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Subprime policy recommendations
Congress should simply outlaw adjustable-rate mortgages, which basically ask borrowers to treat their home mortgages like stocks...Congress should also ban private lenders and brokers from issuing sub-prime loans of any kind.
I am curious as to whether subprime marriages should be outlawed as well. Starting a small business? How about having a kid? Of course we shouldn't give them credit cards. Outlawing loan sharks will be easy too.
The weakness of these policy recommendations is a sign of how lost our current understanding is. In most policy areas, the left has a better idea than simply shutting down the market. The reality is that we don't know how to legislate against bubbles. Nor is it mentioned that there's not a clear definition of what a subprime loan is or how such a ban would be enforced in practice. Remember the good ol' days when Joseph Stiglitz argued that credit rationing meant that banks made too few loans to high-risk borrowers?
Here is the much longer piece, which has a good deal of content. The economic history in the linked article is very, very wrong, no matter what your political point of view. Imagine discussing the S&L crisis of the early 1980s without even mentioning the high inflation of the late 1970s or the resulting low levels of bank capitalization. It's fair enough to blame the right for relative silence on the real estate bubble -- a clear case of market failure -- but this article has to go in the Hall of Shame.
Posted by Tyler Cowen on December 21, 2007 at 05:21 AM in Economics | Permalink
Comments
You will get no argument from me about the over-simplicity of these recommendations, but I don't think it's worthy of the Hall of Shame. Perhaps if these are acted upon, but currently these suggestions are just whistling in the dark. HoS caliber policy recommendations are things like "Tax cuts increase revenue." or "Deficits don't matter."
I thought that a (the?) real cause of this event was that loans were not being serviced by loan consolidators and it is difficult for borrowers and loan owners to renegotiate terms of a loan to their mutual benefit. Allowing some mechanism of mutually beneficial renegotiation sounds like it couldn't be a bad thing.
Posted by: MostlyAPragmatist at Dec 21, 2007 5:54:35 AM
Tyler,
Are there any studies of the psychological profiles of those who cheat on loans and those who don't? Is it possible to ask a short set of questions which can lend greater certainty to the loan provider and may even give the benefits of lower rate to the borrower? If such are not known, isn't it of interest of the financial industry to sponsor some such studies?
-warm regards, Prakash
Posted by: Prakash at Dec 21, 2007 7:19:04 AM
The pendulum swings. That snippet is pretty silly, but we are still coming from decades of indecent debt-love. We still stack kids today with college loans bigger than my first mortgage ... and my first mortgage wasn't that long ago.
Posted by: odograph at Dec 21, 2007 8:48:47 AM
I agree - sounds like the cure is worse than the disease. Here's a radical suggestion - get the government out of it entirely. Let those who engage in risky economic behavior suffer the consequences of their folly.
Posted by: Ned at Dec 21, 2007 8:49:44 AM
Duh. Government WAS out of it. Look what happened.
Posted by: meter at Dec 21, 2007 9:24:56 AM
The housing bubble is a clear case of market failure? Gee, what did you expect to happen to all that money the Fed pumped into the economy? Or are you saying that the lack of response from the right represents the market failure?
Posted by: Perry Willis at Dec 21, 2007 9:44:36 AM
The reality is that we don't know how to legislate against bubbles.
. . . the real estate bubble -- a clear case of market failure . . . .
Serious questions: If by "market failure" we mean something bad that warrants government interference, are bubbles really market failures? Are boom-and-bust cycles market failures? Would it not be better to accept them as normal variations?
FWIW, subprime-mortgage pain seems to me like a once-burned type of thing, comparable to the off-balance-sheet liabilities of Enron. Clever people came up with a product or framework that most observers were unfamiliar with and didn't completely understand, and we/they then learned the hard way. We now "know" about those risks (the same way we "know" about the risks of what our great-grandparents called watered stock and the risks of lending to undercapitalized entities), and we can and will deal with them through voluntary arrangements going forward.
Posted by: jp at Dec 21, 2007 9:46:47 AM
odograph: "we"?
Who is this "we" loading college students up on debt (and engaging in "indecent debt-love")?
Whose choice is it for a student to go to a more or less expensive school, to work or not work summers or work or not work during school, to attend part-time rather than full-time, to attend a less expensive community college for the first two years, to explore other means of paying for college like ROTC, or working and saving for a few years then going to school? "We"? Oh, the inhumanity of it all!
btw - what does "decent debt-love" look like?
