Should consumers be protected from themselves?

silverharp

My example is the 40 year mortgage, Should these kinds of financial products be banned on the basis that it is very risky for the borrower and if it becomes common place it will inflate the property bubble even further and could pose strategic risks to the Irish economy in the future?

On the one hand I believe in free markets and that everyone has the right to make bad financial decisions if they so please, I also have reservations about the "nanny state" but on the other hand how can first time borrowers truly understand what they are letting themselves in for and may need more protection from big banks who have a vested interest in lending the most money to the most amount of people.

bonkey

Consumers already are protected from themselves in many ways.

Its simply a question of where to draw the line.

Investment/Loan risk/return levels are one of the trickiest areas to police, though. While usurious charges have been prevented, there is still little or nothing to stop Joe Bloggs getting in over his head other than the bank staying no.

When it comes to loans and investments, all the government can and should do is require proper disclosure. After that...what can you do?

Should these kinds of financial products be banned on the basis that it is very risky for the borrower

The mathematician in me immediately wonders what you mean by "very risky". Can you quantify the risk, and compare it to the equivalent risk from (say) 20-, 25-, 30- and 35-year mortgages?

and if it becomes common place it will inflate the property bubble even further and could pose strategic risks to the Irish economy in the future?

Again, the mathematician in me asks if this can be shown. My immediate reaction is to wonder whether its not more a case that existing mortgages are already being shown to be stretched to the limit so Joe Q Housebuyer simply can't afford to get in to the game (though investors can) and that the banks can either offer something more or wait for the market to collapse (thus making existing mortgage options viable once more, but risking already-made investments on their part.

Bear in mind that it is not to a bank's advantage to get into high-risk investments....which is what this would be from the bank's perspective if the allegations about the risk are true.

jc

Jackie laughlin

No one at all believes in the "nanny state". We all want freedom to make choices. The problem is that "beggars can't be choosers", even the well-off and educated can be deceived or in a complex situation acquiring the information necessary to making "choice" meaningful can be onerous.

The state can't help the wilfully stupid. Apart from that, it should intervene in defence of meaningful choice.

As far as possible the state should seek to educate and inform consumers about their choices rather than dictate their choices.

Jackie laughlin

I don't need education in how to consume. I do need information. I expect the state to step in if information is misleading or if there is overload. I've not the slightest problem with the state banning scams. Being poor means having no choice and I'm favour of state intervention here. By the way, I'd consider being desperate for a house a form of poverty which is easy to exploit and the state should protect us from exploitation.

silverharp

Quote Bonkey - Again, the mathematician in me asks if this can be shown. My immediate reaction is to wonder whether its not more a case that existing mortgages are already being shown to be stretched to the limit so Joe Q Housebuyer simply can't afford to get in to the game (though investors can) and that the banks can either offer something more or wait for the market to collapse (thus making existing mortgage options viable once more, but risking already-made investments on their part.
Bear in mind that it is not to a bank's advantage to get into high-risk investments....which is what this would be from the bank's perspective if the allegations about the risk are true.


This is my concern that banks are reducing credit standards in absolute terms. In the 70’s and 80’s house prices would have had to fall by more then 25% before people would have had negative equity. Today if prices fell by 20% a significant number of people would have the incentive to hand back the keys thus creating a negative feedback loop. The collective assumption is that a Japanese style deflation cannot happen here. To the extent that the banks have helped create this “credit monster” they have to keep feeding it, thus all the measures get pushed out a little more each year (as happened in Japan in the late 80’s).
You are correct that there is no scientific measure of what is prudent and what is risky, all one can say is that when historic norms are pushed out one is increasing relative risk. Does it help the borrower? I’m not sure, if lending practices were more in line with traditional norms then house prices would have gone up at a slower rate and the number of properties being built would have been the same. Each time the credit standard is lowered a few people get to “jump” the queue however house prices then adjust upwards and potential borrowers in the queue now have to borrow more. From the banks point of view think Nasdaq bubble in the late 90’s where otherwise “smart” people bought into a collective delusion of what was fair value or a sure bet.

bonkey

silverharp wrote:

This is my concern that banks are reducing credit standards in absolute terms.

