There’s a credit crisis going on right now. Credit is what you get when a lender
lends money to a borrower. Therefore, any attempt to address any credit crisis
is, by definition, going to affect lenders. For pundits of a certain political
disposition, that’s all they need to know. In one of the most annoying rhetorical
tropes around, they take any kind of policy which might impinge borrowers or
lenders, and immediately decree that it’s going to have adverse deleterious
effects. For a prime example of this, look no further than Peter
Schiff:
Although there are mountains of uncertainty as to how the plan will be structured
and implemented, there is no question that as lenders factor in the added
risk of having their contracts re-written or of being held liable for defaulting
borrowers, lending standards for new loans will become increasingly severe
(higher down payments, mortgage rates, and required Fico scores, lower loan
to income ratios, and perhaps the death of adjustable rate loans altogether).
According to Schiff, there is no question! None at all! But this
is utter bullshit, and it’s worth unpacking the reasons why, since the same
argument is trotted out in all manner of other contexts as well. (Regulate payday
lenders? Stupid idea! It will just make vital credit that much harder to find!
Reform bankruptcy laws to include mortgage debt? Idiotic! Mortgage interest
rates would certainly rise as a result!)
For one thing, it’s worth looking at what the mortgage-lending industry did
at the end of 2006, when subprime default rates started skyrocketing. Everybody
expected underwriting standards to tighten significantly, but they didn’t. It
turns out that an industry as enormous as the mortgage industry takes a very
long time to turn around, which is why so many bad loans continued to be written
in 2007. If something as obvious as soaring default rates didn’t result in much
tighter underwriting standards, it beggars belief that something as marginal
as this voluntary mortgage-freeze plan would do so.
Now it’s entirely possible that lending standards are still unreasonably lax,
and that they will be tightened in further. But that would happen anyway: it’s
got nothing to do with the mortgage-freeze plan. How do I know this? Because
the lenders, who Schiff seems to think are going to be worse off as a result
of this plan, are the people who came up with it in the first place!
The plan is first and foremost in the lenders’ best interest: it was designed
by lenders for lenders, and the borrowers come second, not first. Are the lenders
really going to punish themselves for their own initiative? Indeed, can Schiff
point to a single lender who has said that he will be damaged by this policy
or will raise lending rates as a result of it?
As for the "death of adjustable rate loans", that’s not going to
happen. What might happen is the death of teaser-rate loans with high
prepayment penalties and rates which adjust to ridiculously high levels when
the teaser period is over. And good riddance, if those things no longer get
offered. But a simple UK-style adjustable-rate mortgage where the borrower pays
a small fixed premium over Libor or Treasuries is a very good idea for both
lenders and borrowers. As a general rule, no one should ever offer or take out
a mortgage where the one-year adjustable rate, if applied using today’s prevailing
interest rates, is higher than the rate on a 30-year fixed mortgage.
And as an even more general rule, be extremely suspicious of anybody who tells
you that a given proposal is certain to result in a rise in lending rates. That’s
a tired rhetorical device, and it has had precious little predictive success
in practice.
(Via Carney,
who’s also guilty of false certainty when he says
that the mortgage-freeze plan is a bailout, on the grounds that someone,
somewhere, may end up losing money as a result of it.)