Friday, May 2, 2008

Barr, Mullainathan, and Shafir on Behaviorally Informed Home Mortgage Regulation

Michael S. Barr (U. Michigan), Sendhil Mullainathan (Harvard), and Eldar Shafir (Princeton) have posted Behaviorally Informed Home Mortgage Regulation on SSRN.  Here's the abstract:

Choosing a mortgage is one of the biggest financial decisions an American consumer will make. Yet it can be a complicated one, especially in today‘s environment where mortgages vary in dimensions and unique features. This complexity has raised regulatory issues. Should some features be regulated? Should product disclosure be regulated? And most basic of all, is there a rationale for regulation or will the market solve the problem? Current regulation of home mortgages is largely stuck in two competing models of regulation - disclosure and usury or product restrictions - neither of which take adequate account of behavioral psychology or market incentives. This paper seeks to use insights from both psychology and economics to provide a framework for understanding both these models as well as to suggest fundamentally new models. We understand outcomes as an equilibrium interaction between individuals with specific psychologies and firms that respond to those psychologies within specific markets. Regulation must then account for failures in this equilibrium.

Ben Barros

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There is nothing new under the sun...

I really don't see where this paper is substantively different than so many of its predecessors: more oversight is needed to keep those dastardly lending people from gouging consumers.

Meanwhile they've managed to fill yet more journal space with classic euphemisms like "asymmetric information"...I love that.

It sounds like they simply want yet more governmental regulation in order to save consumers from their own stupidity. In this day of the internet and say nothing of academic papers freely available on said's far easier for consumers to find out what they need to find out than ever before...and correspondingly harder for lenders to hide behind such "asymmetric information."

Noticeably absent from this paper is a suggestion for the government to stop mandating that lenders lend to the most abysmal credit risks out there...which of course directly led to to so much of this sub-prime mess.

There still is no substitute for basic common sense: if it (mortgage) seems too good to be true, walk away from it. If you don't know or can't tell the difference, then get help: ask friends, relatives, research on the internet. If that still doesn't help, then walk away. And if that still doesn't help, then the prospective borrower is just too stupid to deserve a "symmetric" information-based mortgage.

There's only so much that can or should be done to protect stupid people. But the authors' suggestions are based largely on the premise that people are in fact stupid and that lenders should take that into account (a classically elitist view, by the way). For instance, the authors mention a scenario where a borrower only considers the monthly bottom line when shopping for a mortgage, ignoring the potentially much more serious cost of credit over the mortgage lifetime. Be that as it may, most consumers, even highly educated and informed ones, still insist on looking only at the monthly payment.

No matter what a lender is forced to reveal, or voluntary reveals within a context of "behaviorally considered" market interaction...there's always going to be idiots out there who are too stupid, too greedy, or too materialistic to understand what they're getting into with a given mortgage.

Here's a suggestion for these authors, for others with similar mindsets and for potential mortgagors:

Instead of viewing the mortgage biz as a gamble with the attitude of "how much can I win?", take the stance of the smart gambler (the one who more often than not wins): ask instead, "how much can I lose?" The latter usually keeps people from insolvency and generally leads to positive lender response.

Posted by: Sam Gompers | May 5, 2008 9:05:08 AM

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