Dispensing with the libertarian objection to regulating mortgages

I actually agree with the "libertarian mentality" on private contracts, but remember, this doesn't apply to fraud. If someone mischaracterizes the interest rate as being lower than it really is, that's fraud. If they say the interest rate for the first two years is 2%, all while the debt is increasing at 10%/year, the interest rate is 12%, not 2%, and to say otherwise is fraud.

It's true that reading the full contract reveals the sleight-of-hand, but think of it this way: if someone sells you a "car", but the purchase contract mentions that you need a horse to pull it in order to move, the fact that you could have read the contract does not negate that it is fraud to sell as a "car" something that is really a "carriage".

If cases where fraud like that didn't happen, let 'em burn.

"The question isn't whether mortgage lending is going to be regulated, it's how."

Only if you have a context-dropping, open-ended definition of the word "regulated."

Stated differently: "Banning" is not "regulating." Especially when the ban is based on nothing more than subjective fondness for "I'm smarter than you" central planning cloaked as benevolent paternalism.

Remind me again who's got it backwards?

It would be interesting to see how many people would claim or accept the title of being a certified "Competent Consenting Adult" (a requirement in Kip Esquire's example) if they could get all the benifits of that risky claim. Taxes for a CCA could be much lower because a CCA would not be taxed for any of the welfare programs. No social security taxes, all that money including the employer's contribution would be part of the CCA's take home pay. And the prices of items a CCA purchased would be much lower because the seller or manufacturer would have no future liability other than what was warrented in writing. The risks however, could be deadly.
My guess is roughly 25 percent of the adult population would chose to become CCAs because they would get a roughly 20 percent reduction in their cost of living after taxes.

GLD, that is great! Sign me up! Hey Justin, would you qualify?

If the question is how we shall regulate, may I suggest measures that better achieve transparency and simplicity in the presentation of loan products to consumers? The requirement that interest rates charged be presented on a standardized basis, comparable across product offerings, as an annual percentage rate (APR) is an example. The premise is that complexity and deception cause confusion among non-expert consumers -- which is quite different from the irrationality alleged in this posting.

Another form of risk revealed in the current "sub-prime mess" is what economists call asymmetric information, resulting from uncertainty about the extent to which specific financial assets incorporate sub-prime risk. This uncertainty has contributed to the general liquidity crisis/credit crunch as would-be lenders wonder about the credit quality of these assets when proferred as collateral. It's like a chunk of bad beef ground into the nation's sausage supply -- some sausage's may still be good, but who knows which ones. The remedy, in principle? Again, transparency.

My preference would be to allow the market, the invisible hand, to develop transparency solutions, that is, to move down the learning curve of this experience and work out market protocols to avoid a recurrence. But if government insists on "doing something", I rather imagine a modest and sensible role in contributing to greater transparency in the future might be helpful and at worst would do little if any harm.

Boltuck: "The premise is that complexity and deception cause confusion among non-expert consumers -- which is quite different from the irrationality alleged in this posting."

No, the complexity of the loans does not negate the irrationality of the borrowers. A rational being would respond to excessively complex mortgages by simply not taking one. It is the willingness to supsend standards of rationality that allows lenders to get away with such messy loan structures.

Ditch the "gaga over real estate", and brokers will have to make simpler offerings.

Of course, agreeing to a contract while ignoring any reasonable effort to understand its terms and implications would be irrational. But I don't think that describes the situation here. A perfectly rational response to life's complexity is to rely on time-tested rules of thumb, thereby getting decisions right most of the time and economizing on the very real costs of acquiring expertise sufficient to fully master legal provisions.

Indeed, that worked well for mortgage borrowers for many decades, safeguarded by banks that required adequate assurance about the borrower, or market-generated rules about securitizing mortgages that similarly imposed standards on borrowers and the structure of loans. But when the standards changed quickly, the old rules-of-thumb used by borrowers proved suddenly unreliable.

For those caught in the transition, ought one to say they were irrational? I don't think so. Still there are lessons for borrowers, lenders, investors, central bankers, and others in this experience that, if learned, should prevent this problem from happening again -- but of course, will not prevent all future errors that may result in liquidity crises.

Well, this thread appears to have gone stale, but I did think it useful to add one item. One Wednesday, two days ago (9/12), Bank of Canada Governor David Dodge spoke in London in some detail about the importance of improving transparency in debt markets, citing both the principal-agent problem between loan brokers and originators, on the one hand, and investors on the other, as well as the devilish opacity of structured financial products layered with derivatives, hierarchies of fund ownership (funds owning funds owning funds), and so on. This is the main point I hoped to make above. You may find his remarks here: http://www.bis.org/review/r070914b.pdf .