Ezra Klein and Ryan Avent are having a throw-down over the subprime mortgage market. Did borrowers borrow more than they could afford, or were they rooked by unscrupulous mortgage brokers?
Neither Ryan nor I have any data on how these conversations actually went. But whether it was the loan officer pushing the borrower off the variable-rate cliff or the borrower begging for a bit more rope with which to hang herself or, most likely, a bit of both, doesn't much matter. It is perfectly well understood that borrowers, by and large, know nothing of loans. It's a market that operates with a huge asymmetry of information. And though we know that loan officers are, in fact, loan salesmen, they are not presented that way -- instead, they're offered up as helpful experts waiting to guide you to a safe and secure financial solution. They're presented, in other words, like loan doctors.What's supposed to govern their behavior isn't merely basic morals and business ethics, but a sense of concern for their company. If too many individuals enter into loans they can't afford, defaults will rise and the bank will suffer. Which is exactly what's happened. The loan officers, and above them, the banks, and above them, the regulators, were the ones with the knowledge, power, and authority to head off this mess. This market works, it exists, because we trust them to run it in such a way that does not massively exploit the ignorance of individuals, and does not put the entire economy at risk. They failed. But, unlike with the individual borrowers, they failed when their whole mission in life was to not fail, when they were paid to have the tools and information to not fail, and now, in reconstructing this market, we need to figure out what regulations will keep them from failing again.
To which Ryan responds:
Somewhere between the idea that consumers are wholly responsible for their own actions and the idea that the state must be an attentive and omnipresent nanny, there has to be some middle ground. I thought, and I thought that others generally thought, that businesses were generally out there to turn a profit, and while this might often encourage them to engage in helpful, service-oriented behavior, I should not assume that any business has my well-being as its first and highest concern. That’s my job. I cannot fathom the notion that customers ought to be able to walk into a lender’s office with no idea what they can afford and expect that they’ll get a product that’s best for them. I can’t imagine excusing customers who “know nothing of loans” and yet borrow five times what they earn in a year.There is absolutely a limit on the due-diligence that we can expect consumers to undertake. Having to outthink devious loan sharks is one thing. Understanding that it might not be a good idea to borrow massive amounts of money under terms one doesn’t entirely understand is quite another. If we approach the economy from the point of view that consumers are essentially idiots who can be easily played by anyone, anytime, then the entire economy falls apart. Democracy falls apart. We have to begin from the point of view that people will try to look out for themselves, and when they don’t, there should be consequences.
Technically, Ezra's analysis strikes me as simply incorrect: whatever asymmetries of information exist run towards the borrowers, not the lenders. The terms of the mortgage you sign may be disguised in fine print, but the lender has to put them in print in order to get you to sign them. The lender, on the other hand, has only limited means at his disposal to determine your likelihood of paying.
That does not excuse mortgage brokers who deceived confused borrowers about the terms. But realistically, lenders did not lend to massive number of people who couldn't repay them because they wanted to be mean, and damn well didn't care what it cost them as long as they could thrust massive numbers of people into bankruptcy. We've just participated in a national folie-a-deux, where overoptimistic lenders gave too much money to slap-happy borrowers counting on a miracle to bail them out of a mortgage they couldn't really afford.
But I'm not sure that it really matters who's at fault, because whoever started it, everyone's hurting about equally. Ezra's argument, naturally, is that this means the government should step in to prevent this sort of thing. But the government is a very blunt instrument. As of this writing, the vast majority of subprime borrowers are making their payments on time. Defaults are expected to rise sharply, but even if the number doubles, or more, that would still mean that a majority of subprime borrowers are able to make their payments. Should the government have "protected" them from owning their home?
The government used to protect poor people, and young people, and people with bad credit histories, from getting loans, by making it illegal to charge the high interest rates that would make those loans profitable. Were they better off? They didn't have credit card debt, to be sure, or huge mortgages. Instead they had pawnshops, or time payments, or convictions for kiting checks, all of which used to be popular ways of handling things like emergency car repairs.