Posted by: chug at Dec 21, 2007 9:51:33 AM
Aristotle observed that one of the causes of the failure of democracies is the rise of the demagogues. We are seeing an ample supply of demagogues arising from the Democrat party. Hilary, Obama, Edwards, Dean, Biden, Rangel, etc. No brains, all talk.
Posted by: jorod at Dec 21, 2007 9:52:18 AM
Calculated Risk sums up the ah issue as "we're all subprime now". Why would that be? The right got what they wanted, and the experiment was performed. And we all hope that *one* of the outcomes isn't a trillion or two in losses. Think LTCM, across the financial world.
BTW, this is the very first MR post that beat me at my RSS reader game of "guess the author". Not good.
Posted by: Russell L. Carter at Dec 21, 2007 9:53:57 AM
odograph: "we"?
Who is this "we" loading college students up on debt (and engaging in "indecent debt-love")?
Whose choice is it for a student to go to a more or less expensive school, to work or not work summers or work or not work during school, to attend part-time rather than full-time, to attend a less expensive community college for the first two years, to explore other means of paying for college like ROTC, or working and saving for a few years then going to school? "We"? Oh, the inhumanity of it all!
btw - what does "decent debt-love" look like?
Posted by: chug at Dec 21, 2007 9:54:03 AM
Well from all the "state of the market" real estate meetings I've been in, most of the subprime loans given out were to speculators who were looking to flip the house before making principal payments. And many of the lenders were shady fly-by-night organizations.
What I see is a speculation bubble. Firms see the economic profits of ARM's and want to jump in and grab a piece. Speculators see the same thing on the housing side. And uninformed home buyers toss their hats in the ring as well. Turns out all sides made mistakes.
How exactly is the market going to regulate speculation? Tax excess profits? Put up barriers to industries? Talk about a slippery slope, we already dove off the cliff here.
Posted by: Jarick at Dec 21, 2007 10:08:43 AM
I see the start of a new meme. Wall Street wasn't driven to subprime by the crazy money that could be made. They were just trying to appease the libruls crying out for broader home-ownership.
Blame Joseph Stiglitz!
Posted by: Ken at Dec 21, 2007 10:09:55 AM
"Duh. Government WAS out of it. Look what happened." - meter
I don't know if this was facetious, but it is the typical reaction of the press. Not that the press is entirely to blame, as they are merely reflecting the knee-jerk reaction of the readers: if something goes very badly in the market, it's because the government wasn't paying enough attention.
Unfortunately, we can't hit the rewind button and see what it would have looked like is the government truly did have nothing to say about lending practices before the credit bubble. Maybe we need to hear from "clio-meter."
Posted by: M. Hodak at Dec 21, 2007 10:21:21 AM
I think people go a bit crazy here in the US, but it's not like those albania ponzi schemes that you read about. There will always be a percentage of the population gamble in any market.
Posted by: jr at Dec 21, 2007 10:26:54 AM
"Who is this "we" loading college students up on debt (and engaging in "indecent debt-love")?"
We the people, created Sally Mae. In the modern neither fish nor fowl sense, it is a "private" organization that "remains the country's largest originator of federally insured student loans."
The feedback loop between easier loans and higher tuition should be obvious to any observer.
This was broadly a cultural error, not strictly market, and not strictly governmental.
Posted by: odograph at Dec 21, 2007 10:41:37 AM
The feedback loop between easier loans and higher tuition should be obvious to any observer.
I've often wondered about this.
Posted by: jp at Dec 21, 2007 10:45:55 AM
"btw - what does "decent debt-love" look like?"
I think the only long term debt a family should carry is its mortgage, and that should be paid off rather than re-expanded. How old-fashioned am I? I don't even believe in car loans.
Posted by: odograph at Dec 21, 2007 10:45:59 AM
Homeownership in the US went from 64 to 69% from 1994 to 2005, after holding steady for decades. In particular, many of the new homeowners were low-income and minority. Almost by definition, more people with bad credit will default than people with good credit. After the "crisis" is over, we'll still have a market where many more people owned homes than any time in American history.
