Who Gets Protection?

Two numbers summarize US consumer protection policies for financial products:  1) The SEC is considering a modification of a rule so that hedge funds cannot sell their high-risk investment devices to 98.7% of all Americans.  2)  An estimated one in five recent subprime home mortgage borrowers will lose their homes.  There it is:  When you might lose your investment in stocks, the SEC imposes suitability rules that prevent brokers from selling high-risk products to all but the most sophisticated investors.  But when you could lose your home in a refinancing, federal regulatory agencies have largely left consumer to the wolves. 

Investors get protection because the government decided a long time ago that there would be more confidence in the market if the repeat players (the brokers) bore some obligations to their customers not to steer them to high risk investments. Over time, the market has evidently agreed and regulations to protect consumer investors have been strengthened.   But high risk mortgages reflect the opposite mindset.  The home is the largest single investment the typical middle class family will ever make, but it's "buyer beware" in the subprime mortgage market.

Who cares if one in five subprime borrowers lose their home?  The family cares, of course, because they lose everything they invested and many will end up with deficiency judgments that they can never pay off.  CRL estimates that these families will forfeit $164 billion in home equity as these loans are foreclosed.  Their neighbors care, because foreclosures depress everyone's home values.  People who worry about racial inequality care because subprime loans are disproportionately sold to African-American and Hispanic borrowers, with the result that all their accumulated financial gains will be wiped out.  Anyone with a job in the construction industry cares because foreclosures depress new housing construction.  And all of us who have jobs that depend on a robust consumer economy care because of the potentail fallout from a housing market crash.

Should mortgage brokers have similar responsibilities to evaluate suitability as stock brokers?  It isn't a complete solution, but it would go a long way toward ending the practices by which mortgage brokers steer clients to mortgage products that they know the customers are unlikely to be able to repay.  If stock brokers must help investors with $100,000 to invest in the stock market avoid certain risks, should mortgage brokers be required to do the same for those borrowing $100,000 to buy a home? 

Comments

[sally]

Elizabeth-

You raise an interesting policy question in asking what role regulators should play in the mortgage market. To answer that question we cannot simply rely upon an analogy and the emotion associated with losing ones home.

A more reasoned approach would explore the nature of the information disparities that exist in the market between consumers and brokers. Your suggestion that there is a material disparity is probably correct. Work needs to be done to characterize the nature of the disparity and the consequences that ensue. I would not simply conclude that disparity means we should regulate. We need to understand the consequences of the disparity at the individual and the market level.

The $164 billion in forfeited home equity is an interesting factoid. What does it really mean? What is the true nature of that equity? Is that equity really assignable to the "home owner" or is it jointly owned by the mortgage holder (legally we may assert it belongs to the home owner unless we expect malfeasance of some sort)? I would hypothesize that most of the equity that exists in the sub prime market is driven by appreciation of the property. The consumer can and indeed many did unlock that equity through home equity loans. I will further posit that many consumers extracted most of the value in their homes via such loans. More work needs to be done to understand how much equity was forfeited and how much was extracted before foreclosure (ie home is completely underwater). Banks do not make money foreclosing.

In summary, I think regulation may be in order to protect both consumers and lenders.

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