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Helping Consumers While Helping Banks

Alyssa Katz has a very interesting piece about how contrary to the stereotype of Texas as a wild west land of deregulation it actually had a number of strict regulations on mortgage lending that helped avoid a housing bubble. But Felix Salmon says she focused on too narrow a piece of the overall story:

The point here is that Texas had a set of strict restrictions on mortgage lending, all of which emerged naturally from an overarching philosophy which was generally suspicious of banks and leverage. In the language of rules vs principles, we can say that the rules were put into place in order to express a relatively simple principle.

As a result, I don’t think that Katz is right when she suggests that simply adopting Texas’s restrictions on Helocs and cash-out refis is an easy and obvious way to prevent future housing bubbles nationwide. As we saw over the past few decades, it’s easy to repeal rules if there isn’t a strong set of principles underlying them. And I think that what we saw in Texas wasn’t one rule having a large effect; rather, it was a large set of rules, including crucially a ban on prepayment penalties, having a large cumulative effect.

In any case, I think that the example of Texas does go to show that rules put into place to protect consumers are likely to help, rather than harm, the safety and soundness of banks. Texas didn’t think that giving consumers access to mandated cheap credit would help them, as John Dugan seems to fear. Instead, the state put limits on how much credit they could take out. And that worked out very well, in the end.

This is perhaps a reminder of the two faces of regulation. When you have an existing marketplace, participants tend to reject the idea of regulation to curtail their activities. But when you have an existing regulated marketplace whatever else the regulations may do for consumers or anyone else, the regulations help incumbent firms by protecting them from competition. After all, once you start letting some firms make crazy loans, then you create a problem for all firms. Either you follow down the rabbit hole of unsound lending, or else you see your market share dry up.

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In most markets, this regulatory dynamic is ultimately bad for everyone as it prevents efficient-increasing competition and innovation. But in a financial sector where you ultimately need to choose between costly bailouts of firms that have gone bust, or else costly disruptions to the monetary system then rules that limit the competitive dynamic can be broadly beneficial.