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HR 3915 Is Dangerous

HR 3915, The Mortgage Reform and Anti-Predatory Lending Act of 2007, was introduced by Barney Frank, (D-MA). Congressman Frank is also the Chairman of the House Committee on Financial Services. I outlined the key components of the bill with a link to the text here.

The danger behind this bill is that it doesn’t regulate the proper parties. When you read through the text, you’ll discover that there are two entities that are shouldering the brunt of the blame for the meltdown of the sub-prime mortgage market: originating firms and Wall Street securitizers. The bill stops short of levying any responsibility to the two most interested parties: borrowers and lenders (the individual investors). This bill exonerates them of the responsibility of due diligence.

Experience is the best instructor. An investor needs to lose 10% of his mortgage pool investment and a borrower needs to have his home foreclosed. That experience will instill a sense of personal responsibility in both parties. While loss of investment principal and foreclosure are devastating experiences, the old adage “time heals all wounds” truly is appropriate.

Jane Shaw, discussing Public Choice Theory:

Public choice takes the same principles that economists use to analyze people’s actions in the marketplace and applies them to people’s actions in collective decision making. Economists who study behavior in the private marketplace assume that people are motivated mainly by self-interest.

Ms. Shaw further exposes the dangers of regulation to correct market failure:

In the past many economists have argued that the way to rein in “market failures” such as monopolies is to introduce government action. But public choice economists point out that there also is such a thing as “government failure.” That is, there are reasons why government intervention does not achieve the desired effect.

This bill will provide a false sense of security to the consumer and encourage even more irresponsible behavior. Rather than let the instructional nature of failure naturally correct the market, the regulation would contract the industry so as to dissuade innovation and competition. The scoundrels will fleece the ignorant under the protective cloak of a highly regulated industry- it happens on Wall Street daily.

Big lenders will support this bill because it allows them to narrow the eye of the needle through which future borrowers will pass . Ms. Shaw illustrates this theory with the anti-competitive nature of the Clean Air Act of 1977; the polluters, in Rust Belt states, screamed for regulation so that the more nimble Sun Belt firms couldn’t open. The regulations protected the very scoundrels who should have been allowed to fail.

Peter Van Doren illustrates this theory, applied to banking, for the Cato Institute:

Supposedly, banks are regulated and bank deposits are insured to correct defects in the market for information about the quality of banks’ investments. But, again, recent scholarship indicates that the threat of runs on banks induces banks to make sounder investments. And healthy banks can form private associations to insure one another against runs that are motivated by fear, not facts. Even in the Depression, most banks closed by runs were insolvent and should have been closed. Instead of making banks sounder, regulation (especially restrictions on branch banking) and deposit insurance simply allowed smaller (and usually weaker) banks to survive against their larger and more efficient competitors.

This is why the scoundrels support this bill. A free market would allow for upstart competitors to gain market share from the wounded giants. Rather than suffer from their poor lending practices, big lenders will benefit from the high barrier to marketplace entry this bill promotes.

Allow failure. Foreclosed borrowers will think twice about leveraging up their next ranch to buy a Hummer. Investors will demand that lending decisions fall within acceptable risk parameters. If we deregulate the lending industry rather than tighten the laws, the American homeowner and American investor will emerge from the protective cocoons of ignorance as beautiful butterflies. Pass this bill and they will emerge like moths, serially attracted to the only source of light they know.

That light is government promoted ignorance.
 
 
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