Its a fair concern, but it should be categorically demonstrable if true. From my experience, I would be inclined to say that its being looked at in the following approach:

Payback over <current max term> = X per month
Payback over <new max term> = Y per month, (where Y < X)

The risk of JoeQ having problems with the remainder of the amount, at the end of the cycle is weighed against the risk of JoeQ running into difficulties for having (X-Y) less cash in his monthly pocket at the start to middle of the term.

Houses 30 years ago cost what...under 20,000? People borrow more than that today to buy a car and pay it off in 3 years. The monthly payments on a 40-year loan from 30 years ago would not be a significant strain on your budget. So what would the risk really be if you project to an extension from 30 to 40 (which is what they're proposing, right?). It exists...definitely...but is it really the monster its made out to be?

However, knocking a couple hundred off your monthly repayments today could make much more of a difference.

Now...having said all of that, I do recognise the other side - which is what you pointed out I think. Rather than borrowing the same amount over a longer term, Joe Q is just as likely (or moreso) to borrow to the same monthly repayment giving him/her more cash to buy a nicer house.

This will inevitably contribute to the drive-up in prices....sure. Its not the only factor, but it is unquestionably a factor. I mean...the banks don't have to loan him more - although they probably will.

Personally, I'm more of the opinion that ultimately, if the government have to intervene, it should be to regulate the housing market itself somehow, not the banks (and other financial institutions) in this matter.

The collective assumption is that a Japanese style deflation cannot happen here.

Who's collective assumption? If its something the financial experts are in broad agreement with, then surely the banks (and arguably the populace in general) should listen to their advice. The alternative suggests that financial experts aren't worth listening to.

To the extent that the banks have helped create this “credit monster” they have to keep feeding it

Yes - pretty much by definition. Unless we posit that financial organisations should be morally responsible for what is done with the money they provide to others, its hard to see what else they should be doing.

Remember - a banks job is to maximise profit. It doesn't help them to bring down a huge sector of the economy, so they are generally playing ball to ensure that a crash doesn't happen.

One could argue that they're pushing growth too far when they should be seeking a levelling off, but again thats unquestionably something that their experts will have looked at.

Does it help the borrower?

No-one forces the borrower to borrow. Owning a residence is a choice, not a requirement or a right, despite what we may like to think.

I’m not sure, if lending practices were more in line with traditional norms

What do you mean by "traditional norms"?

From the banks point of view think Nasdaq bubble in the late 90’s where otherwise “smart” people bought into a collective delusion of what was fair value or a sure bet.

its not quite the same, but I take your point. I'm not even saying you're wrong, just that I would imagine that the banks can produce their numbers to show why this is not a bad thing if and when it ever becomes a serious issue, so any challenge to their position must be - to my mind - similarly well prepared.

silverharp

Quote Bonkey- Who's collective assumption? If its something the financial experts are in broad agreement with, then surely the banks (and arguably the populace in general) should listen to their advice. The alternative suggests that financial experts aren't worth listening to.


The whole population frankly, a house used to be a house, now it’s an investment a pension plan, a sure bet, if people thought property could ever go down one wouldn’t take on so much leverage nor would the banks let them. Again in the end I do veer to the view that the gov should stay out of it, as they have a history of not getting it right when they interfere with the market.


Quote Bonkey - What do you mean by "traditional norms"?

In the 70’s mortgages were based on 1 salary and a small fraction of the other spouse, so if the main earner lost his job there was at least the potential of the other spouse getting a job, or both getting part time etc. Fast forward to today and both salaries are basically treated equally, there is now no “wiggle” room for the borrower, both have to be working full time or the payments won’t be met. Sure economic conditions are better then the 70’s but if there is a serious recession in the Irish economy in the future the effects will be worse then past experiences due to the high debt levels.

bonkey

silverharp wrote:

The whole population frankly,

With or without the experts agreeing with them?

