Amar Bhide has produced a compelling Hayekian argument about underwriting efficiency and financial regulation, summarized here. His essential insight is that lending is not a process that is conducive to mechanization and centralization, suggesting that efforts to do so are at the heart of the subprime mortgage bubble and the current foreclosure fraud calamity. It’s certainly the best argument I’ve heard against retail bank concentration.
So, while I don’t agree with all the conclusions that Bhide draws from these premises, I do wish more conservative thinkers would recognize the importance of information in financial transactions, since it’s really at the heart of debates over how we regulate consumer financial products. Consumers are almost always suffering from a major asymmetry in information when they purchase financial products, for reasons both prosaic (lenders inevitably have more experience dealing with these products than the purchasers) and pernicious (banks go out of their way to make loan agreements harder to understand and easier to change without notice; it’s very difficult to compare the costs and benefits of different credit products).
Conservative commentators often don’t acknowledge these realities; or when they do, usually after buying a mortgage, they suggest that it is a failing on the part of the consumer; either they should learn to understand these things or not get credit. But the impact of this information problem is felt by all of us, not just people victimized by bad consumer products, and ignoring it won’t make it go away. Nor is there a “free market” solution -- the problems we’re seeing, in fact, are the free-market solution: Businesses will maximize profit up to the point where there actions are forbidden by law or made prohibitive by cost.
The liberal response, thus far, has been the Consumer Financial Protection Bureau, which is designed to improve the market by making disclosure useful, prohibiting certain business practices and enforcing principles that Bhide would be inclined to support, like loan agreements that can be understood by any well-educated person. Bhide, though, would likely oppose the “centralization” of the CFPB; there, we disagree; while underwriting should be an individualized process, it’s not immediately clear why the rules for transactions should vary from place to place -- that sort of regime immediately incentivizes a raise to the bottom. But Bhide’s thinking -- which Reihan Salam has been promoting forever -- is a brisk corrective from the many conservative economic commentators who don’t think the events of the last few years signal the need for serious change.
— Tim Fernholz
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