Which is to say, maybe there aren't regulations that can keep them from failing again, at least not at acceptable cost. I think it's safe to say that the fallout from this credit crunch is that subprime borrowers, including people with fine credit but low incomes, will be finding it harder to get any sort of loan; to that extent, Ezra's wish has already come true. Pushing to further restrict their credit access might well hurt more people than you help.
nice timing, this video covers the source of the original problem. leave the branches for the birds, look to the root..
http://video.google.com/videoplay?docid=-466210540567002553&q=money%2Bbanking%2Band%2Bthe%2Bfederal%2Breserve&total=294&start=0&num=10&so=0&type=search&plindex=0
Any time I hear anyone proposing a new law to protect dumb people from themselves, I assume that the proponent is the one seeking protection.
In addition to the flaw you noted, Mr. Klein also overlooks the fact that securization eliminated the banks' incentives to watch over the behavior of their loan officers, because the loans weren't going to stay in the bank even overnight. The folks who created these new instruments did so with complete disregard for basic management principles, thus creating risks that they blissfully ignored despite the warning sign of high returns.
Who benefits most from the proposals to protect the innocents borrowers? The very same folks who accepted the high returns and ignored the risks.
When someone presents me with an offer I don't understand, I say no until I can understand it and approve of it. What do y'all do?
I actually was restricted to subprime mortgages despite being basically an ideal mortgagee. When my best offer is 10% adjustable, I said no. What do y'all do?
Bill: Keep in mind that corporate loans are securitized as bonds and they don't seem to have a similiar moral hazard problem.
Wikipedia: Securities and Exchange Commission
"The SEC was established by the United States Congress in 1934 as an independent, non-partisan, quasi-judicial regulatory agency following years of depression caused by over production of goods, the introduction of consumer credit, and the Great Crash of 1929. The main reason for the creation of the SEC was to regulate the stock market and prevent corporate abuses relating to the offering and sale of securities and corporate reporting."
So, Megan, do you hold that the creation of the SEC was a needless intervention into the operation of the free market? Since after all it was expressly created to prevent destructive behavior, just like mortgage lending regulation would do...
Ezra Klein hints at the problem when he says, anachronistically, "The loan officers, and above them, the banks...." That was a valid model when George Bailey was running the Building & Loan, and even when I got my first mortgage. But originators (generally not banks) don’t write mortgages for their own portfolios anymore. They instantly sell them into the secondary market and pass on the risk. Mortgage salesmen get paid according to their production, not their default rates.
I have to agree with others... the problem is that a bunch of high risk loans were bundled together to "reduce the risk." This can work, in theory, but my understanding is that these subprime mortgage bundles were collected together and sold to people who didn't really understand the aggregate risk.
All we would need to do is to make sure that risk reduction through aggregation isn't abused.
EI
Here's a facet of this mess that I think about alot and find underreported: while rising property values increased the net worth of those borrowing on mortgages, thus helping them to refinance and keep things afloat, that net worth increase isn't liquid capital. And as the value of your property increases, your property tax increases too. So while you technically are worth more because of the rising value of your house, you haven't actually increased the amount of money you have on hand, money you need to pay your taxes.
I think that's one example of how it's deeply weird to consider buying and mortgaging a property an investment.
I was going to make the same point pct made. So, to amplify, the S&Ls' balance sheets were never at risk (unless there was a re-sale obligation) therefore not only did the loan officers not care about the default rate; the institutions didn't care. The underwriting guidelines were set by the investment banks who bought, bundled and resold the loans and as long as the S&L loan officer adhered to those guidelines, the loans were presold.
Both the lender and the borrower thought that house prices would continue to soar. If that were true, you could get out of your lousy subprime ARM and into a 30-year fixed when the reset happened.
So banks didn't care about low downpayments, since the house would be worth 20% more in two years. The mortgage broker might have cringed over the hopeless financial condition of the borrower, but figured in two years, they could sell at a profit if they couldn't make the payments. And the borrower had little money in the deal, and was told that owning a house was a great investment anyway.
It all works until house prices stop going up. Then you have the current situation -- the borrower can't afford the payments and can't refinance (because they are a bad risk and the house isn't worth the amount they need to borrow.) The CDO investor doesn't want a pile of bad mortgages backed by houses worth less than the loan. The bank can't offer new mortgages because it can't sell them on to the market.
Foreclosures put more houses on the market. Banks stop offering generous mortgages, making it hard to sell your old house even if you want to buy. And all of this feeds into falling house prices, making the problem worse.
This is what happens when bubbles pop. They don't go from being good investments to slightly worse investments. They go from good to bad overnight, leaving everyone stuck with bad investments.
