More Regulation of Mortgages would Likely Hurt Consumers-Becker

No doubt many consumers made mistakes in their credit decisions during the past few years, perhaps especially in the mortgages they chose. It is equally clear that many lenders wish they had never given the mortgages they gave since they lost their shirts by doing so. Does any of this mean that a commission to protect consumers would be a welcome piece of legislation? I am first of all dubious that consumers would have behaved much better if they had simpler contracts, or had the terms better explained to them. The fundamental problem is that consumers are generalists who must make thousands of decisions in highly different areas. As a result, they rely not only on their own limited knowledge, but also on competition among producers to help protect their interests. When that breaks down, as in the housing bubble, many consumers get hurt, but overall it is an excellent strategy for those who must make so many decisions based on quite limited information. Even if we agree on the above analysis, some will argue that a consumer "czar" would help protect the interests of consumers who make mistakes that markets fail to correct. For after all, the czar and other members of her commission would be specialists in consumer issues that might enable them to discover and correct consumer mistakes. This type of analysis is behind the "libertarian paternalism" in the book "Nudge" by Cass Sunstein-a former colleague and the present regulatory czar-and Richard Thaler, a colleague at the University of Chicago. A realistic view of the political process casts strong doubts on whether this is how such a commission would actually operate. Many political decisions are the result of a fierce contest between interest groups with different positions, as we are seeing clearly now in the fight over how health care delivery in the United States should be changed. In these battles, producers, like health insurance companies and doctors in the health care case, are much better organized politically than consumers. Producers can more easily coordinate their actions politically since they are usually either relatively few in numbers- as with health insurance companies- or they have effective trade associations that push their agendas, as with the farm lobby or the American Medical Association. Moreover, since what gets passed can greatly affect the livelihood of producers, they have a strong financial interest in getting legislation that helps them, or at least does not do much damage. The emphasis on consumer ignorance and mistakes makes it harder, not easier, for consumers to act as an effective political counterweight to the political power of producers since they supposedly do not fully know their own interests. So I would expect producers, such as issuers of mortgages or credit cards, to be able to manipulate in their own favor any attempt by the Commission to push regulations to help consumers. These advantages that producers gain from regulations have been called the "capture theory" of regulation in the political economy literature. In the case of consumer ignorance, capture by producers of the regulators is even more harmful to consumers since consumer regulations are likely to end up exploiting, rather than combating, this ignorance in order to benefit producers, the way a private monopoly exploits consumer mistakes. The cigarette settlement with the State Attorney Generals is a good example. Cigarette manufacturers paid billions of dollars to the states based on present and future production, even though they were being penalized for the harmful effects of past smoking. They got a settlement that also taxed potential new cigarette producers, so that cigarette producers were able to raise prices in response to the tax. In fact, prices went up by considerably more than the additional tax per unit. This enabled producers to recoup most of their payments to the state governments. But smokers paid a lot for the settlement through the much higher prices they had to pay. Perhaps that was desirable in order to cut smoking, but producers got off quite cheaply, and the poorer individuals who tend to smoke a lot were hit heavily by the settlement. I am dubious about this proposed regulatory commission for all the reasons Posner gives. In addition, I have argued that the Commission, whatever the intentions of Congress, the President, and members of the Commission, is likely to end up furthering the interests of mortgage companies, credit card issuers, and other producers at the expense of the very consumers it is supposed to be protecting.

Comments

[Anonymous]

Good idea.

[Anonymous]

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[Anonymous]

Another interesting (and related) question you may want to explore in a future post: Would a mortgage system providing creditors with full recourse against the borrower (rather than limited recourse against the borrower's mortgaged property) result in increased stability and lower borrowing costs?

In many countries other than the United States (including Canada), borrowers are generally required to declare bankruptcy when they are unable to make their mortgage payments. In the United States, it appears that borrowers are simply required to walk away from their home.

I would be interested to hear your thoughts on the relative benefits and drawbacks of the two policy approaches in a future post.

It would seem that the "full recourse" (Canadian) approach could reduce the incentive of borrowers to default when their mortgage is greater than the nominal value of their home and thereby could both reduce borrowing costs and increase stability (as well as encouraging more prudent decision making). Of course, these potential benefits would need to be weighed against the increased losses for defaulting homeowners, the associated political drawbacks and other concerns.

[Anonymous]

I think that saying the people handing out the mortgages lost their shirts is a bit misleading, the middlemen made a TON of money, and by any measure a lot of that money ended up shielded behind the corporate veil. If I make 20 million dollars and then my company goes bankrupt and I lose 5 million dollars, ya I just lost 5 million dollars but I'm not exactly crying while wearing a barrel.

[Anonymous]

Perhaps that was desirable in order to cut smoking, but producers got off quite cheaply, and the poorer individuals who tend to smoke a lot were hit heavily by the settlement.
I am dubious about this proposed regulatory commission for all the reasons Posner gives.

[Anonymous]

Experience with deficiency recourse mortgage lending (e.g., TX) versus non-recourse (e.g., CA (still, I think)) deserves academic attention in light of the 2005 means-testing amendments to the Bankruptcy Code and the band-aids Congress has recently applied to discharge-of-indebtedness income under the tax code. A deficiency judgment after a foreclosure nearly always used to mean a Chapter 7 filing to get rid of the debt and the tax liability, even for affluent people. But it may be today, with means testing, that some of these people would have to pay on the judgment for as long as 5 years pursuant to a Chapter 13 plan.

[Anonymous]

The comment from Aug 31, 5:02 hits on what may secretly be the biggest issue in all of this (although it does get 'some' attention). We need to change the way we publicly think and talk about bureaucratic behaviour in general, but corporations in particular. Until we do, we'll never have sensible regulations that prevent individuals from burning the ship and stealing the cargo.

[Anonymous]

Becker,

I think with your argument, you have failed to make a case.

Interest groups influence decision-makers differently in different contexts. The influence that interest groups exert over Congress is different than what they exert over the Federal Reserve which is different than what they exert over OSHA. You cannot just talk about "capture" generally without talking about specifics.

Also, "capture" represents on extreme level of influence. I think a relatively rare level of influence. There are levels of influence less than this, and those levels of influence can even be a good thing BECAUSE, industry interests should be taken into account along with other interests.

Let us talk about OSHA for a moment. It probably is the case that OSHA is more "captured" during Republican administrations than during Democratic administrations. Part of the "capture" of course is ideological, as appointees to this agency are likely to have different views regarding the proper balance of regulation.

But really, I don't think workers are less safe because of OSHA. The difference between Democratic and Republican administrations is a difference between somewhat more versus somewhat less regulation versus the extreme without OSHA of no regulation whatsoever.

How has "capture" made workers worse off in terms of safety with OSHA than they would have been without it? I don't think you could make the case that OSHA has workers less safe.

The point is this. You work is NOT done merely waving your hand and pointing to the abstract concept of "capture" which is so often pushed by "public choice theorists" aka "libertarians." You must get concrete and demonstrate that plausible mechanisms of capture exist in this context and explain how they would work and what damage they would do and further that such outcomes have substantial probability and are not merely speculative. You have shown neither (1) plausible context-specific mechanisms of capture or (2) substantial probability. Thus, I find your argument thus far to be nothing more than inarticulate hand waving and gesturing.

David Welker

[Anonymous]

It's a dog eat dog world - Darwinian economics and all that - it would help however if they taught economics and money management in school, instead of nonsense about ancient Egyptians, so that kids knew what was waiting for them,

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