the document, and obtain all the information prescribed by regulation.

In the end, regulated disclosures are buried, “spun” or both, which obfuscate the consumer.

While it appears that the existing disclosure requirements in the regulatory regime may not be adequate, there is a two step process to ameliorate this situation. The first is to provide earlier education in financial literacy – likely at the secondary school level, when students start getting their first jobs, and social security numbers. Helping consumers understand the financial contracts being put in front of them is a good first step to empowering them to make informed choices. I would note that the Government of Canada dedicated resources in its budget a couple of years back specifically to further this type of idea.

The second, revamping the regulatory oversight regime is thornier. There are, in my opinion two directions. The first is to make financial disclosures more prescriptive. Not in terms of the information to be provided, but the placement of such information. This has already been done to a limited extend in the disclosure boxes for credit cards. However, one can envision the penultimate result being disclosure requirements similar to what the Securities and Exchange Commission requires – specifically vetting any information before it can be published. While creating more similarity and comparability among and between lenders’ documents, it would be costly in terms of regulatory burden.

The other option is for a less prescriptive regime that is strongly enforced – along the lines of the principles based regulation the UK is experimenting with. The UK regulations require that institutions “communicate with their customers in a way which is clear, fair and not misleading.” Such a provision could permit a less prescriptive set of disclosure requirements. However, this would require the various regulators (Fed, FDIC, OTS, OCC, etc) to be more active. This increased activity would likely increase the budgetary costs for these organizations. I also note that the UK has a single financial services regulator, compared to a plethora here.

Michael LittleBig

How Much government Regulation to "Protect" Consumers?Becker
It might surprise you to learn that if you have a mortgage loan with a federally chartered savings bank
that there are NO Federal Consumer Banking Regulations. The Office of Thrift Supervision stated in writing
that there was nothing they could do regarding a federally chartered savings bank in Cleveland Ohio that had placed me financially in harms way. The FBI told me that this was a civil matter. The US Attorney told me their mission was to protect the bank. The State of Ohio told me they had no authority over a federal bank. After 2 years of research and spending $23K in court I can tell you that the federal regulations that exist regarding mortgage lending
basically protect the bank from crimes against them and there are absolutely no consumer federal regulations that protect the mortgage borrower from a bank who harms them. The reason why the Congress has not passed any consumer federal regulations is that the wealthy and powerful Banks will not permit them to enact those regulations. This has recently been apparent when Congress tried to pass different solutions to the foreclosure crisis-the banks said no. This is still apparent when the Congress tried to resolve the credit card crisis-the banks said no. My federally chartered savings bank mortgage holder, also the originator of my loan performed a flawed appraisal with some 9 violations of State and Federal regulations. It took a year for the State of Ohio to process my complaint against the bank’s employee appraiser only to have the bank and the state make a deal behind closed doors. The Inspector General of the Treasury department stated that my year and half complaint with the Office of Thrift Supervision was meaningless since the bank committed no violations ( since there are no regulations to violate). The average person cannot afford to fight their foreclosure since attorneys have priced their creativity beyond the reach of the average person. There is no avenue for the federal mortgage borrower to look to for protection. Therefore the that borrower has no voice. The proof is in the fact , that there are less than a handful of federal mortgage holders that have fought their foreclosure in the courts. In Ohio a foreclosure in filed with a state court and NOT a federal court keeping in mind there are no federal regulations to protect you.
The result is that the wealthy protect the wealthy, otherwise this foreclosure crisis would have never happened with the proper laws, regulations and supervision of federal banks who took advantage of those amongst us who could not protect themselves. You must understand that federal savings banks operate with absolute impunity when lending mortgage money. Your elected representative in the Congress I believe is trying to maintain what is known as “When the government lives better than its people.”
Michael LittleBig, POB 16588, Rocky River OH 44116

Brian Davis

Folks, I can't help you with the banks. I'm not confident Ben Bernanke can, either. Congress passed a tough banking law in the summer of 1989. Washington's mantra was "Never Again!" The bankers and Wall St dealmakers couldn't stand it - "Tangible capital? What's that?" During the succeeding decade people died, got old, got tired, lost their appetite to resist the unsafe and unsound lures that had broken the S&Ls and a huge number of banks. The majorities in the House and Senate turned over, too. The looseness you see today in banking regulation mirrors what was already in train at the OCC and OTS by the time Congress validated it with the 1999 Gramm-Leach-Bliley Act. Get yourselves a strong credit union. That's the best I can do in a nutshell.


