George Mason University professor Todd Zywicki offered his own interpretation of the financial crisis at a recent CATO Institute event, “Did a Lack of Consumer Protection Cause the Financial Crisis?” Other speakers at the event included Janis Bowdler, Deputy Director of the Wealth-Building Policy Project at the far left National Council of La Raza; Former Federal Reserve Board economist Thomas Durkin, and Ed Mierzwinski, U.S. PIRG’s Consumer Program Director.
In his presentation Professor Zywicki argued that “The subprime problem was an ARM [adjustable rate mortgage] problem not a subprime problem.” He referred the audience to handout he had distributed containing graphs detailing mortgage default rates, interest rates and other financial data.
“What do we see [in this graph]?” he asked. “Subprime ARM mortgages foreclosures explode.”
“What about subprime fixed rate mortgages?” he said (emphasis added). “What you see is [that] subprime fixed rate mortgages foreclosures did not rise.”
Similarly, Prof. Zywicki said, “Prime adjustable rate mortgage foreclosures actually rose faster as a percentage rate than subprime adjustable rate mortgages.”
Prof. Zywicki told this correspondent that his foreclosure data was purchased from the Mortgage Bankers Association, while “the data on interest rates comes from HSH [Associates Financial Publishers] research.”
“When consumers rationally respond to incentives, that is not a consumer protection problem,” argued Professor Zywicki at the CATO event. He asserts that the financial crisis came in three waves, started initially by a “drunken” Federal Reserve policy.
In the first wave, he argues, “monetary policy created a big gap between long term interest rates on thirty-year fixed-rate mortgages and short-term interest rates for adjustable rate mortgages and everything else that went along with that.” Therefore it was rational for consumers, as they have historically done, to prefer ARM mortgages over fixed rate ones because of cheaper prices, he said. “Then, on the back side, the Federal Reserve ratcheted up interest rates again to the prevailing level [of] thirty-year fixed-rate mortgages,” he said.
The second wave, Prof. Zywicki argued, was caused by the “option model” where “Every month you’ve got a decision. Do I continue to pay my mortgage and if I continue to pay my mortgage in the end I can buy the house, or do I stop paying my mortgage and basically give the house back to the bank?” Some homeowners who primarily viewed their homes as investments had little incentive to stay in a home which was “underwater,” or worth less than its original purchase value.
“As we see in states like California and Arizona, which are states that have so-called anti-deficiency laws, or non-recourse laws, that if you stop paying your mortgage the bank is limited to taking your home back. They can’t sue you for any amount you owe on your—any more [than what] you owe on your loan,” he said. “Estimates over time vary, but basically what we find is in the neighborhood of two to—the foreclosure rate is two to three times higher in a state that has an anti-deficiency law when house prices go down.”
Prof. Zywicki’s handout stated that if California, Florida, Nevada and Arizona were excluded, the national foreclosure rate would be 1.01% and that these four states composed “46% of foreclosure starts.”
The third and ongoing wave, he argued, is where “the fastest rising group of home foreclosures are now our traditional prime-fixed-rate mortgages…” He attributed this to “traditional macroeconomic problems like rising unemployment” and that “people become much more reluctant to stick it out, even in that situation when their home is underwater.”
“None of those [things] have anything to do with consumer protection,” he argued.
Mierzwinski, representing U.S. PIRG, noted that the Cato Event that U.S. PIRG and the National Council of La Raza are “both part of Americans for Financial Reform, the leading coalition seeking to rein in Wall Street, stop the reckless bankers, and protect consumers, taxpayers and main street from their actions…”
U.S. PIRG is a “the federation of state Public Interest Research Groups (PIRGs)” and “stands up to powerful special interests on behalf of the American public, working to win concrete results for our health and our well-being,” according to their website.
Bowdler argued that predatory lenders had steered the Hispanic community away from prime loans into subprime loans and had “built-in traps” in their mortgages which made defaults inevitable. “The products themselves were built on the belief that the bubble would continue to expand forever and there was pretty much no way that your average first-time homebuyer was going to be able to detect that,” she said.
Durkin suggested a “simpler goal” for reform where not everybody is completely informed but “people know to go to institutions that are functioning in a competitive marketplace.”
“We don’t want to drive away the good institutions because the regulation is so difficult and they’re badgered and have problems with regulators that are so great that the major institutions, the ones that have a vested interest in developing a reputation for good dealing in the marketplace, are driven away from it,” he argued. “Then what you do is you end up with friendly Bob on the corner.”
Bethany Stotts is a staff writer at Accuracy in Academia.