Loan lending is regulated pretty heavily already. Still not sure if the current crunch in mortgages is really a call for still more regulation and bailouts, which are unlikely to impart financial wisdom, or if this is one of those times to nod sagely in response to the litany of "I lived above my means and now I'm broke, pity me" stories and reply, "Huh..bet you won't do that again."
At the moment, student loans aside, the extent of my open credit lines comprise a credit card and a secured auto loan. Both of those are from the same bank. The initial credit limit on the card was a full grand higher than the entire value of the auto loan, and has been rising steadily ever since based on a post facto analysis of my credit behavior. I can incure a debt of that magnitude, on any product or service I please with no provision of security to the lender, at will. Meanwhile, the auto loan is a fixed amount to be paid in three years. The bank collects most of its interest profit out of the initial payments and holds the lien and physical title, with right to reposses the secuirty, until the final payment is completed. Now: One for one of these two lines of credit, I was preapproved based on my customer history, required merely a phone call with sufficient proof of identification in order to receive it, and a couple pages of terms were mailed to me after the fact. I also get more offers like it, from agencies with whom I have never done business, on a regular basis. The other line of credit required me to apply, receive counteroffer, accept counteroffer in person, review thirty pages of terms, and sign in four different places in the presence of a banker. Guess which one was which.
Question: How did methods of obtaining lines of credit (and the requirements to obtain said credit) become so thoroughly confused? Answer that, and we may be on our way to discovering how lenders were able to offer, and how borrowers were able to assume, grotesquely unreal mortgages -- and discern whether it really calls for more regulatory hurdles in the credit & lending industry, or maybe something else.
Freddie-
Here's a facet of this mess that I think about alot and find underreported:
And as the value of your property increases, your property tax increases too.
Why doesn't it work the other way?
I've seen predictions of a 15% "national" drop in home prices (up to 25-30% in some markets)-- What are the odds that the property tax revenue collected by cities and states will decline by a similar amount next year?
I will personally "appeal my appraisal" this year if my taxes don't drop by 20%...
I can't wait to see the number of "school issues" on the nationwide Nov 2008 ballot- with every Dem candidate pledging to raise taxes and spending -during a recession...
Excellent point, Fletch. I think there already stacks of governments (notably NY and CA) whining about the property tax hit to their budgets in the coming year(s). Everyone at every level was all too eager to benefit from the boom, including the people who are ostensibly to 'regulate' such behavior.
I don't know how much faith I put in the SEC, given they didn't shut down my very dodgy former employer (private equity/venture capital) in the wake of an audit that lasted about a month. Same goes for the NASD, though they're private. Money finds a way over, past, or through - it's like water, you know...
I guess I frankly am with Ezra on this one. Yes, people should know better about their own personal financial dealings, and if anything, this is a failing of our public school systems for teaching one more class of British literature versus mandating classes in personal finances. But the fact is, most people cannot handle even understanding their credit card terms, much less their mortgages. So we can sit here and moralize about personal responsibility, or we can take into account reality:
(1) Mortgages and mortgage agreements are extremely complex contracts, written by the originator of the loan, by professional, licensed lawyers, who understand the nuances of contract law, and legal bankruptcy rights in each state their institution offers a mortgage. Consumers on the other hand likely have a high-school degree, with the most complex agreement they likely signed before-hand was their car financing agreement, which, if it not for the low cost of autos, would likely also catch most consumers off-guard as to all the terms and conditions for which the financing institutions have claims and/or rights to modify rates, terms, or conditions without the express written consent of the borrower.
(2) Homeownership, and the assigned value society places on one when you own is an enticement, which, unfortunately (especially when you have a family), causes some people to make decisions which they would not make other wise. I myself am a renter, because I understand I cannot afford to buy anything decent at these prices. But my wife and I are also without kids, and the expectation of providing for them; including, but not limited to; a decent home, in a decent neighborhood, with decent schools. Megan may not like to admit this, but it is easier to be a renter when you are in your 30’s and single, rather than in your 30’s and with kids. The pressures, both external (friends, family, society) and internal which make you take risks on something such as an expensive house that likely they never should have been moved into.
(3) Loan Officers as Loan Doctors: I happen to think this is a bit of a stretch. I prefer to equate loan officers to instead, investment advisors. You expect each one to lead you down the correct (or at last proper) strategic path, and you expect (even though loan officers have little to no obligation legally) to provide a quasi-fiduciary duty to ensure you are matched up with a loan that does not put you at risk of future financial ruin.
