The Pandora’s Box of financial regulations
Glenwood Springs, Colorado CO
The Law of Unintended Consequences is part of that pantheon of statutes written into the fiber of human existence, like Murphy’s Law, that we would love to repeal if we could.
It’s never been more apparent than in the three-year frenzy of policy makers and politicians to right wrongs and quell the financial excesses resulting from the Great Meltdown.
The Dodd-Frank Act is the federal legislation enacted to remake the financial and banking landscape so that greed can never again bring the world to its economic knees (good luck with that one).
The LUC statute is painfully apparent in the effects of Dodd-Frank, which, just in terms of wordage, is one of the most extensive laws ever written. And that’s just the tip of the iceberg: the law left the task of writing the regulations to enforce the law up to federal regulators in the various agencies and departments.
The regulators, being regulators, and surprise, surprise, also human, are going to cover their you-know-whats. They’ve written draconian regs that have often had the effect of stifling credit just when it’s needed most. There’s a proposal on the table right now that, as LUC would have it, could result in some pretty bizarre consequences.
On April 10, the director of the Federal Housing Finance Authority gave a speech to the Brookings Institute in which he revealed that an agency study had indicated that Fannie Mae and Freddie Mac could save a ton of money for the insolvent entities, and thus for the taxpayers, by simply reducing the amount owed by defaulting underwater borrowers rather than foreclosing.
You may have heard about it. If you haven’t, a lot of your neighbors have. Mortgage lenders’ phones are buzzing as homeowners try to find out how to take advantage of what they think is already a program in place. (It’s not yet.)
What a wonderful idea! What a great way to stimulate the economy! And it’s a charitable, heartwarming thing to do. But the gentleman was smart enough to see those unintended consequences.
He used terms like “moral hazard” leading to “strategic default.” Meaning that human nature will raise its ugly head. Think about it: You know that the equity in your home has disappeared, but you’re still trudging along, making your payments on time. Maybe you say, “Hey, why not? You gotta live somewhere.”
Or you figure it’s stupid, but, a deal’s a deal, a promise is a promise, so you make the payments as long as you can afford it.
Or, just maybe, you’ve scrimped, cut every corner possible, maxed out your credit cards, and pulled the kids out of private school, because you really don’t want to lose your home and tell the family that you got your house taken away from you.
And you learn that there’s a program out there that will reduce your mortgage by a big chunk and your payments as well, and all you have to do is stop making your payments. Tempting, isn’t it?
There’s another consequence that the director sees, and it’s one the banks would probably love. Rough estimates show that as much as 50 percent of Fannie and Freddie loans have second mortgages behind them. Reducing the principal balance of the first makes it easier for the borrower to pay off the second, thus benefitting the second holders (banks) and whacking the taxpayers.
Maybe the balance of every Fannie- and Freddie-owned loan should be reduced. Now that would be a stimulus to the economy, a bill to the taxpayers, and a chain of unintended consequences reaching from here to Siberia.
When fixing the economy, it’s well to remember all of those natural laws, like Murphy’s, the Law of Supply and Demand, and so on. As well as one from physics: For every action, there’s an opposite reaction.
Pat Dalrymple is a valley native. He’s been in the mortgage and banking business since 1961. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
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