So the FSA have greatly extended their regulation of mortgages.  Some people wanted them to be tougher (e.g. Which?) and others fear the unintended consequences (see same link). The Telegraph are concerned that ‘Home owners will be forced to disclose how much they spend on alcohol, tobacco and even summer holidays when they apply for a mortgage’, and also mention the (understandable) risk that some people will be frozen out of the market.

The FT likes it. “The FSA’s new proposals for regulating the residential mortgage market are crude. But they should, nonetheless, be welcomed.”

But Vince is deeply sceptical, while at the same time teasing out the philosophical point I would like to raise:

Should borrowers and lenders be protected from the consequences of their mistakes? That is the big question that underlies the Mortgage Market Review issued yesterday by the Financial Services Authority. It would normally be a no-brainer; in a free society, borrowers and banks alone should be responsible for their actions.

Having decided it is a some-brainer, he argues that the FSA does not go far enough.  I say ‘argues’ but maybe it should  be ‘asserts’ – because I am not sure if what follows is really an argument.

Banks lent money like houses could never fall.  They got it wrong.  We had to bail them out.  The shareholders were 90% wiped out.  Some of the managers got out, some got humiliated.  Some foolish borrowers are now struggling.

These things we all know.  Some of them point to market failure, but I would argue that they are the ones where the bank got to (a) sell on their risks and (b) rely on the government bailing them out if they went wrong.  Neither directly concern the relationshp between lender and borrower.  In both cases, there remains an excellent incentive NOT to be stupid – you end up in negative equity/County Court Judgement Land/lending money you don’t get back/buying a security you can’t sell.

The problem is that on a systemic scale these issues spelled trouble for us, the taxpayer, not the banks.  If the banks had had enough capital, this would not have been a problem – then their problems would have been their problems, not ours.  Their profits would have been lower, their implicit insurance from You and me would have been lower, and their own natural incentives might have prevented them from setting out in a business to do stupid things.

What is really interesting about Vince’s argument is that he talks, at length, about how the housing market is overvalued, and finance not going to the right places:

There nonetheless appears to be an unmet demand for mortgages, one that is currently being held at bay by large deposit requirements . . . Any eagerness to return to former lending practices should be a source of concern. The housing market has not adjusted, at least yet, to realistic levels. . .  The regulators must operate from a broad national-interest perspective. At present there is a national interest in banks increasing business lending on reasonable terms to solvent small and medium-sized companies because many businesses are being forced to contract production and employment through a lack of credit . . .It is less obvious that there is a national interest in pumping up the housing market again. A revival of asset prices helps the balance sheets of banks, but creates bigger obstacles to first-time buyers and those on modest incomes.

First, notice the bit in bold.  It might mean ‘people are madly speculating’, but I suspect it means “there are more people needing a house than there are houses”.  Which is surely right. But then he later writes “It isn’t sensible to run up large personal debts gambling on future house prices. Property speculation is not a productive industry.”

I agree with many of Vince’s points, but question whether micro-regulation of the relationship between individual borrowers and lenders is the way to deal with the MACRO problem of housing supply and housing demand and too-high prices.  It would be bad to get another housing bubble, but if we are making few houses than we need, how can it be avoided – fairly – by frustrating the demand of marginal buyers? Loan sharks, etc will flourish.   Instead, we should look at: freeing up supply, dealing with institutional Nimbyism (see the Tim Leunig paper, right), a Land Tax, and so on.

Regulating micro to deal with a macro problem is a strange approach.

With this in mind, an excellent letter to the FT makes a similar point:

Sir, The public holds so devotedly to the belief that regulation is the solution to all our woes because of the rudimentary errors being spread by experts like John Kay (“How the skies proved the limits of regulation”, October 14).

Prof Kay says it is obvious that civil aviation must be regulated because, while an airline that did not maintain its aircraft would acquire a poor reputation after its planes crashed, that is rather too late for the victims. But the very anticipation of such an outcome is enough to constrain careless behaviour from the outset. Does Apple have to learn by experience that selling empty shells as computers will harm its long-term profits? Does Nike try to cut corners by forgetting to include shoelaces?

I would far rather trust my life to a company striving to protect and enlarge a billion-dollar investment, than to a whole department of civil servant jobsworths motivated by the desire to deflect criticism and dodge blame.

The problem is not that borrowers and lenders did things they should not be allowed to do.  The problem – in the case of the lender – is that they were able to anticipate the problem being someone else’s – the mug security buyer or the government.  Deal with that, and you can then let people alone to make their own mistakes.

(Written in 9 minutes so apologies for errors and misjudgements.  Revisions to follow).

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3 thoughts on “Do we need protection from ourselves?

  1. I can see a rationale for regulating particular types of mortgages when they are a large share of the banks lending, since then they can threaten the bank, and so tax payers, but none for regulating them if they are a small share (i.e. they do not theaten the bank even if they all go wrong). Self-cert, on a small scale, is a perfectly reasonable product to offer.

    (At peak I once had mortgage debt of 7.87x gross household income, but, given my circumstances this was perfectly sensible. I also once ran an overdraft of approx 1.8x gross personal income, which again was perfectly sensible in the circumstances)

  2. Definitely.

    By the way, I thought you gave a good account of yourself on that BBC2 programme. JP utterly failed to engage with the difference between North and Northerners

  3. Congratulations on your deserved award, Giles. Good to see others understood the value as well as the excellence of your publication.
    This post points the torch in another valuable direction and is actually linked, I think, to the large question about how one might, at a suitable time, reduce Government Expenditure which will be not only helpful economically but essential if diversity, openness and liberty are to flourish.
    Changing the scale of Government, must be a case of cultural change in the relationship between the citizen and the state. The matter of protection, is about changing attitudes on an individual basis to risk, responsibility and self government issues right at the heart of freedom. But each act at that level adds up to the sum of state activity.
    The letter from the FT that you quote is very helpful. Maybe what is required is a test of where public protection is required and where it serves only to make people less able to self assess risk, take responsibility and practice self government.
    Do we want public health inspectors looking at practices in cooked meat shops?
    Do we want public wealth inspectors looking at bank lending and personal borrowing practices?
    Too much makes us dependent, too little removes the benefits of being members of communities.

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