This is what I'm driving at. I couldn't care less what the populuos thinks. Arguably, the whole population thought investing in Eircom was a sure thing. The experts were far from being so certain.

When it comes to putting my money on the line, I'll listen to the people I believe are most capable of giving me an informed answer. I don't ask doctors to do plumbing, nor do I ask mechanics to do surgery. Why would I ask either to do long-term financial analysis that my future prosperity hangs on?

, if people thought property could ever go down one wouldn’t take on so much leverage nor would the banks let them.

The banks don't care what people think. They don't let people borrow money because the people think its a good idea. They do so because their risk/reward analysis tells them its a good investment.

The banks don't really care if people end up with negative equity, as long as those people can continue to pay off their loans. If you buy a car, you have negative equity on that investment the minute you drive it off the forecourt, but that doesn't stop the bank loaning you the cash. They loan it to you because they believe you can afford to repay it.....not because they think you can sell the house for a profit at some later point.

Again in the end I do veer to the view that the gov should stay out of it, as they have a history of not getting it right when they interfere with the market.

So who's going to regulate the banks, as you think might be needed? Its not in the banks' interest to do it, and you don't believe the government should interfere at all.....so even if you conclude consumers should be protected from themselves, there's not really anyone to do it.

In the 70’s mortgages were based on 1 salary and a small fraction of the other spouse, so if the main earner lost his job there was at least the potential of the other spouse getting a job, or both getting part time etc.

In the 70s, Double-income families were the exception, particularly after kids came on the scene, so this made sense.

Fast forward to today and both salaries are basically treated equally,

Today, it is far more common to have double-income families. It would be remiss of the banks to ignore this social change and to treat Irish people as though they were still in the 70s.

And why are the 70s traditional? Why not go back another decade, when women often had to leave work (civil service at least, if memory serves) when they got married. So, "traditionally", one could argue that the banks shouldnt' consider women's salaries at all and single women shouldn't be given mortgages in any situation.

This is why I was asking. When people use terms like "traditional", they generally refer to a subset of practices from a short period of time, without regard to why those practices existed at that time. This appears to be what you're doing here.

The financial structures of the 70s were designed to match with the social structures of the time. You seem to want to cherry-pick bits of the financial structure of the 70s

I'm pretty sure, for example, that you wouldn't support a return to the traditional interest rates on mortgages from that same period either....seeing as it was much higher than today.

there is now no “wiggle” room for the borrower, both have to be working full time or the payments won’t be met.

And when my parents raised me, my Dad had to work full-time, it was the norm for only one parent to work, my folks had to make cutbacks, we couldn't afford a huge number of luxuries that today are taken for granted.

There wasn't much wiggle room back then either, but the thought of actually doing without luxuries to make up for some of that was less anathema than it appears to be today.

Sure economic conditions are better then the 70’s but if there is a serious recession in the Irish economy in the future the effects will be worse then past experiences due to the high debt levels.

Will they? You can show this, right? Its not just supposition?

At the end of the day, what you seem to be saying is that people shouldn't run up debt, becasue the risk is too great, but you don't trust the government to stop them and the banks obviously disagree with you....so I'm not entirely sure what it is you're driving at.

