Regulation We Don't Need
By Arnold Kling
The problem with securitization is that it dilutes individual responsibility. The mortgage broker can easily become disconnected from the outcome of the initial lending decision. Federal regulation is needed to ensure that mortgage originators perform the appropriate due diligence in matching potential borrowers with loan products. Underwriters should be required to retain an interest in what they issue.
This is false. We do not need federal regulation to fix this problem. Markets can fix this problem. They already have.
The problem is not securitization. The problem is that when house prices are going up, there is no such thing as a bad loan. Even a loan where obtained by total fraud will work fine if the price of the house goes up.
In the mortgage market, people saw risk-takers outperforming prudent lenders. So they took more risks. There is no simple fix for that. For the foreseeable future, we can count on investors sticking to prudence when it comes to mortgage lending. We don’t need any regulations to close that barn door.
But somewhere, some time, in some other market, there will be another outbreak of excessive risk-taking. You can’t make the system idiot-proof. They’ll just build a better idiot.