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Paul Krugman, writing about the missed opportunities to regulate the subprime market and the many warnings offered by respected overseers, says:
In his final paper, Mr. Gramlich stressed the extent to which unregulated lending is prone to the “abusive lending practices” he mentioned in his 2004 warning. The fact is that many borrowers are ill-equipped to make judgments about “exotic” loans, like subprime loans that offer a low initial “teaser” rate that suddenly jumps after two years, and that include prepayment penalties preventing the borrowers from undoing their mistakes.Yet such loans were primarily offered to those least able to evaluate them. “Why are the most risky loan products sold to the least sophisticated borrowers?” Mr. Gramlich asked. “The question answers itself — the least sophisticated borrowers are probably duped into taking these products.” And “the predictable result was carnage.”This sort of language freaks people out ("are you saying poor people are stupid!?"), but it's quite important, and quite true. In a market with asymmetrical information -- i.e, a market in which sophisticated banking professionals are encouraging desperate individuals with meager financial knowledge to sign up for loans -- the advantage, the massive advantage, will always go to the side with more information. In some markets, you can't do much about that. The asymmetries are unpredictable, and dispersed. In the subprime market, the asymmetry was structural, and of a single nature. And members of the relevant regulatory authority -- the Federal Reserve -- saw it, and raised the alarm. They were beaten back by those with an ideological allergy to regulation.For more on all this, I highly recommend Bob Kuttner's recent web article, "The Fed as Enabler."--Ezra Klein
