Arnold Kling  

Regulation We Don't Need

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Jeff Frankel on the Faith Trap... Fools and Their Money...

Vince Reinhart writes,


The problem with securitization is that it dilutes individual responsibility. The mortgage broker can easily become disconnected from the outcome of the initial lending decision. Federal regulation is needed to ensure that mortgage originators perform the appropriate due diligence in matching potential borrowers with loan products. Underwriters should be required to retain an interest in what they issue.

This is false. We do not need federal regulation to fix this problem. Markets can fix this problem. They already have.

The problem is not securitization. The problem is that when house prices are going up, there is no such thing as a bad loan. Even a loan where obtained by total fraud will work fine if the price of the house goes up.

In the mortgage market, people saw risk-takers outperforming prudent lenders. So they took more risks. There is no simple fix for that. For the foreseeable future, we can count on investors sticking to prudence when it comes to mortgage lending. We don't need any regulations to close that barn door.

But somewhere, some time, in some other market, there will be another outbreak of excessive risk-taking. You can't make the system idiot-proof. They'll just build a better idiot.


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COMMENTS (7 to date)
Jeff writes:
The problem is that when house prices are going up, there is no such thing as a bad loan.

True enough, but you should also ask why house prices were going up so much. Were it not for the artificial supply constraints, prices would have increased only a bit (see Houston). Lenders would not have made so many foolish loans if slow-growth zoning policies hadn't suppressed the supply response.

Ned writes:

Arnold, I agree. Reinhart's thesis is just silly ("The problem with securitization is that it dilutes individual responsibility. The mortgage broker can easily become disconnected from the outcome of the initial lending decision...").

The same can be said for trade in general: if you make boots for yourself, you are going to suffer the consequences is they are of shoddy quality. But if you sell them to a wholesaler, who sells them to a retailer etc., pretty soon the individual responsiblity will be diluted - you cannot expect this process to deliver quality boots!

John V writes:

Jeff,

And the other side of that coin lies with the Fed.

Super low, unjustified, unrestrained interest rates encourage more home buying and drive up prices.

Phil writes:

@Jeff,

I'm probably misunderstanding your point: I thought that the worst US excesses were in locations (AZ,CA,FL) where the (housing) supply constraints were the most lax.
Here in London we have geology and gravity constraints which would better prove your case. Not so artificial.

Lord writes:

Regulations have longer lives than memories though, which makes them worth doing.

Jeff writes:

@Phil,

Not so. California is where the "slow growth" movement really got underway way back in the late 1980's and 1990's. Various zoning restrictions, proffers, lawsuits, and just plain obstructionism greatly restricted the number and kind of houses that can be built in areas where people actually want to live. New housing development was so restricted in areas like San Diego, L.A., and San Francisco that people were forced to move ever further out, making traffic ever worse and turning the Inland Empire into one giant bedroom community. The fact that people were putting up with two hours commutes each way just shows how badly they wanted houses, houses that were priced out of reach in closer-in areas due to the multiple kinds of building restrictions.

Florida is much the same story. In areas like Houston, where there are no zoning laws, there was even more housing growth (proportionally) than in California, but since suppliers were free to respond to increased demand, the stock of housing went up a lot without much increase in price.

The market works, when we let it.

Jeff writes:

@John V:

Super low, unjustified, unrestrained interest rates encourage more home buying and drive up prices.

Oh, I agree with you that the Fed kept (and still is keeping) short interest rates much too low for far too long. This WSJ op-ed by James Grant describes what happened very nicely.

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