By Kurt Davis '09
Columnist

One of the best definitions I have come across lately relating to predatory lending has been: “Predatory lending is defined as intentionally placing consumers in loan products with significantly worse terms and/or higher costs than loans offered to similarly qualified consumers in the region for the primary purpose of enriching the originator and with little or no regard for the costs to the consumer.” In the discussion around subprime mortgages, however, the phrase has been used loosely without regard for the entire situation. Predatory lending is always a possibility in financial markets, specifically where there is a large pool of low-income borrowers.

The crumbling of the subprime mortgage market and the subsequent slowing of the American economy has led to a natural knee-jerk reaction from politicians in Washington. Subsequently, Congress has sought to push through stronger regulations which protect current and potential homeowners from falling prey to high-cost loans that lead to foreclosures and bankruptcy, among other problems.

We must ask ourselves, however, what are the costs of these new regulations? Forgotten are the benefits that have fallen to millions of American homeowners who would not be homeowners in the absence of the subprime mortgage market. The United States saw unparalleled growth in home ownership in the midst of this market boom, particularly among low-income and minority borrowers. Regulating the riskiness of banks is not always the answer, as it was a risk for banks to even try providing loans for risky borrowers. Though clearly these banks were attempting to maximize profits, their risk benefited Americans who would be outside the housing market in any other situation. If any regulation is to come to this market, it should be done with both a sensibility for the benefits of the market and also a recognition of the choices Americans are making in their borrowing and saving practices.

The latter of those sensibilities has almost been forgotten. Democrats and Republicans have pushed through an economic stimulus plan that focuses on getting money to Americans so they can spend even more. The incessant consumer spending is part of the reason we are in the current situation. According to the Treasury Department, the personal savings rate of Americans is in negative territory and has been for a good while. The average household owes somewhere between 15 and 20 percent more than what it makes in a year.

The availability of credit, in all its well-deserved glory, has lead to a lack of prudent decision making on the American consumer’s behalf. The obvious example of this is when Americans are buying homes that cost four or five times their yearly income. Such a ratio only leads to constant insecurity concerning payments on the home and other bills.

Other examples include the high credit card debt of many Americans. The ease with which Americans can get credit leads to the spending of the future dollar. In other words, Americans spend money they don’t have in expectation of it coming in the future—payday loans are a prime example. The refinancing of mortgage loans to cover the costs of numerous other expenses was, somewhat predictably, driven by the continued increase in the value of the home each year. The boom in the market clearly invigorated consumers with a recklessness for taking risk on what they could afford at the moment, and in the future.

The insecurity of the American economy accentuates the problems that can arise with this universal credit. First, the American economy, for all its strengths, is too dependent on consumer spending. No one considers saving. Many Americans expect Social Security to bail them out when retirement comes, forgetting that the debt is not accounted for in those payments. Second, the world economy is too dependent on American consumerism. The minute Americans slow their spending, the world economy feels the repercussion through slower returns on resources, slower returns on treasury debt, inflation, and so on. Accordingly, a minor shock (or major one in the current situation) is an immediate hit in the pocket of most Americans and can send many plummeting towards bankruptcy, or just short of it.

In other words, the pre-existing debt only becomes larger. Yet, in the wake of these problems, Congress is asking Americans to spend more through the upcoming tax rebate. This is exactly the opposite of what they should be doing. It would be better for Americans to use the rebate to pay down their debt or just save the money. Instead, Americans are fundamentally being asked to go against their best interest for the sake of the larger American group or economy.

One possible regulation could be to limit the amount a person can borrow. Do this in concurrence with better financial education for American consumers and Congress could substantially reduce the problems associated with the current economy. Nevertheless, the former should not be introduced in Congress. While bad times may increase urgency and force quick reaction, paternalism should not be the medicinal remedy for any situation. In its best-case scenario, it would stop some Americans from unwittingly entering into situations that will hurt them in the end. At the same time, it will severely limit those Americans who wittingly play the American market to their advantage through smart investments. The small business owner who took a reasonable risk on a new business, with a loan against his house, would almost be eliminated from the business world.

Lastly, it should not be encouraged that Americans just save money and pay off all their debt. Again, debt is a great instrument through which many Americans can create better financial prospects and even create wealth. The American economy would fail with extremely high savings and no debt. It should come as no surprise that many other countries have been trying to push their citizens to spend more to strengthen the financial outlook of their economies. Without spending and some debt, investments and returns as we know them would not exist. That would be a huge loss for Americans. With all that said, many American consumers, who complain about being left of the previous good times in the market, could easily better their positions with a little less debt and a little more savings, and see the American economy prosper with them as a part of it.

Email: kld4s@virginia.edu