When Creditors are Predators

from The American Prospect:



When Creditors are Predators
We need to regulate to assure that loans work -- and stop the loans that work people over.

Tim Fernholz | August 10, 2009


"How many people remember the sub-prime crisis of 1991-1993?" William Black asked me the other day. Black is a longtime federal regulator turned economics professor. We were talking about how the collapse of the housing market in 2006-2008 catalyzed today's Great Recession.

"It's a trick question," he continued. "The same stuff was developing, all the non-amortizing loans, all the qualifying of borrowers at the teaser rate. We killed it by regulation, and there was no crisis, period. There were maybe two or three failures of institutions, but hardly in the way of that, either. It always starts out fairly small, and if you squash it when it's nice and small, there is no systemic problem at all."

Nobody squashed our current crisis, which has been building for nearly a decade. The tale of bad incentives and free-market profit-maximizing gone wrong is, by now, familiar: Dubious loan products created an artificial demand for buying and building homes. This all created a huge bubble in the housing market; when it inevitably popped, a financial sector, swollen by deregulation, crashed down with it, starting the self-reinforcing cycle of deep recession. Businesses unable to obtain credit laid off workers, and workers, already overburdened with credit-card debt and stagnant income, defaulted on loans of all kinds, further damaging banks.

As the administration attempts to deal with the immediate effects of the crisis, the next task is figuring out how to realign the bad incentives in the financial industry through regulation. Rep. Barney Frank passed legislation in the House, now awaiting Senate consideration, to prevent predatory mortgage lending, and President Barack Obama has signed legislation limiting credit-card practices that hurt borrowers. These efforts are a start, though consumer advocates want the government to go further. But the premise of all this legislation is relatively simple: We need lenders to profit when loans succeed, not when they fail. That idea needs to be the centerpiece of the next era of consumer regulation. ..........(more)

The complete piece is at: http://www.prospect.org/cs/articles?article=when_creditors_are_predators