Preventing Another Mortgage Crisis

Two Obama advisers apply the principles of “iPod government” in their proposal to mend the lending system:

The basic idea is that for complex financial products, the government should strive for what might be called “simplified transparency.” The Truth in Lending Act, enacted in 1968, was a good start along these lines. That law required lenders to report interest rates in terms of Annual Percentage Rate, so that borrowers could easily compare the costs of different loans.

The problem now is that both mortgages and credit cards have rates that vary over time, and numerous other fees that are difficult to understand. It has now become virtually impossible to offer a simple, one-page, plain-English document that explains all the relevant features of a mortgage or credit card.

The best response would make use of modern technology to create a Truth in Lending Act for the 21st century.

In brief, government would achieve simplified transparency by requiring all lenders to provide borrowers with an electronic file that contains, in standardized form, information on every feature of the contract.

Instead of fine print, there would be electronic information. And because disclosure would be standardized, consumers could easily compare one mortgage, and one credit card or school loan proposal, with many others.

Now, you might wonder, how do these electronic files, even if standardized, help us mortals who have trouble learning how to record a TV show on a VCR? The answer would come through the market.

As soon as the government required electronic disclosures, websites would quickly emerge to help people in the task of comparing offerings. A borrower would go to “mortgageevaluator.com,” upload the relevant quote, and receive an easy-to-understand analysis of the loan they have been offered, plus other loans that they might consider.

This proposal illustrates the essence of good policymaking from the standpoint of behavioral economics. Government does not tell people what to do. Instead, it tries to improve markets by making it easier for busy people to make good decisions.

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