To the People

The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or TO THE PEOPLE.

Thursday, August 09, 2007

The Credit Crunch and Market Meltdown

Now we know the answer to two questions that anyone who lives in DC has been asking for years: how can so many people afford such expensive homes and how the hell are my middle-class friends bankrolling such expensive home renovations? The answer: easy and dumb credit.

The Dow is down 270 points as I write, mortgage and corporate credit markets are in chaos and even French banks are taking a hit.

How can we fix this mess and prevent it from happening again? Hillary has it wrong. She has proposed a $1 billion fund to bail out the people who took on exotic loans that they no longer can afford. This would mean that Joe Renter and Joe 30 year fixed rate loan have to pay for the ill-advised excesses of their fellow citizens. It also creates a moral hazard, in which risk takers do not suffer the consequences of their risk-taking when it goes South, so they take on more risk. From Wikipedia, the definition of 'moral hazard':
Rescue operations carried out by governments, central banks, or consortiums of financial institutions can encourage risky lending, if lenders know that in case of serious problems they will not have to take losses.
One poster on a Wa Post web chat with Steven Pearlstein, that paper's economic guru, made another interesting point:
it's interesting to reflect that it used to be considered a scandal to withhold% loans from minorities, whereas now it is apparently reprehensible to extend too much credit.
To be intellectually honest, do the Feds want more or less credit available to the poor?

The federal government's policy of promoting home ownership versus renting also had a hand in this debacle. The IRS's treatment of mortgage interest as tax deductible makes people want to purchase a home for tax reasons and wildly inflates the cost of homes. That is insane and should stop.

I have two simple proposals that I think would protect consumers without interfering with the markets:

1. Mortgage documents ought to be written in plain English, just as SEC docs are required to be. Nowhere in my mortgage docs was something so simple as: this is a 30 year fixed rate with an interest rate of x% ever noted. I had to keep calling the lender on the phone to understand and clarify what I was getting into.

2. Mortgage brokers ought to be held to the same standards that stock brokers are. For most people, a mortgage is their biggest financial commitment, yet mortgage brokers have no professional commitment to give clients good advice. Stock brokers, in contrast, have a "suitability" requirement that is enforced by the NASD. They can be fined and disbarred for recommending a financial commitment that is "unsuitable" for the customer. This is a simple reform that could be governed by a non-Federal entity and would protect borrowers as it does stock investors.

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