I’ve blogged a few times now about the causes of the meltdown and some of the commentators on it that I’ve found to be helpful. (As a moral philosopher interested in character I’ve tended to concentrate on writers who have looked at the imprudence and irrational optimism that affected so many people.) A recent column by the economist Richard Thaler, of the University of Chicago, about these issues is worth reading.
Thaler is one of the leading figures in ‘behavioral economics’, an important new field that he explains briefly. He takes it as a given that many people do not make financial decisions completely rationally. So we need, Thaler says, to think about the financial decision-making not of the mythical ‘homo economicus’ but of ‘Homer [Simpson] economicus’. He here discusses the recent proposal by the Obama administration to make mortgages more understandable and comparable. (His co-author Cass Sunstein, a member of the administration, presumably had a hand in this.)
As the administration plan describes it, lenders could be required to offer some mortgages they call “plain vanilla,” with uniform terms. There might be one vanilla 30-year, fixed-rate mortgage and one five-year, adjustable-rate mortgage. The features of these plain mortgages would be uniform, much as in a standard lease used in most rental agreements.
Lenders would also be free to offer other exotic mortgages–perhaps called “rocky road” mortgages?–along with the vanilla variety, but these offerings would receive more intense scrutiny from regulators.
Although the details of this dual ice-cream approach have not been fully specified, the concept has two main selling points.
First, inexperienced borrowers are steered toward the vanilla mortgages, the terms of which are chosen to be easy to understand. Vanilla mortgages would be the equivalent to the green runs at ski resorts that are intended for novices. The rocky-road mortgages would at least come with warning labels (“Don’t even think about going down this run unless you are an expert skier, or have a trusted professional instructor by your side”), and it is possible that for very exotic mortgages, borrowers might have to demonstrate that they understand the risks or have been aided by a certified mortgage planner.
Second, because the terms of the vanilla mortgages are all the same, they are more easily comparable; just as in the good old days, the A.P.R. will be a good basis for assessing the cost of the mortgage.
Here we see some nice thinking about how society can try to curb excessive risk-taking, and in that sense act ‘paternalistically’, without completely eliminating options for those who may have special expertise or needs. I wonder, though, how effective this sort of proposal can be if lenders or brokers have strong incentives to induce people to take out loans which are riskier, even if they are somehow so labeled.