Market Deja Vu and Accountability

This was posted on the Banking Law Prof Blog today:

It's the dot com bubble, it's the '80s s&l crisis, it's what happens when people don't follow prudent lending and investment principles.

What we're seeing now in the subprime market is the result of poor credit underwriting standards. Bankers know better. Regulators know better. Even borrowers know better (if they can decipher the fine print). But when the economy is good and there are more dollars chasing loans than there are prime loans to be made, it's "Let the good times roll!"

From the lenders' perspective: After all, these subprime loans yield a higher interest rate in a banking world experiencing ever narrower interest-rate margins (the difference between the interest rate lenders pay for deposits and other funding sources and the interest rate they receive on loans). In a low-interest rate environment, many borrowers can and do make the monthly payments. Lenders are looking for new markets -- and here's a big one.

From the borrowers' perspective: The American dream is owning your own home. And it looks so easy when lenders are aggressively seeking out borrowers with "less than perfect credit". Many borrowers have gambled that rising home prices and low interest rates will continue. Few really take to heart what will happen if the loan reprices in two to three years.

From the regulators' perspective: Providing "guidance" should suffice. No one likes a heavy-handed regulator -- and there is competition for charters and Congressional oversight to consider. There's no immediate problem to address. The free market will sort this out. Should there be isolated issues, informal non-public measures avoid creating a generalized atmosphere of panic and possible adverse business consequences for a given lender or for all lenders -- and may avoid the extreme case: "runs" on a financial institution.

I strongly agree with most of what Professor Graham says. The only thing I would comment on is the tone of the note on the regulators' perspective. It sounds like she would be in favor of a more "heavy-handed" approach. While I can understand in this environment that more regulation might seem good...I really disagree. I place the burden on the bankers and the borrowers. They are intelligent people. Bottom line is that, if you can't afford a monthly payment, don't borrow money. If you can't afford for someone to default on a high interest loan, don't lend them the money. People are ultimately responsible for their own actions. They need to recognize the affects on society as a whole...that is what being a responsible citizen is all about. But people do not need to be regulated into stupidity. Learn from your mistakes and move on.