Consider another regulatory example. In the 1920s, anyone who had a bathtub and a few boxes of chemicals could be a pharmaceutical company, and the company could make any claims they wanted about cures. Products sold in the 1920s, according to the manufacturers, cured cancer, hair loss and every other sort of malady. In a market like that, no one invests in research and development. No one invests in developing products that work better for consumers because they are competing with snake oil.
“We have had change in financial services, but not consumer-oriented innovation.”
When regulators started taking the most dangerous products off the market and forcing a lot more disclosure in the pharmaceutical industry, companies started investing in products that really worked for consumers. I see the same kind of thing over in the financial services market.
We have had change in financial services, but not consumer-oriented innovation. 2/28 mortgages were sold to people who did not understand that in the third year, if the market was not rising, they would lose their homes. That's not an innovation. That's a new business practice that doesn't help consumers and it doesn't help result from a competitive market.
Am I being clear?
Definitely. You're saying it's the kind of thing that's an implication in a loan paperwork, but it's not spelled out.
Exactly. It's there, somewhere buried in here. Let's go run a survey: How many people, a) will know if they had a prepayment penalty in their mortgage, and b) will understand the implications of it?
You and I both know that prepayment penalties are a way to fool people about pricing. They may also have other functions in limited circumstances, but the innovation in the marketplace over the last few years was to use prepayment penalties as a way to mislead people about pricing and risk. Prepayment penalties were what permitted the companies to lend to people knowing that those people could not afford to pay this mortgage in the third year.
When the industry says, "The new consumer agency is going to stifle innovation," I think they have it exactly backwards. The agency opens the door to innovation, at least the innovation that will be helpful to consumers. It will drive out the kind of tricks-and-traps pricing that rewards the lenders who can come up with product that fools the maximum number of people.
Kind of reminds me of psyching yourself up to shop for a car. You feel like, "Oh my gosh, I'm in for manipulation and all sorts of psychological tricks."
You put your finger on another important issue: the importance of consumer confidence. When I put money in a bank, I have a lot of confidence that I'll be able to get it out on the other side. And look how well that has worked for us. We know that there are still a lot of shaky banks out there, and yet there has been almost no run on the banks as people try to withdraw their money from their savings accounts or checking accounts. People still write checks and those checks pass through the system. Consumers have confidence in the system. They know that it's an honest and straight-up system, and that as long as it's an FDIC-insured bank, they're fine.
The analogy breaks down a little with credit. We all understand that if you're borrowing money, you're taking on risk. You could lose your job tomorrow, the market could fall out, the housing market could fall. Those are risks that families take on.
“Prepayment penalties are a way to fool people about pricing.”
But not so long ago, no one thought they were taking on a risk that -- even if they made all their payments on time, and even if they filled out all the paperwork honestly and they continued to have their jobs -- that they would wake up one day and their mortgage payments would have shot up by several hundred dollars and no longer be affordable.
Bad actors in the mortgage industry not only changed industry practices but changed consumers' understanding of the home buying transaction. No one knows what the long-term cost of the loss of trust is going to be.
Today lenders work to hide their revenue enhancers so that there's no direct competition in this marketplace. This marketplace is broken. It's broken for credit cards, it's broken for mortgages. It's broken for all of these consumer products where the model has shifted way from making the price and the product clear up front and doing a head-to-head competition in the marketplace that benefits consumers.
We have a window of opportunity to fix this. Right now people recognize that this market didn't work. I think that there's a shot to try to clean things up. The question is: "How?" We can pass more laws that say you can do this kind of thing and you can't do that kind of thing. Or we can push toward a real reform that makes the market work again.
The irony is that I want just enough regulation to get this market working again. I want this market to work the way that most of the other markets work. Regulation can work. We sometimes complain about the FDA, for example, but the problems are at the small margins. Does anyone want to go back to a world with no FDA? A world where anyone can sell any product that they can brew in a bathtub?
Do we want to go back to a world in which there's no Consumer Product Safety Commission and anybody can put out something and call it an infant car seat, even if it collapses on impact?
Regulation pushes those kinds of products out of the marketplace so that competition works for consumers.
There are a lot of people who are alive today because of the Consumer Product Safety Commission and the FDA. And there are a lot of people who are financially dead because of a broken mortgage market.
We can do better.