The Myth That Lending Rates Rise in Response to Policies

There’s a credit crisis going on right now. Credit is what you get when a lender

lends money to a borrower. Therefore, any attempt to address any credit crisis

is, by definition, going to affect lenders. For pundits of a certain political

disposition, that’s all they need to know. In one of the most annoying rhetorical

tropes around, they take any kind of policy which might impinge borrowers or

lenders, and immediately decree that it’s going to have adverse deleterious

effects. For a prime example of this, look no further than Peter


Although there are mountains of uncertainty as to how the plan will be structured

and implemented, there is no question that as lenders factor in the added

risk of having their contracts re-written or of being held liable for defaulting

borrowers, lending standards for new loans will become increasingly severe

(higher down payments, mortgage rates, and required Fico scores, lower loan

to income ratios, and perhaps the death of adjustable rate loans altogether).

According to Schiff, there is no question! None at all! But this

is utter bullshit, and it’s worth unpacking the reasons why, since the same

argument is trotted out in all manner of other contexts as well. (Regulate payday

lenders? Stupid idea! It will just make vital credit that much harder to find!

Reform bankruptcy laws to include mortgage debt? Idiotic! Mortgage interest

rates would certainly rise as a result!)

For one thing, it’s worth looking at what the mortgage-lending industry did

at the end of 2006, when subprime default rates started skyrocketing. Everybody

expected underwriting standards to tighten significantly, but they didn’t. It

turns out that an industry as enormous as the mortgage industry takes a very

long time to turn around, which is why so many bad loans continued to be written

in 2007. If something as obvious as soaring default rates didn’t result in much

tighter underwriting standards, it beggars belief that something as marginal

as this voluntary mortgage-freeze plan would do so.

Now it’s entirely possible that lending standards are still unreasonably lax,

and that they will be tightened in further. But that would happen anyway: it’s

got nothing to do with the mortgage-freeze plan. How do I know this? Because

the lenders, who Schiff seems to think are going to be worse off as a result

of this plan, are the people who came up with it in the first place!

The plan is first and foremost in the lenders’ best interest: it was designed

by lenders for lenders, and the borrowers come second, not first. Are the lenders

really going to punish themselves for their own initiative? Indeed, can Schiff

point to a single lender who has said that he will be damaged by this policy

or will raise lending rates as a result of it?

As for the "death of adjustable rate loans", that’s not going to

happen. What might happen is the death of teaser-rate loans with high

prepayment penalties and rates which adjust to ridiculously high levels when

the teaser period is over. And good riddance, if those things no longer get

offered. But a simple UK-style adjustable-rate mortgage where the borrower pays

a small fixed premium over Libor or Treasuries is a very good idea for both

lenders and borrowers. As a general rule, no one should ever offer or take out

a mortgage where the one-year adjustable rate, if applied using today’s prevailing

interest rates, is higher than the rate on a 30-year fixed mortgage.

And as an even more general rule, be extremely suspicious of anybody who tells

you that a given proposal is certain to result in a rise in lending rates. That’s

a tired rhetorical device, and it has had precious little predictive success

in practice.

(Via Carney,

who’s also guilty of false certainty when he says

that the mortgage-freeze plan is a bailout, on the grounds that someone,

somewhere, may end up losing money as a result of it.)

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