January 30, 2010
Sacramento Bee, January 30, 2010
See article on original website
Deceptive mortgages helped feed the housing bubble whose collapse wrecked the economy. Ten percent unemployment and 20 million homeowners underwater might seem a good reason to impose tighter standards on mortgages and other loans. In the last two decades the financial industry has been innovating at a rapid pace. These innovations have been designed to find new ways to separate people from their money in ways that they will not understand.
Virtually everyone has had some experience with the industry’s deceits. How many people have found themselves owing large penalties on a credit card because the grace period had been shortened without clear notification? Similarly, how many people find that the interest rate on their credit card went up only after they are charged a higher monthly bill? Sure, the bank sent you a notification. It was buried in a thicket of mail offering discounts on magazines, luggage and thousands of other items that no one wants to buy. But the credit company did notify you.
A consumer financial products protection agency would prevent these sorts of abuses by requiring that credit cards clearly disclose all interest charges and fees. The agency would also ensure that consumers are properly notified of any changes in charges and fees.
Such an agency would also protect against the sort of abuses that we saw in the mortgage industry during the bubble years. Most people have full-time jobs that do not involve writing or reading financial contracts. It is not surprising that smart people who have a full-time job designing financial contracts can write contracts that confuse many borrowers.
This is especially likely to be the case with major purchases like buying a home. Most people buy a home rarely in their lifetime, and everyone has a first time, so naturally many buyers will be unfamiliar with mortgage contracts.
A consumer protection agency can ensure that mortgage contracts are clear and understandable. People should know how much they will pay and what penalties they face for not making their payments on time.
This transparency should benefit both home buyers and responsible lenders, since lenders lose money when home buyers can’t afford their mortgages. This discipline did not work in the bubble years, when banks could sell almost any mortgage at all in the secondary market to be packaged into a mortgage-backed security.
The financial industry has been whining that a consumer protection agency will stifle innovation. In fact, a consumer protection agency should actually stimulate useful innovation.
The financial industry, like any industry, innovates in ways that maximize its profits. If the industry can maximize profit by developing products that will better serve consumers, then it will be happy to do so.
However, if their best profit opportunities come from designing deceptive mortgages, then it will design deceptive mortgages. By closing off the market in deceptive financial products, a financial products protection agency will steer innovation toward finding ways to better serve consumers.
Ideally, a new agency would not be needed to ensure that home buyers are given clearly written, transparent mortgages and that banks don’t try to deceive their customers. We can hope that the financial industry will repair itself after the collapse of the housing bubble; after all, many of the country’s largest financial institutions were brought to the brink of collapse by their bad lending practices.
Unfortunately, the lesson many of the biggest banks probably learned is that at the end of the day, the Treasury Department and the Federal Reserve Board will come to your rescue no matter how irresponsible you have been. Because government bailouts prevented the market from imposing discipline on failed banks, we will have to rely on government regulators to ensure that consumers get sound financial products.