(4) Real Estate Agents – they are getting off completely free in this mess. These people should have provided much, much, more guidance to their customers. It seems to me, that one of the best changes in the structure of our real estate market is for real estate agents to stop just trying to move product, but provide additional guidance, much like an investment advisor. It seems to me, that had more real estate agents taken the duty to try to match their customers with homes which honestly made sense, a lot of this mess could have been mitigated. Imagine if you will, that all sellers are provided guidance, where they offer unbiased advise about what is too much house, the expected direction of the market, and/or a risk assessment regarding the buyer’s income, price of the house, and the potential for foreclosure.
(5) Finally: Reality. Mr. Trump rubs me the wrong way, but to paraphrase the man: “If you owe the bank $1 million dollars, that is your problem. If you owe the bank $1 billion dollars, that is their problem.” This folks is why, for all of Megan’s crying about fairness of intervention and what about letting the market punish those who made the mistake foolish. The fact is, when an entire national and potentially world economy is at risk because of foreclosures and defaults on mortgages, that is all of OUR problem. And quite frankly, Megan and I will each be better off if we try to save the financial markets from the ruin if we just let the entire mortgage and credit crisis unwind without any intervention. Sure, eventually, all will return to normal, and creditor will lend more money. But no one, knows when this could be, and given Megan and I are near the same age, right at the beginning of what it suppose to be the peak of our earning years, I do not want to find out what “eventually” means.
The fact is anyone making prognostications about when the credit crisis will end are idiots or lying to us. These are the same people who told us (hmm.hmmm. – the Economist Magazine anyone) who informed us that the mortgage crisis would not really impact the rest of the economy. Well, as Paul Krugman wrote in the Monday NY Times, he has never seen insiders so scared, ever. This is because, for the first time in a long time, we, collectively as a world, face a libertarians wet-dream: the market correction.
"whatever asymmetries of information exist run towards the borrowers, not the lenders. The terms of the mortgage you sign may be disguised in fine print, but the lender has to put them in print in order to get you to sign them. The lender, on the other hand, has only limited means at his disposal to determine your likelihood of paying."
Odd. It's news to me that **borrowers** invented the no-doc loans that are at the heart of this growing financial disaster. I know McArdle's every bit as bright and honest as darling Andy Sullivan (i.e., not very), but is she really **this** clueless?!?
The Atlantic used to be a fine publication.....
"Sure, eventually, all will return to normal, and creditor will lend more money."
Posted by Brad | December 4, 2007 10:47 PM
Brad,
do us a favor, show us who, exactly, in this daisy-chain, was lending 'money' (?)
http://www.legallawterms.com/legal-definition-MONEY..html
Of course, it's all obvious to me now! We should probably repeal all predatory lending and usury laws too. After all, people could use that money loaned at 400% to buy things they want!
Technically, Ezra's analysis strikes me as simply incorrect: whatever asymmetries of information exist run towards the borrowers, not the lenders.
I'm sorry, this is ridiculous. Average people are no more capable of understanding the real implications of the fine print in mortgage or credit card contracts than the Aztecs were capable of understanding the "Pronunciamento" asserting their allegiance to the Spanish crown, which was read to them in Spanish when the conquistadors landed, and which the Spanish then considered legally binding. Credit card company officers know, and you too in your heart of hearts know, that 99% of credit card holders have never read the fine print of their contracts and have no idea what they say; and that credit card companies count on their customers not to read the fine print, which is why it's in fine print, while the "0% interest on cash advances!*" or whatever on the front of the envelope is in bold.
In fact, I'll wager you don't, yourself, know what interest rate you would be charged if you let a credit card payment go unpaid for 6 months. Where then is the "asymmetry of information" between you and your credit card company? Who has more information about the other?
As for the folie a deux: lending institutions will suffer. The individuals who did the lending will most likely not -- neither the CEOs nor the loan officers nor the call-center employees of third-party firms who handled most of the routine business. They all had personal incentives that had nothing to do with prudence and everything to do with maximizing bank "assets", i.e. loans. Borrowers stand to lose their houses, their access to credit, and a whole lot of money. Mortgage brokers and bank officers stand to lose...probably nothing, except perhaps a dry spell for bonuses -- or unless their whole firm goes bust, which would be a tragedy-of-the-commons situation.
n fact, I'll wager you don't, yourself, know what interest rate you would be charged if you let a credit card payment go unpaid for 6 months.
