{"id":283712,"date":"2010-02-05T11:15:26","date_gmt":"2010-02-05T16:15:26","guid":{"rendered":"tag:business.theatlantic.com,2010:\/\/3.35272"},"modified":"2010-02-05T11:06:55","modified_gmt":"2010-02-05T16:06:55","slug":"should-individuals-be-regulated-like-wall-st-banks","status":"publish","type":"post","link":"https:\/\/mereja.media\/index\/283712","title":{"rendered":"Should Individuals Be Regulated Like Wall St. Banks?"},"content":{"rendered":"

Since the beginning of the crisis, the debate on financial regulation has focused on placing limits on financial services firms’ behavior, based on the idea that the government has to protect Main Street from Wall Street. Recent history suggests that bankers lack the incentive or will to avoid unsustainable, economically disastrous, and downright predatory behavior.<\/p>\n

But just as a securities trader can focus on short-term profits and
\nignore the incremental systemic risk
\nintroduced with each transaction, the average American often
\nignores the incremental risk he incurs with his own financial behavior — each credit card
\nopened, or each mortgage refinance. If we acknowledge that bankers lack the will-power to judge how much is too much*, then we must acknowledge the same failing in the common man, who lacks the banker’s financial background.<\/p>\n

The average American deserves protection not only from Wall Street, but also from himself. What if, hypothetically, we imposed regulations on individuals similar to those imposed on banks?<\/i> Here are three ideas for saving average Americans from our own worst impulses.<\/p>\n

First, the government should require borrowers to make at least 20% to 30% down payments (twice what Congress is asking) on residential real estate, unless the potentially borrower has income and\/or savings sufficient to cushion against significant home price depreciation. Interestingly, after I began this experiment, the FHA announced “more stringent” requirements for certain borrowers, as the WSJ<\/a> points out:<\/p>\n

The FHA will keep minimum down payments at the current 3.5%
\nlevel for most borrowers. But the agency will require riskier borrowers
\nwith credit scores below 580 to make a minimum 10% down payment. While
\nthe FHA doesn’t have a credit-score cutoff, most lenders require a
\nminimum 620 score.<\/p>\n

Some housing analysts have pushed for higher down payments on
\nFHA-backed loans, and a bill in Congress would raise down payments to
\n5%, from the current 3.5%.<\/p><\/blockquote>\n

It looks like the Government is making steps in the right direction, but I don’t think its nearly enough.  First Fair Issaic<\/a>
\nreports that ~13% of the general population has a FICO score below 600,
\nwhile Experian reports ~20% are below 619. I’m curious why the new FHA rules would require the riskiest 10% – 20%
\nof borrowers to put only 10% down when buying a home (whether credit
\nscoring is an accurate or appropriate measure to use is another
\nstory). Most data suggests
\nlow-“quality” borrowers are long-term risks for lenders, and this is especially pertinent since the subprime meltdown. Thus, the government should mandate that high-risk
\nborrowers must exhibit verifiable and stable high income and\/or put
\ndown 20% if not 30% equity at closing. <\/p>\n

Critics of this approach may
\nargue that riskier borrowers compensate lenders by paying higher
\ninterest rates. But the same critics often fail to acknowledge that
\nbringing more equity to the table generally helps the borrower — with a
\nlarger cushion against declines in home prices and lower monthly
\npayments. A higher interest rate hurts
\nthe borrower by imposing higher monthly payments, the bulk of which
\nwill be allocated to interest for the first few years of the loan,
\noften the riskiest ones. Indeed, we’ve seen that ARM recast\/resets
\nhave accelerated delinquencies, and in some cases, defaults.<\/p>\n

This approach would correct biases — like
\nborrower over-confidence — that are often discounted or ignored by lenders. If a potential borrower can’t afford the higher
\ndown-payment, they should find an affordable rental in the short term. Chances are the amount they’d spend on rent
\nwill actually be roughly the same (and perhaps, less than the) amount
\nof interest many low-quality borrowers would otherwise pay in interest
\nover the first few years of the mortgage, when only a tiny portion of
\nthe monthly payment gets allocated to principal reduction.<\/p>\n

