Monday, October 12, 2009

How to create better financial regulation

From the comments of Saturday's blog post:
The trick is to have professional regulators who actually believe in the rule of law. Bush's fox-watching-the-henhouse approach was destined for failure.
My response:
Lots of people like to blame stuff like this on the opposing political party. For example, note how Republicans like to blame the housing bubble on the Community Reinvestment Act.

The truth is that nobody of any political affiliation likes to step in and take away the punchbowl when everyone's partying. Just look at the failure of anyone to do anything about the stock market bubble during Bill Clinton's second term.

Bubbles are caused by human nature. Since regulators are human beings, they are as susceptible as anyone else. How many home-owning regulators of any political affiliation would have wanted to rein in the rapid rise in housing prices, for example?

Instead what are needed are mathematical rules, such as requiring home buyers to make 20% down payments when buying homes. (Note that under President Obama and a Democratically-controlled Congress, the FHA is actively encouraging absurdly low 3.5% down payments.)

Larger down payments would encourage home buyers to care less about monthly payments and more about overall price. They also would give home owners a bigger buffer to protect themselves when home prices fall. They would also force home buyers to have more skin in the game, so they will be less inclined to just walk away when their home price falls.

All financial institutions should be required to maintain sufficient capital reserves, not just traditional banks. The required reserve ratio should automatically rise during booms and fall during busts. Countercyclical reserve policy like this would help stabilize both the financial system and the money supply.

Finally, teaser rates should be outlawed. Teaser rates are intended to take advantage of people's innate susceptibility to hyperbolic discounting. If someone isn't willing to buy a home based on the regular interest rate and the regular monthly payments, then they shouldn't be buying the home.

15 comments:

  1. "Just look at the failure of anyone to do anything about the stock market bubble during Bill Clinton's second term"

    You guys realize that nothing during Bill Clintons term got passed without republicans right? Bill Clinton was just a veto to the republican ran government. The republicans have owned the US since the beginning of the 80s.

    So yes, its VERY VERY easy to blame "the opposing political party" cause they are the dictators and make the rules.

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  2. Umm, the issue at hand is the enforcement of EXISTING regulations, so Republican control of Congress at the time is irrelevant.

    Clinton re-appointed Greenspan just as Obama re-appointed Bernanke. Once you choose to appoint someone, you bear partial responsibility for their actions -- or lack thereof.

    Besides, today Democrats have complete control of the White House and both houses of Congress. So, your argument fails to explain why Democrats are allowing -- and encouraging -- 3.5% down payments on homes. Low down payments will lead to more trouble eventually.

    Your "dictator" comment demonstrates that when it comes to politics, you're as irrational as the far-right Republicans who keep calling Obama a Nazi.

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  3. Anonymous said...
    "The republicans have owned the US since the beginning of the 80s."

    Wait. What? Democrats had control of Congress during most of the 1980s and early 1990s. Democrats had control of both the White House and Congress from 1993-1994, but blew it. Democrats continued to have control of the White House until 2001. Democrats had control of the Senate from 2001-2002. Democrats have had control of both houses of Congress from 2006-present. Democrats currently have control of both the White House and Congress.

    Are you really trying to argue that Republicans have dictator-like control anytime Democrats don't have complete control? If there's a separation of powers between the political parties, then Republicans are dictators? That's your argument? Seriously?

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  4. You said it all well. I think you should be writing the laws:-)

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  5. ndpwood said...
    "You said it all well. I think you should be writing the laws:-)"

    Thanks. If I can be dictator without being Republican, I'll do it.
    ;-)

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  6. This is yet another attempt to create a false moral equivalence where none exists. It is child's play to dismiss the nonsensical claims about the Community Investment Act and many have done so. It is impossible to do so with the regulatory failures that contributed to the meltdown, most though not all of which are distinctly due to deliberate Bush decisions to refrain from substantive regulation. You do yourself a disservice to engage in this kind of sophistry.

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  7. Dupontguy,

    I was never a fan of the Bush administration. I voted for Gore, Kerry, and Obama.* In 2002 when Bush had a 90% approval rating, I was one of the other 10%. However, blaming Bush for the housing bubble completely fails to explain the stock market bubble during the Clinton years.