You're right. But then, I don't spend beyond my means, so I don't NEED to know.
As I said in the other thread, it doesn't take a ton of brain power to understand 1) you're borrowing money, and 2) you have to pay it back. The fine print lists all the unpleasant things that happen to you if you don't pay it back. If you can understand 1) and 2), you won't ever have occasion to care what the fine print says.
Brooksfoe, that isn't an information asymmetry, any more than the fact that I can't understand complex derivatives transaction means that there is information asymmetry in the hedge fund industry. Asymmetrical information is about knowledge, not understanding.
brooksfoe-
In fact, I'll wager you don't, yourself, know what interest rate you would be charged if you let a credit card payment go unpaid for 6 months.
Bet!
How much do you want to wager?
Did a majority of subprime borrowers understand every detail of their mortgages? No, they did not. Still, virtually all of them understood the big picture: their payments were going to increase over time if and when interest rates rose. They were betting their ability to pay would improve by the time the teaser rate period ended (or they would be able to sell their home at a substantial profit, or refi into another teaser rate loan). Some have lost that bet. Most, so far, have won the bet. Because of the evident pain those who lost the bet, some are now arguing that the rules be changed. (At what casino is it allowed for me to place my bet and only keep the winnings and stick the casino with the losses? I'm not in favor of gambling, but I'd be willing to play at that casino.)
If we are going to rewrite the rules, can't we make them retroactive for all borrowers? Those who took advantage of teaser rates paid lower than market rates of interest. If we're going to make the casino give up its upside, shouldn't we recoup the "winnings" afforded by the lower initial rates?
Correction: both the lender and the borrower knew that housing prices would not continue to soar. They just gambled that they would continue to soar for long enough for them to cash out with a profit.
There are many nuances related to mortgages. For instance, if you default, what are your rights in foreclosure? How can you redeem, and when? But it wasn't any nuances that tripped people up. "The monthly payment is more than I can afford" is not a "nuance."
Moreover, information asymmetry is about being unable to obtain the information -- not being too lazy to read the document that provides the information.Hmmm. I hate the whole judgmental overtone here, on both sides, especially when people don't seem to really understand what's driving these subprime defaults. This whole discussion seems premised on the notion that most recent subprime borrowers were novice first-time homebuyers - painted either as ignorant idiots or helpless victims of fraud.
But an enormous number of subprime borrowers aren't getting a home loan for the first time. A near-majority (~40%) of the currently active subprimes are cash-out refis. So are a near-majority of defaults. Think about that. It means a significant chunk of these people first had prime loans (or owned a house outright), then something bad happened that both (a) gave them a need to dip into their home equity, and (b) ruined their credit so they no longer qualified for prime rates.
So it's not surprising that these particular homeowners are defaulting, it's not even surprising that they're defaulting before the higher rates kick in. It's utterly predictable when you also consider the tepid consumer economy and the rising cost of living and the rising instability of annual income for middle-class Americans. Many current subprime borrowers initially bought a large house with a low prime rate because they reasonably thought they were financially secure. But these days, a significant percentage of those people are wrong about their future income security. For those who got it wrong, a subprime loan is the equivalent of grabbing the last, ill-fitted life vest on a rapidly sinking ship. For many of them, the vest isn't sturdy enough to save them, but that doesn't mean they won't take it if it's available.
So most probably know exactly what they're doing, and mortgage agents would be hard-pressed not to sell these loans when the banks want to take the risk, and the customer is aware of and willing to take the risk. So I don't see either side of the mortgage transaction as the biggest root of the problem. That blame lies at the feet of the jerks at the CDOs, SIVs, and rating companies who believed a wad of subprime cash-out refi paper was just as valuable as prime paper. Without that immense oversight, the collateral damage to the broader economy would have been minimal.
gave them a need to dip into their home equity
Or a "want" to dip in
David_Nierpotent:
There are many nuances related to mortgages. For instance, if you default, what are your rights in foreclosure? How can you redeem, and when? But it wasn't any nuances that tripped people up. "The monthly payment is more than I can afford" is not a "nuance."
I just wanted to give you a much-deserved LOL for this :-) Well put, my friend.
I would add that "adjustable rates adjust" is also a non-nuance.