Second, we should implement interim safety limits over the course of the loan. For example, if a borrower already has 6x debt\/income and wants to
\ntake-on more debt, he or she would have to either put up more
\ncash or exhibit increased earnings so that ratio wouldn’t increase with
\na higher loan balance.  If the borrower doesn’t have the cash on-hand
\nor higher earnings, they can reduce their discretionary spending for a
\nfew months (years) to repay their existing debt.  Such regulation would
\nnot only protect existing lenders from increased default risk, but it’d
\nprotect borrowers from predatory lending standards. It’s
\nfair to ask what would happen under these regulations in an
\n“emergency” situation?  Here, I’m not sure, but riddle me this: how
\nmany such situations are caused, or at the very lease exacerbated by
\nyears, if not decades of financial irresponsibility?  <\/p>\n

The third and most crucial regulation is that
\nloan originators should be required to scan copies of official
\nclient-provided income, indebtedness, and net-worth information to a
\nclients’ electronic file. The originating broker should be
\nresponsible for personally inputting this information into the firm’s
\nloan application system and, verifying its accuracy.  Then,
\nbased upon government-imposed maximum indebtedness, coverage, etc, the
\noriginator could decide, based-upon their own scoring, how much debt
\nthe borrower is capable of handling, any amount up-to, but not
\nexceeding the government-regulated number.  These firms should have
\nstrict compliance and internal controls, empowered internal and
\nexternal audits, and random federal inspection to ensure they aren’t
\nabusing regulations, as well.  <\/p>\n

In much of my prior work I’ve expressed significant skepticism of our government’s ability to not only create effective regulation, but to
\nenforce it with any success, especially during those times when its
\nneeded the most.  While I’m no fan of creating more government
\nbureaucracy, I don’t see a reasonable alternative. As much as I’m loathe to admit
\nit, the laissez faire approach has failed. We return to the status quo at our peril.  <\/p>\n

Would all this added red tape make it more difficult than in
\n2004-2006 to obtain credit?  For many people, absolutely. But look what happened when we let firms and
\nindividuals obtain virtually as much debt as
\nthey cared to take-on. We came precariously close to destroying the
\nentire global financial system! Surely, GDP growth may suffer as
\nexpectations for consumer spending and home-price appreciation revert
\nback to non-bubble-period means, but we’d be making a marginal
\nsacrifice today in exchange for a much safer financial system down the
\nroad, one that would be far less at-risk of credit-fueled boom\/bust
\ncycles.  <\/p>\n

The ideas expressed here are admittedly nowhere near perfect. But the financial regulation debate deserves honesty. We must accept the fact that the crisis
\nwasn’t caused just by bad actors on Wall Street, but by Main Street, as well.<\/p>\n

_________________________________<\/p>\n

*I’ll be the first to admit that one would be hard-pressed to make the case that Wall Street is even tangentially concerned with the “greater-good,” so long as its making money.  While he’s even more cynical than I, The Epicurean Dealmaker<\/a> captured what many observers fail to realize:<\/p>\n

Investment bankers have almost no interest in why things are the way they are. Rather, they spend all their considerable intellectual and psychological resources on understanding how they can take advantage of the way things are.  <\/p><\/blockquote>\n

This may be a bit of an over-simplification, seeing as TED, myself, and several others who work(ed) in Finance do exactly that which apparently we do not, but as the recent FCIC hearings illustrated, TED’s description certainly seems to apply to those at the very-top of the game.
<\/span>
\n

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\n\"\"<\/p>\n","protected":false},"excerpt":{"rendered":"

Since the beginning of the crisis, the debate on financial regulation has focused on placing limits on financial services firms’ behavior, based on the idea that the government has to protect Main Street from Wall Street. Recent history suggests that bankers lack the incentive or will to avoid unsustainable, economically disastrous, and downright predatory behavior. […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[7],"tags":[],"class_list":["post-283712","post","type-post","status-publish","format-standard","hentry","category-news"],"_links":{"self":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts\/283712","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/comments?post=283712"}],"version-history":[{"count":0,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts\/283712\/revisions"}],"wp:attachment":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/media?parent=283712"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/categories?post=283712"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/tags?post=283712"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}