Todd Zywicki - George Mason UniversityThe Consumer Financial Protection Agency idea really upsets banksters, but their howler monkey lobbyists need academic cover. Fortunately they can turn to old reliable, Todd Zywicki, to provide a g-string of academic cover from his perch at George Mason University. When he last made news, it was to provide “academic” “justification” for the Bankruptcy Amendments of 2005.

Now he has emerged in full John Galt regalia to complain about the paternalistic restrictions that the CFPA will put on all their libertarian glory.

Treating all consumers as hapless victims rather than recognizing that many consumers rationally respond to incentives is a recipe for unintended consequences. It can lead to counterproductive regulation that makes loans more expensive and harder to get.

Zywicki and his fellow Randians think that the FCPA wouldn’t have made the slightest difference in the conditions that led to the great crash of 2008. He says all of these borrowers understood the exact nature of the loan terms in those option ARMs, and fully grasped the way the credit card companies would interpret the 63 pages of terms and conditions. They took out loans they couldn’t pay on the theory that the value of the house would go up so they could refinance the loans and borrow money to make the payments. Or something. Anyway, they were acting rationally.

Each one of those lenders was acting rationally too, since their incentive, making commissions, was to sell the worst possible loan to anyone, regardless of their ability to pay, because the worse the loan terms, the higher their commissions would be.

Zywicki explains that “Virtually every credit product is valuable to some consumers.” The logical implication is that banksters should be allowed to try to make loans on any foolish terms they can think up, whether or not it makes sense for the borrower. It’s up to us to figure out whether they are cheating us. I really like the idea that Zywicki will have to read the kinds of loan agreements I slave over for hours, and see if he can figure out what the bankster lawyers are doing with the English language.

By Zywicki’s theory, it was perfectly rational for buyers to take out house loans leaving them only tiny amounts of money for food and transportation. So many people did this that it is fair to ask what their motivation was. Edmund Andrews, a financial reporter for the New York Times, is a perfect example, and most people aren’t as articulate as he is. He explains that he and his wife both “succumbed to magical thinking.” He felt it was kind of cool to be able to borrow enough to get the house of his fiance’s dreams on a mortgage payment of $2,500 when he only had take-home pay of $2,777. It’s amazing anyone would lend him the money, and indeed, his lender went broke before he did. This guy is smart and knowledgeable but he did something truly stupid, and so did the lender. Zywicki thinks this is rational.

I’d say that Zywicki might have a point if Andrews and his lender were the only people doing this. Andrews would be forced into bankruptcy, and the lender would fire the guy who made the loan. That isn’t what was happening. Instead, banks and mortgage brokers were lending to anybody who could sign a name on the forms, responding to the incentives they themselves set up. They used derivatives to protect themselves from risk, dumping the losses onto AIG and pension plans and eventually onto taxpayers.

The lesson here is that consumer protection cuts in two directions. Consumers need to be protected from lenders, and they need to be protected from themselves. Banks are protected to some extent by collateral, and by their ability to dump losses onto others. Banks need to be protected from their own greed, and taxpayers are entitled to be protected from that greed. Moving the consumer protection powers of the Fed to a separate agency insures that both consumers and taxpayers are going to get some minimal level of protection, whether banks like it or not.

The odd thing is that in connection with the Bankruptcy Amendments, Zywicki was outraged that consumers were taking advantage of the system to borrow money and then file. They were responding to the incentives they faced, so the solution was to change the bankruptcy system. It would have been really wrong to insist that the banksters manage their approach to credit better, although I can’t remember exactly why. The actual causes of bankruptcy were irrelevant. The mere possibility that a few people might cheat the system was enough to justify radical change.

At least Zywicki is consistent: banks should be allowed to mishandle lending, and taxpayers and consumers and other leeches should suffer the losses in every case. John Galt would be proud