I won't comment on the macro side, which I'm largely indifferent on, but I disagree with this on the micro level:
Neither Ryan nor I have any data on how these conversations actually went.
Having met with several mortgage brokers before purchasing my first home this year, I know exactly how these conversations go. In short:
1. Mortgage brokers are complete slimeballs who should never be trusted.
2. Nevertheless, they cannot flat-out lie to you, and borrowers always get to see the literal bottom line of the various payment options. I was given a needlessly complicated document detailing the various payment options which still, at the very bottom of the page, had three numbers on it: my current monthly net income, my 'teaser' payment (broken down between principal and interest), and the monthly payment following the maximum upwards adjustment after the teaser period ended. Even if I didn't understand all the crap on the top 3/4ths of the page (and I didn't), I damn well understood the last line.
3. ARMs are in fact very good deals - for people who don't really need them. Namely, 25 year-old professionals expecting to earn manager salaries in two years.
4. Even if you don't understand your loan, it's incredibly easy - and cheap - to hire an attorney to explain it to you. $500 attorney fee on a $200,000 loan seems like as much of a no-brainer as the home inspection.
In short, whatever justifications there are for bailouts & regulations to forestall a macro crisis, I don't see how things could be helped on the micro side.
In addition to the flaw you noted, Mr. Klein also overlooks the fact that securization eliminated the banks' incentives to watch over the behavior of their loan officers, because the loans weren't going to stay in the bank even overnight.
Way back when I learned the basic principles of accounting (with ink-pens, ledgers, and electromechanical adding machines), it was common for businesses to sell debts owed to them, but the original lender was still responsible to whoever held the loan now for losses due to default. (If it had changed hands many times, every seller was responsible to all subsequent buyers, but the chain ended at the originator). IOW, you couldn't trick others into taking the losses on bad loans, although you might delay your loss a bit. Has this changed? When and why?
On the other hand, this might make for an interesting case study on the intersection of neoclassical and behavioral economics.
As a purchaser, I was the perfect rational consumer of the neoclassical model - waiting until I could afford a 20% deposit, then waiting some more until buy/rent price ratios dropped to an acceptable level. And yet, I object to bailout plans based on the behavioral model - even though I'm effectively unhurt by bailouts for my neighbors, I still object to them on a gut level because it seems to reward their irresponsibility.
I'm pretty sure this means something, though I'm not sure exactly what.
Brooksfoe, that isn't an information asymmetry, any more than the fact that I can't understand complex derivatives transaction means that there is information asymmetry in the hedge fund industry. - Megan
If you worked in the hedge fund industry and you couldn't understand complex derivative transactions, then yes, there would be an information asymmetry involved between you and the rest of the people in the industry. (Maybe. It now appears some of the people in that industry can't understand some of the derivatives they were dealing with either.) Disclosure means nothing if you know the other person can't understand what you're disclosing. It's sophistry to pretend otherwise. If we're both holding the Encyclopedia Britannica in Swedish, but you don't speak Swedish and I do, then we have an information asymmetry. More concretely, information is meaningless without context. Loan officers know a tremendous amount about the context of the loan they're offering; the question "is this a good deal?" always means "relative to what?" Borrowers know much less about the context. That's an information asymmetry.
I love it. So rather than deal with the actual problem, which is that these bad mortgages are getting ready to throw the entire world financial system into crisis, you'd much rather sneer at the suckers who took out the mortgages for "more house than they could afford." Brilliant!
It never ceases to amaze me how myopic people can be. Amaze and disappoint.
Consider this: the people had ample opportunity to exercise personal responsibility and NOT take out these loans; yet they did so anyway. As a result, the world financial system may collapse.
What gives you any reason to believe that absent any regulatory oversight the people will not take out these bad loans AGAIN?
brooksfoe: If you worked in the hedge fund industry and you couldn't understand complex derivative transactions, then yes, there would be an information asymmetry involved between you and the rest of the people in the industry.
That would be a diligence asymmetry or a mental-processing-power asymmetry, not an information asymmetry.
liberalrob: It never ceases to amaze me how myopic people can be. Amaze and disappoint.
And you don't see any myopia in telling all future homebuyers that the government will make up all losses on your home investment for you?
Bonus question to both: In the past 6 years, have interest rates been too high or too low? Isn't interest an evil form of "unearned income"?