Brian you and LittleBig are a breath of real-world fresh air after all the pontificating of the ivory tower academics! Yes, home loan lending is neither rocket science, nor is it supposed to be set up for devil-take-the-hindmost, no holds barred, business world speculation with big winners and big losers, it's just a home loan to facilitate ownership of a place to live.

We know from statistical evidence gathered over many years the percentage of documentable and established income a home owner can pay back and that having at least some skin in the game stabilizes the market and lowers foreclosure rates. We also know foreclosures are costly to the entire system and that despite Michael's experience, wise bankers know that aggressive foreclosure policies are hardly their least costly means of handling those who get into unexpected difficulties.

What were bankers thinking to lend the deposits and assets of others on No Doc, No Asset loans?

It appears that most of that biz is shut down and that a 3% down FHA is the 'best' loan, though it appears that the 3% can still be rolled into the loan, along with 2% of closing costs, so 5% underwater to start.

Austin......... I got a chuckle out of your ivory tower observation about knowing whether the buyer was moving into a neighborhood of zero down buyer that probably made for good seminar theater.

I got an even bigger chuckle out of the conclusion of involving municipalities who are usually boosters, in the loan regulation game. Instead of trying to find out if the prospective neighbors were stuffed in there on flaky lending criteria, why not return to responsible lending criteria across the board?

In the meantime the buyer is safe to assume that if he buys in an entry level neighborhood that 80% of his neighbors will be in there on the minimum required down payment, while in a "move up" neighborhood many will have put 10-20% down to avoid the extra costs of mortgage insurance. Perhaps it's good to recall that PMI or mortgage insurance is there to make low down payments safer for the lender and should pay a chunk of the first losses.


I would like protection from the government not by the government. And please, don't buy anything that is the "best", the "best Value", the "newest", etc. It IS safe, however,to assume that no commercial transaction takes place without ROI being the primary motivation. If the folks cannot make reasonably safe purchasing decisions 80% of the time, they need to spend a greater part of their assets on education. By the way, the government spends half of it's revenue on debt interest and close to the other half on waste (see the W.R. Grace Commission report from the 80s). Who will protect us from that sort of poor judgement?


Debt service as of March 2008 was 9.7% of tax receipts. Just my 2 percents:)

Saint Darwin Assissi's cat

Your comments are longer! "Foul the nest" I believe is cousin to "don't get your meat where you get your money" and "don't s___ or defecate in your mess kit"....however Judge Posner always writes so eloquently and he is such a gentlemen "foul the nest" is much more a Posner comment! Personal reponsiblity is the ultimate Professor Becker...Ah, Mr. Littlebig, have we not the conspiracy of silence? "While one is pursuing justice a lot is walking out the door" (NO COUNTRY FOR OLD MEN) ...We all need to make our Bucket List and get on with the business of living b/c life will be over and we will all have fussed, speculated and blogged away our precious time! (But I am glad I get to read Becker and Posner, they are like great chocolate -- the Caldicots of adult writers)The deal with smoking and overeating is ADDICTION -- one puff can set up certain DNA/genetic coding for addiction..overeating, same deal, the cell structures of certain people will be altered so quickly that making healthy choices to avoid smoking or obesity will be the dominant mantra of that person's life which is ok -- everyone has a mantra that dictates their daily choices; addicts may have to be vigilant in a different manner than say someone with epilepsy or scoliosis or one leg...I learned from a brilliant attorney with the US Justice Deparment in Washington, DC that we are all temporarily able bodied and to a lesser or greater extent we are all mentally ill to one degree or another ... the government cannot be expected to protect each personal DNA/genetic coding (gosh can one even wrap their mind around the number of various codes for each person?). What is the cost of my being upset over the voting in Nevada? I voted three times for my candidate and she won each time. The fourth time I had to spend 21 hours and $200 to vote and she lost. What kind of democracy is this? Can the government even begin to intervene and protect or reimburse?


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