Wednesday, July 8, 2009

How Far Should We Take Paternalism?

This is a two slice toaster.

In a Wall Street Journal article, Todd Zywicki highlights an analogy made by Elizabeth Warren, a Harvard Law professor:

[C]onsumers cannot buy a toaster that has a one-in-five chance of exploding, but they can get a subprime mortgage that has a one-in-five chance of ending in foreclosure.

I see one big problem with this analogy. A toaster would explode because of shoddy manufacturing - unless, of course, you have a child who puts his toys in the toaster. It is the manufacturer's fault when the toaster explodes.

On the other hand, in almost all cases mortgages end in foreclosure because of consumers' mistakes. It is not the bank's fault that the mortgagee lost his or her job (speaking of any single bank), it's not the bank's fault the mortgagee used too many credit cards, it's not the bank's fault the home lost value, and it's not the bank's fault mortgagees bought multiple investment homes. Consumers lived on credit because government tax breaks and low interest rates gave them a strong incentive to live accordingly. A foreclosed mortgage is nothing like an exploding toaster.

To be fair, many mortgage brokers were disingenuous in how they presented loans. I'm thus in favor of behavioral economics-type disclosure regulations. But I don't think the government should, in this case, impede freedom of contract. As Zywicki writes:

Treating all consumers as hapless victims rather than recognizing that many consumers rationally respond to incentives is a recipe for unintended consequences. It can lead to counterproductive regulation that makes loans more expensive and harder to get.
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