STOCK MARKET WATCH -- Thursday, 17 January 2013

[Demeter]

1. The CFPB’s New Stealth Usury Law on Mortgages and Why It’s Desirable

http://www.nakedcapitalism.com/2013/01/the-cfpbs-new-stealth-usury-law-on-mortgages-and-why-its-desirable.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29

With the looming debt ceiling pigfight consuming a lot of financial media bandwidth, some important stories are not getting the attention they warrant. One is on the hard fought and finally settled qualified mortgage rules just finalized by the Consumer Financial Protection Bureau. Georgetown law professor Adam Levitin in a new post describes how the new QM rules are a defacto usury law for the 21st century. Despite his good discussion of the QM and the history of usury laws, however, he peculiarly does not explain why usury laws are a good thing. Perhaps it seems obvious, given the explosion of economically unproductive consumer debt since they’ve effectively been eliminated.

Let me give you the reason why well designed usury laws are desirable, then I’ll turn the mortgage-related issues specifically.

One of things that early economists agreed on was the necessity and importance of usury laws as a foundation of a healthy, productive economy. Their reasoning was simple. Lenders would tend to seek out the highest return they could get, in light of repayment risk. Even a very successful business or venture could afford only so much in the way of interest payments on borrowers. If creditors could lend at any rate to any borrower, they would prefer wealthy speculators (in those days, aristocrats with gambling habits) to loans that would support trade and enterprise.

And we’ve seen how lending has followed that pattern. Consider credit cards. Levitin points out that usury laws were vitiated between 1978 and 1982. Even so, banks (which at that point still held credit card loans on their balance sheets) were somewhat restrained in their behavior until later in the 1980s. They all stuck with a maximum interest rate of 19.8% and charged annual fees. The fees were critical to the pricing structure, since it meant that credit card companies made money on every type of customer: one that used the card only sporadically, say for airplane tickets or when he was caught without cash, the one that used cards regularly but paid off his balance in full every month, and ones that ran balances occasionally. Banks did not find it attractive to have customers carry balances all the time; even at 19.8% (with higher risk free interest rates than in the early-mid 2000s), perma borrowers were seen as risky and default-prone.

The market saw a race to the bottom when no-fee cards were introduced. Suddenly, the intermittent-use customers were money-losers and the “pay in full” types not so attractive. The banks began to seek out customers who’d use their card to run occasional balances or become credit addicts, and they changed their fee structures and interest payment schedules to suck more out of them before the ones who couldn’t get out of their borrowing tar pit went under for the final time. We saw a variant of this pattern in “private label” (non Fannie, Freddie, FHA) mortgages, in which lenders sought out higher interest rate, non-Fannie and Freddie loans. For the most part, they kept the ones on balance sheet that they thought were higher quality (home equity loans, “jumbo” loans) and securitized the rest. We know how that movie ended. A small private label MBS market developed, became speculative, and hit the wall at the turn of the millennium; the second go at a private label market started in 2003 and helped set off the global financial crisis (note bad MBS were not sufficient to create that scale of calamity; credit default swaps increased the level of financial exposure to a significant multiple of the value of real economy loans made). What has been stunning about the period after the crisis is the failure to do anything to address the defects of the private label market. There’s a reason the mortgage market is still on government life support; investors were burned badly and won’t consider these investments unless real reforms were made, and the so-called sell side has fought those reforms tooth and nail (it also does not help that despite widespread misrepresentation of the quality of mortgages in SEC documents and other marketing materials, that they few investors who have pursued litigation have found it costly and difficult to obtain redress due to various legal and practical impediments, and the fact that regulators and prosecutors have made only token efforts in this arena)....MORE