Legal Commentary

More Regulation of Mortgages would Likely Hurt Consumers-Becker

By Gary Becker

No doubt many consumers made mistakes in their credit decisions during the past few years, perhaps especially in the mortgages they chose. It is equally clear that many lenders wish they had never given the mortgages they gave since they lost their shirts by doing so. Does any of this mean that a commission to protect consumers would be a welcome piece of legislation?
I am first of all dubious that consumers would have behaved much better if they had simpler contracts, or had the terms better explained to them. The fundamental problem is that consumers are generalists who must make thousands of decisions in highly different areas. As a result, they rely not only on their own limited knowledge, but also on competition among producers to help protect their interests. When that breaks down, as in the housing bubble, many consumers get hurt, but overall it is an excellent strategy for those who must make so many decisions based on quite limited information.
Even if we agree on the above analysis, some will argue that a consumer "czar" would help protect the interests of consumers who make mistakes that markets fail to correct. For after all, the czar and other members of her commission would be specialists in consumer issues that might enable them to discover and correct consumer mistakes. This type of analysis is behind the "libertarian paternalism" in the book "Nudge" by Cass Sunstein-a former colleague and the present regulatory czar-and Richard Thaler, a colleague at the University of Chicago.
A realistic view of the political process casts strong doubts on whether this is how such a commission would actually operate. Many political decisions are the result of a fierce contest between interest groups with different positions, as we are seeing clearly now in the fight over how health care delivery in the United States should be changed. In these battles, producers, like health insurance companies and doctors in the health care case, are much better organized politically than consumers.
Producers can more easily coordinate their actions politically since they are usually either relatively few in numbers- as with health insurance companies- or they have effective trade associations that push their agendas, as with the farm lobby or the American Medical Association. Moreover, since what gets passed can greatly affect the livelihood of producers, they have a strong financial interest in getting legislation that helps them, or at least does not do much damage.
The emphasis on consumer ignorance and mistakes makes it harder, not easier, for consumers to act as an effective political counterweight to the political power of producers since they supposedly do not fully know their own interests. So I would expect producers, such as issuers of mortgages or credit cards, to be able to manipulate in their own favor any attempt by the Commission to push regulations to help consumers. These advantages that producers gain from regulations have been called the "capture theory" of regulation in the political economy literature. In the case of consumer ignorance, capture by producers of the regulators is even more harmful to consumers since consumer regulations are likely to end up exploiting, rather than combating, this ignorance in order to benefit producers, the way a private monopoly exploits consumer mistakes.
The cigarette settlement with the State Attorney Generals is a good example. Cigarette manufacturers paid billions of dollars to the states based on present and future production, even though they were being penalized for the harmful effects of past smoking. They got a settlement that also taxed potential new cigarette producers, so that cigarette producers were able to raise prices in response to the tax. In fact, prices went up by considerably more than the additional tax per unit. This enabled producers to recoup most of their payments to the state governments. But smokers paid a lot for the settlement through the much higher prices they had to pay. Perhaps that was desirable in order to cut smoking, but producers got off quite cheaply, and the poorer individuals who tend to smoke a lot were hit heavily by the settlement.
I am dubious about this proposed regulatory commission for all the reasons Posner gives. In addition, I have argued that the Commission, whatever the intentions of Congress, the President, and members of the Commission, is likely to end up furthering the interests of mortgage companies, credit card issuers, and other producers at the expense of the very consumers it is supposed to be protecting.

Full post as published by Becker-Posner Blog on August 30, 2009 (boomark / email).