    Furthermore, most of the bad behavior that the press has cited occurred post-2003, even though there was clearly a mild housing bubble in 2000, before Bush entered office. Thus, I believe that the bubble caused bad behavior, rather than bad behavior causing the bubble. All bubbles ultimately collapse.

    The Obama administration is currently encouraging reckless home loans with down payments as low as 3.5%. This demonstrates that Democrats will encourage reckless behavior as eagerly as Republicans will.

    Finally, even if Republicans were responsible, do we really want to be dependent on a form of regulation that only functions when Democrats are in power? That type of regulation is destined to fail 50% of the time.


    * Note: 2008 was the first presidential election of my lifetime in which I liked both parties' presidential candidates. It was the VP candidate who determined my vote.

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  8. There's nothing wrong with specific numerical rules for things like mortgage downpayments and bank reserves. But no matter what the rules we need active, motivated regulators. Regulators have failed in both republican and democratic administrations, though I would ceratinly argue that during the bush years that failures were much worse. But the point is that very smart, motivated and powerful banking and financial interests are going to try to subvert or circumvent any regulations that are enacted. So I agree its not about political parties, but effective, independent enforcers are necessary. How that's accomplished is a difficult problem, but someone better figure it out.

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  9. I like the idea of requiring a larger down payment for home buyers but let's face it, in tough times who has the 10 even 5 percent to buy a home? We need to give more incentives to attract buyers and not reward those who have more money to spend. The tax credit of 8,000 to first time home buyers was a way to do that. Close to 40% of homes sold in Colorado this year were bought using this tax credit. EXTEND THE CREDIT PLEASE

    If you can put down 20% you can avoid paying mortgage insurance. Then again, if you can put down 20% you can probably afford mortgage insurance. There are incentives to put more money down and avoid higher mortgage payments, but it is not aimed at the right type of home buyers we need in the market today.

    21 % of our country's G.D.P is based on Real Estate transactions and we need to promote more sales not less. Getting pre-qualified through a trusted professional lender is the best way to get a loan you can afford and not fall behind on.

    Parker Krug Toria Team Coldwell Banker
    www.blogtherockies.com

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  10. "Umm, the issue at hand is the enforcement of EXISTING regulations, so Republican control of Congress at the time is irrelevant."

    So its relevant to bring up Bill Clinton, but not to bring up that he was nothing more than just a veto to a controlling Republican dictatorship government?

    Hey man, I was just saying if you are bringing up his name, why not bring up that he had no power either.

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  11. Supervision vs Regulation

    This post sums up the case for strong regulations, as all of the proposed policies (20% down payments, countercyclical reserve policies, no teaser rates) all deal with issues of regulations for leverage and financial innovation. The post that this repsonded to regarding "Fox guarding the Henhouse" is more of an issue of Supervision . Both are important

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  12. Parker said...
    "21 % of our country's G.D.P is based on Real Estate transactions and we need to promote more sales not less."

    That is false. First, sales of existing real estate don't contribute to GDP. Only new construction does. Second, as of mid-2008 real estate construction made up 7.3% of GDP. Residential real estate construction was only half of that.

    Housing services, which include stuff like rent and owner-equivalent rent, make up about 12.7% of GDP. Add that to real estate construction and you get 20%, which is very close to your claim of 21%. However, note that this does not rely on selling existing homes from one person to another.

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  13. Thanks for sharing your opinions to us ,and in my opinion,you have hit the point.Good!

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  14. Did you see that those scumbags at the NAR are lobbying to get the first time home buyer tax credit extended? http://extendhomebuyertaxcredit.com/

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  15. "Parker said...
    I like the idea of requiring a larger down payment for home buyers but let's face it, in tough times who has the 10 even 5 percent to buy a home? We need to give more incentives to attract buyers and not reward those who have more money to spend."

    I think that's the same logic that got us into the bubble mess in the first place. Seems to be politically incorrect in this day and age... but no one is entitled to own a house, ESPECIALLY someone experiencing tough times. What are the chances that they will default on the loan, perpetuating the whole cycle?

    "Those who have more money to spend" (I would call them savers) SHOULD be rewarded for their fiscal stability with the opportunity to purchase a house at a true market price, not an inflated price buoyed by government spending supported by their very own taxes.

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