No-one is forcing these people to run up high debt levels. No-one.

jc

silverharp

bonkey wrote:

When it comes to putting my money on the line, I'll listen to the people I believe are most capable of giving me an informed answer. I don't ask doctors to do plumbing, nor do I ask mechanics to do surgery. Why would I ask either to do long-term financial analysis that my future prosperity hangs on?

oh come on, asking bankers for prudent financial advise is like asking Japanese Whalers to comment on Whale numbers. Most financial institution are geared towards the next Qtr, not 10 years in the future. Do you think AIB has an inside view of energy costs in the next 10 years, How the US economy will perform in the next 10 years, the effects of a derivitive meltdown were it to happen. Banks can't foresee non linerarities.

bonkey wrote:

The banks don't really care if people end up with negative equity, as long as those people can continue to pay off their loans. If you buy a car, you have negative equity on that investment the minute you drive it off the forecourt, but that doesn't stop the bank loaning you the cash. They loan it to you because they believe you can afford to repay it.....not because they think you can sell the house for a profit at some later point.

negative equity doesn't happen in isolation, if negative equity occurs in Ireland it will be because of an external shock, nobody has a forecast for 10% unemployment in the next 10 years, it doesn't mean it can't happen. Banks would worry about negative equity as people have an incentive to hand back the keys

bonkey wrote:

So who's going to regulate the banks, as you think might be needed? Its not in the banks' interest to do it, and you don't believe the government should interfere at all.....so even if you conclude consumers should be protected from themselves, there's not really anyone to do it.

The central bank in theory and now the ECB, however they have shown no resolve to curb property bubbles in Ireland or Spain as they look at things on a pan European basis. The gov here is fully behind the bubble here so they don't have an interest in tackleing this and to be sure it's too late

bonkey wrote:

Today, it is far more common to have double-income families. It would be remiss of the banks to ignore this social change and to treat Irish people as though they were still in the 70s.

And why are the 70s traditional? Why not go back another decade, when women often had to leave work (civil service at least, if memory serves) when they got married. So, "traditionally", one could argue that the banks shouldnt' consider women's salaries at all and single women shouldn't be given mortgages in any situation. .

You are pushing the point too far, social change has no bearing on the length of the mortgage, a 40 year mortgage made no sense in the 70’s , there is no prudent reason for it now, why stop at 40, a 100 year mortgage is possible, let the kids pay it off.

bonkey wrote:

I'm pretty sure, for example, that you wouldn't support a return to the traditional interest rates on mortgages from that same period either....seeing as it was much higher than today. .

Supporting higher rates is meaningless, but anyone who says that you can’t have a 10% mortgage rate in the future is a fool, I doubt if a lot of borrowers in Ireland would stay solvent if rates went above 6%

bonkey wrote:

At the end of the day, what you seem to be saying is that people shouldn't run up debt, becasue the risk is too great, but you don't trust the government to stop them and the banks obviously disagree with you....so I'm not entirely sure what it is you're driving at.

No-one is forcing these people to run up high debt levels. No-one.
.

I’d say that people shouldn’t have been put in a position to run up excessive debt. What has partially happened in Ireland is that too much credit has been thrown at too few assets due to excessive lending by the banks, to the extent that the assets are overvalued therein lies the risks of problems in the future.

Hotblack Desiato

silverharp wrote:

oh come on, asking bankers for prudent financial advise is like asking Japanese Whalers to comment on Whale numbers.

But like the Japanese Whalers, the Irish bankers depend on their predictions for their livelihood.

Do you think AIB has an inside view of energy costs in the next 10 years, How the US economy will perform in the next 10 years, the effects of a derivitive meltdown were it to happen. Banks can't foresee non linerarities.

They don't need to call it precisely, just call it accurately enough to limit their own exposure.

You are pushing the point too far, social change has no bearing on the length of the mortgage, a 40 year mortgage made no sense in the 70’s , there is no prudent reason for it now, why stop at 40, a 100 year mortgage is possible, let the kids pay it off.

Why not, it's not unusual in most of Europe.
There is no natural law which states that a desirable property in Dublin (or elsewhere) must be payable by a mortgage within the lifetime of any given person.

Supporting higher rates is meaningless, but anyone who says that you can’t have a 10% mortgage rate in the future is a fool, I doubt if a lot of borrowers in Ireland would stay solvent if rates went above 6%

But many of them will have been stress-tested pretty close to that level. Whatever about investors, owner-occupiers will hang on no matter what.