February 06, 2006

Misguided Policy

Via Knowledge Problem, I saw this post by Marcus Cole at blackprof.com
The State of Illinois enacted a law that requires all mortgage applications within nine Chicago zip codes to undergo a process of review by the stateís Department of Financial and Professional Regulation. The departmentís review process determines whether mortgage applicants in these neighborhoods must undergo compulsory credit counseling. If they must, then the mortgage lender must pay the cost of the counseling.
He notes that these nine zip codes are predominantly African-American neighborhoods and that, while most likely good-intentioned, this legislation will significantly increase the cost of mortgages to people living in those areas and will subsequently decrease the price they can pay for houses, depressing prices.

This law is a perfect example of misguided policy that is completely divorced from reality. Let us assume for a moment that the backers of this law actually do have good intentions and are worried about predatory lending (and are not people or companies hoping to capture rents from the new law – credit counseling agencies, for instance). It is still a really bad idea.

The first common, and most obvious, mistake is not understanding the incidence of the costs associated with the law, i.e. who will end up paying for the counseling services. While the statute asserts that they must be born by the lender, it's foolish to assume that who pays the check actually bears the cost. The mortgage market seems to be a fairly competitive market, meaning that the price of mortgages will be close to the marginal cost. Thus, anything that increases the marginal cost (like mandatory credit counseling) will be passed on as higher prices (i.e. higher interest rates, points, or fees). Wishing for the banks to pay will not make it so.

The second, and arguably more pernicious, problem is that the law denies, or at least ignores, the agency of the people it is purportedly trying to help. On one hand, it offers them no choice in the matter, making the counseling obligatory, and on the other, it ignores the choices that will likely ensue. (I say pernicious because I believe that the more policies we institute that minimize the agency of the citizenry, the more likely we are to end up with a populace that is dependent on government action and incapable of effecting change. As Marcus states, laws like these are often "motivated by an unspoken belief that poor black people are incapable of making important decisions for themselves." The continuation of this belief serves neither the poor black people nor the rest of the country. I, in fact, would expand his formulation to say that laws are often motivated by the unspoken belief that people, or any race or income level, are incapable of making important decision for themselves – and I fear the day when they aren't because of it.)

A moment's thought, with a mental model that assumes that at least some of the people affected will be rational actors, shows that this law is likely to be, if not a death sentence, then a slow withering plague on the neighborhoods. As mentioned above, housing prices will go down virtually overnight in those neighborhoods as the demand curve shifts down (due to higher mortgage rates). Existing owners' equity will evaporate, decreasing the likelihood and affordability of needed improvements. Over time the neighborhoods will decay relative to nearby ones. Beyond that, the marginal home buyer, seeing that her money can get more house outside the nine zip codes than within, will choose to leave the neighborhood. Not only will this entail the flight of capital, as buyers take their saved down payments with them, but also the flight of human and social capital – the responsible neighbors capable of saving that down payment. Now, of course, not everyone can or will leave, but on the margins the effect could be enough to further drain housing prices – leading to a vicious circle and eventual blight.

Presumably this is not the desired effect.

Unfortunately, policies like this are a dime a dozen in this country. They sound good on the surface, they have a noble cause that lobbyists can latch on to, but they are built on bankrupt, and depressing, models of human behavior that thankfully are not yet reality. Posted by richard at February 6, 2006 11:23 PM

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