Arnold Kling  

The Dodd-Frank Bill

Signal and Noise in Economics ... Association, Exclusion, Libert...

If you don't have anything nice to say, then keep quiet. That's why I have not been commenting on the Dodd-Frank bill. I like what Tyler Cowen wrote, particularly his sentence about the credit rating agencies.


I think that the biggest banks and other large incumbent financial firms will ultimately be the largest beneficiaries, as they will figure out how to game the system and manipulate the regulations to impede upstarts. I will gladly make a bet that our financial system will be more concentrated 5 years from now (or 10 years from now) than it is today, as measured by the share of assets and/or profits of the ten largest financial institutions.

Overall, my biggest gripe is with people who say that the consumer financial protection agency would have prevented the crisis. Obviously, such people are unlikely to read this blog, so I am spitting into the wind, but here goes:

Suppose that we had this agency back in 2005, with house prices rising and lots of people happily buying homes with little money down and occasionally adverse terms (teaser-rate ARMs with prepayment penalties or whatever). My guess is that the agency would have objected to no more than 5 percent of mortgages.

Suppose that the agency had gotten every mortgage to have interest rates and other terms that were within reasonable bounds. Presumably, these loans still would have been made with low down payments on houses where prices were too high. My guess is that relative to what actually happened, the total number of defaults prevented nationwide by the agency's actions would have been fewer than one hundred. That is because I think most of those defaults occurred because of what happened to house prices, not because of adverse mortgage terms. Look at how poorly "loan modification" has done at stemming foreclosures. And that includes loan mods that went way beyond simply changing the most outrageous terms on the most outrageous mortgages.

Do you think that the agency would have had the willingness and political clout to tell low-income and minority home buyers that they could not afford the houses that lenders were willing to lend them money to buy? Of course, we have no way of knowing. My bet is that the agency would not have taken on this skunk-at-the-garden-party role.

But, again, I'm wasting my breath.

Comments and Sharing

COMMENTS (9 to date)
Patrick L writes:
I will gladly make a bet

OK. Put your money where your mouth is: are you making this bet in the markets?

Andrew_M_Garland writes:

Mr. Kling, you are completely correct.

We actually had (and have) Barney Frank on the House Financial Services Committee in 2003-2006 that had/has oversight over mortgages and lending.

He famously said at the time that there was nothing wrong with Fannie and Freddie, move along, no reports or an audit needed, when this was suggested by Republicans.

Fan/Fred set the requirements for loans in the mortgage market, as the largest buyer of those loans. They had to know all of the details of the mortgages they were buying.

Barney Frank at a hearing in September 2003

They liked making the loans, and the loan terms were fine with them.

Chris Koresko writes:

@Arnold: "I think most of those defaults occurred because of what happened to house prices, not because of adverse mortgage terms."

There appears to be empricial evidence to support your impression.

rhhardin writes:

Terms and income didn't matter because it was all a bet on rising house prices, with the expected gain in borrower equity counted as expected income. The plan was to refinance when the adverse terms kicked in.

Boonton writes:

Yawn, are we still going with the discredited idea that the housing bubble was driven by minority and low income borrowers?

I agree with Arnold that a consumer protection agency wouldn't have prevented the entire bubble. It would help, though, take the edge off. Previously Kling has argued that for many the NINJA and other 'nontraditional' loans were really great 'options' on housing prices that had lots of potential upside and little real potential downside for many low income people.

I agree, but fraud is still fraud. If I take $100 from Arnold's wallet and replace it with 100 lottery tickets, its still wrong even if theoretically those 100 'options' are 'worth' exactly $100. If nothing else at least some of the worse loans might have been blunted if lenders were restricted from conning borrowers into the idea that impossible loans were in their best interest because prices never fall, that they could always refinance after their teaser periods ended, that 'establishing good credit' would allow them to always refinance into more normal loans and so on.

Stephen W. Stanton writes:

You are not wasting your breath...

You're right that there is no chance that anyone will change current policy based on your advice.

But you are making an excellent audit trail for the next crisis. My hope is that folks like you have an influence after the next bust, whether in 2 years or 20...

You need to be able to look back and say "I told you so". We need to have a few Adam Smiths, F.A. Hayeks, and Milton Friedmans offering an alternative vision today... So that once again, the freedom, capitalism will be proven the most prudent and practical economic policy (and not just idealistic platitudes).

The voters need to see that they had another option back in the dark days of the late 2000's. The next time they want "change", maybe they'll buy at least some of the vision you are selling.

They did it with Reagan and Thatcher...

Douglass Holmes writes:

Arnold, you are not wasting your breath. It helps us all to review the reasons this legislation would not have prevented the crisis.

Boonton, Arnold doesn't mention minority or low income borrowers as causing the housing bubble. I believe he has, in the past, mentioned that at least some of the housing bubble was caused by speculative buying.

John Schroy writes:

The Dodd-Frank bill spurs sub-prime lending in Title XII. See:

Boonton writes:


I think Kling mischaracterizes the idea that the bill would have had to have told 'low income and minority' borrowers that they couldn't buy a house. What could have been addressed was the rampant marketing of pure speculation plays as loans suitable for people seeking to build their credit and upgrade their living situation. That probably would have prevented some of the worse loans from being made. But by itself it wouldn't have stopped a speculative bubble fueled by endless securitization and up-bidding McMansions.

On the other hand bubbles are by definition highly unstable. Look at the difficulty in finding 'causes' for their popping. Often it's a seemingly random event. A stray newspaper story, a fund collapsing, a major bankruptcy. It would seem for a bubble to form there needs to be a perfect storm where all the forces of irrationality line up just right. It's not unreasonable to speculate that if just maybe one piece of the craziness had a bit of sand tossed in its wheels, the grinding might have caused the larger wheels to take note before they got too deep into the mess. I wouldn't say the bill would have prevented bubbles but in general an environment where bad ideas are a bit harder to take hold is probably a less bubble friendly environment.

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