Saturday, April 26, 2008

Legislating against predatory lending

I have said in the past that I was all for legislating against predatory lending practices. However, this Forbes commentary makes a good point about the current legislation, which is not very specific, may hurt more than it will help. If you need some background on predatory lending, this this Forbes article provides a lot of background like this statement:

Three market conditions are associated with predatory lending, Musto and his colleagues found: There is little competition among lenders, property owners are sitting on lots of equity and borrowers are poorly informed about risks. In casual conversation, predatory lending usually means a loan that is bad for the borrower. "But this begs the question: How do such loans arise in the first place, when borrowing is voluntary?" Musto and his colleagues write.

To many people, loans with extraordinarily high interest rates constitute predatory lending. Critics often cite payday loans, which charge the annual equivalent of more than 100% for loans in advance of a worker's next paycheck. Loans putting borrowers at high risk of default also are often called predatory. This would include "negative amortization" mortgages that allow borrowers to make very low monthly payments, causing the outstanding balance to grow over time rather than get smaller.

The first article makes the claim that the free market has corrected itself:
When bad loans are made, both borrowers and lenders are punished--and must correct course. Observe that Wall Street financial firms and direct lenders who engaged in lax lending are suffering huge losses (such as Merrill Lynch's (nyse: MER - news - people ) $8 billion loss) and internal upheaval--and have changed their practices accordingly. The number of subprime, adjustable-rate mortgages has declined by 50% this year. As for the middlemen who tried to make (and often succeeded in doing so) a quick buck on dubious loans, their reputations are sullied and their business has dried up.

While I believe that it is the case that the market has corrected itself for now, what is to prevent it from getting back this way. These practices have cost everyone in the US money as taxpayers are bailing out the mess that the commercial lenders created. How can we ensure that we do not again get in a situation that our taxes will be used to bail out predatory lenders? The only way I can figure to do that is through legislation. Maybe this legislation isn't the right legislation, I must confess to not having read through it, but I don't again want to pay for these bank's mistakes.

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