As an economist, I just don't see foreclosures as a major problem. Investors who funded mortgage brokers and bought securities made a bad bet about the risk of house price declines, but that's the nature of investing. The vast majority who "lose their house" haven't even made 2 years of payments yet, and many of the foreclosures are investment properties and multifamily homes. On the other side of the ledger, the 80% of subprimes who are paying their bills surely can't be too upset that they no longer have a landlord.
Posted by: cure at Dec 21, 2007 10:54:46 AM
What do you think, as an economist, of the falling equity ratio?
Posted by: odograph at Dec 21, 2007 10:57:36 AM
"Working through the summer" to reduce student debt is a relic of an older pricing model. The model now is
1) College sets ridiculously high tuition -- well above $30,000 / year
2) Nobody can pay ridiculously high tuition.
3) Everybody submits full financial information that reveals exactly how much they can afford to pay, including taking on debt.
4) A miracle occurs! The college gives "financial aid" to lower the price to the level settled upon in step 3.
It's a purely discriminatory price model. Bargains may exist from state colleges or jucos, but if you go to a private school, you will take on debt, even with a student job. The college doesn't leave any money on the table, even money that you have to borrow to put on the table.
Posted by: Zach at Dec 21, 2007 11:03:49 AM
We are bending this a big, from houses to tuition, but I think the parallels just keep on coming. People talk about the fraud in home loans. Remember:
Probe Targets College Financial Aid Kickbacks
Posted by: odograph at Dec 21, 2007 11:08:53 AM
The problem is that this is not a case where only two parties (mortgager/mortgagee) are affected. With the tranching, leveraging, and all the other financial shenanigans encouraged by "the market", this has affected such innocent parties as:
- retirees (see: State of Florida)
- people with honest home purchases who are now sitting in ghost-town-like neighborhoods (see: Arizona)
- those invested in certain funds (see: Bear Sterns)
- insurers (see: MBIA)
M. Hodak, I'm curious how this outcome could have been WORSE had there been governmental regulation of mortgage terms. Please paint us a picture.
A significant factor in this meltdown was fraud; we have agencies and laws to investigate and prosecute fraud in other realms (see: SEC), but I suppose you're in favor of the invisible hand of the market weeding out those dumb enough to get sucked into this mess (see: list above which is not remotely a full list of those affected.)
Posted by: meter at Dec 21, 2007 11:15:12 AM
In the spirit of the holidays, I offer the following from It's a Wonderful Life:
REINEMAN: Look, Mr. Potter, it's no skin off my nose. I'm just your little rent collector. But you can't laugh off this Bailey Park any more. Look at it.
[A buzzer is heard, and Potter snaps on his intercom.]
SECRETARY'S VOICE: Congressman Blatz is here to see you.
POTTER (to intercom): Oh, tell the congressman to wait. [to Reineman] Go on.
REINEMAN: Fifteen years ago, a half-dozen houses stuck here and there. [indicating map] There's the old cemetery, squirrels, buttercups, daisies. Used to hunt rabbits there myself. Look at it today. Dozens of the prettiest little homes you ever saw. Ninety per cent owned by suckers who used to pay rent to you. Your Potter's Field, my dear Mr. Employer, is becoming just that. And are the local yokels making with those David and Goliath wisecracks!
POTTER: Oh, they are, are they? Even though they know the Baileys haven't made a dime out of it.
REINEMAN: You know very well why. The Baileys were all chumps. Every one of these homes is worth twice what it cost the Building and Loan to build. . . .
Posted by: jp at Dec 21, 2007 11:21:53 AM
Why are ARM's such a target? I still don't see ANY reason why ARM's are a bad idea for creditworthy people. I would be tens-of-thousands better off today if I had bought my house 4 years ago with an ARM and refinanced it to a fixed mortgage this year instead of choosing fixed from the beginning. Yes, option ARM's and negative-AM ARM's and subprime ARM's are terrible, but I know many people who gained from their prime hybrid ARM's.
And most corporate lending is on ARM terms, or is fixed rate debt swapped so the coroporation pays a floating rate. Do we believe they are behaving irrationally?
p.s. My best sentence of the day goes to Odograph's "This was broadly a cultural error, not strictly market, and not strictly governmental." Well put, and true for most of the left/right arguments here.
Posted by: DK at Dec 21, 2007 11:32:45 AM