And what about the preferential tax treatment that really underwrites all this?
If there were no mortgage interest deduction, moral hazard would be reduced (easier to understand costs), no guessing on what tax bracket you'd be in (becomes irrelevant).
Freddie asks why investment property makes sense. Oh, that's easy. I own three investment properties which continue to pay off handsomely namely because I get a big tax deduction at year end for all the 'losses' caused to me by depreciation and mortgage interest. Without that incentive, I wouldn't own any of them.
Real estate agents also use the interest deduction to inflate prices..."It doesn't REALLY cost that much because you get to deduct all that interest from income!"
I tend to side with those who believe that simply reading (or getting an attorney to read) the fine print is just an absolute requirement when signing away multiples of your annual income. I've made closing companies sit very uncomfortably while I read_every_word. It's my damn money and I enjoy watching them squirm. It's also saved me a lot of money in unnecessary gold-plated title insurance. I left understanding exactly the terms of my mortgage and secure in the knowledge of what might happen in a financial calamity. I don't think of myself as overly detail-oriented so fail to understand the attitudes of those who want to bail out those that made poor decisions.
liberalrob, the world financial system will survive this.
We have regulations in new jersey requiring several restatements summaries and projections of the interest cost (so you can see what the adjusted rate might be under a variety of scenarios). We also have a rule that the consumer can renounce the contract up to 3 days after signing. The law requires that the loan terms are explained to you in several different ways and that the lender make explicit to you your right to renounce the contract.
At closing, it is standard practice to initial every page of the document because borrowers have challenged that pages were inserted.
I agree wholeheartedly that the core problem with these loans is the amount financed (and the interest rate, but the CLTV is the big problem as the resets haven't really hit yet), and that these aspects of the loan are not difficult to understand.
Furthermore, I have trouble imagining another regulation that would make the terms clearer rather than just add to the 1.5 inch stack of paperwork at closing.
It doesn't sound like some of those clamoring for new regulations have actually taken out a home loan.
I have trouble imagining another regulation that would make the terms clearer rather than just add to the 1.5 inch stack of paperwork at closing.
It's important to remember that adding more "explanations" doesn't mean anyone actually reads them; I've personally seen people sign legally mandated disclosure forms without reading; I've done it myself. When you're sitting there at a meeting or a closing, what you want is to get it done: get into the house, approve the lawyer's fee agreement, buy the car, make the sale. Nobody reads this stuff except a few obsessives, and even then it's futile because 99.9% of it isn't negotiable. Sign it and finish the deal or don't sign it and walk away. Pick one.
Rob - just nitpicking because I generally agree....but it is ALL negotiable. You might be surprised. Especially when you have everyone at the table with the mindset of 'just getting it done'. Amazing what sellers will agree to and amazing what title insurance is sold that is absolutely not needed (the basic policy satisfies 99% of cases but that's not the default policy sold to unsuspecting buyers).
I started to get up and leave at one closing (been through five in five years) and suddenly it was ALL on the table..no one wanted to lose a deal they had invested so much time into making happen.
As a real estate attorney who does closings for a number of companies, it is clear that the "consumer protection" statutes are counterproductive. The bigger the pile of paper is, which is necessary to get the deal done, the less time folks spend reading any of it. 30 years ago, when closings had perhaps 20% of the paperwork we have today, borrowers were much more likely to read and try and understand what was happening. The best way to address the "ignorant borrower" problem would be to repeal all the disclosure requirments currently bogging down the process.
Also not helped because usually the title escrow people and the bank people and whoever else is pushing you to finish signing that stack of papers tout suite. (I had a lawyer with me, and even so it took us over one hour.)
I'm also remembering the stack of paper I got from the bank to explain the possible mortgage terms. Crazy. They took 2 pages each for the 15-year fixed and 30-year fixed, then the rest was dealing with the ARMs, balloon, interest only, and all the other flavors.
(I went for the 15 year fixed because it was the fixed was the only one I could understand and the difference between the monthly payment on the 15-year and the 30-year wasn't enough to make up for the extra 15 years of payments.)
Jennymoose - that sounds very accurate. What's needed is to ensure that the people who are brokering for the buyers are actually impartial, or that there is somebody professional involved whose interests are on the buyer's side rather than the seller's (of mortgages as well as of real estate). Just forcing people to print up more incomprehensible stuff isn't going to help buyers understand things any better.