Lowenstein’s Consumer Protection Stinker

Faulty logic and a false choice on banks

Roger Lowenstein is too contrarian for his own good with his latest Bloomberg column. He writes that “Smart Banks With Dumb Customers Don’t Exist.” Okay, boss.

Since mortgage bankers make money from loans, it’s tempting to think of them as parasites that prey on customers. But there is no such thing as a smart bank with a dumb customer; if the loan turns sour, the banker was dumb, too. And in the mid-2000s, scads of them were.

Got that? “There is no such thing as a smart bank with a dumb customer.” Those Friedmanesque statements always raise red flags, and sure enough, the straw man isn’t far behind (emphasis mine):

The new watchdog, wherever it goes, is the linchpin of the emerging financial-reform bill, and its premise is that greedy bankers exploiting dumb consumers essentially caused the credit crisis. Stop bankers from selling toxic mortgages and other harmful loans and we won’t have any more meltdowns.

Who’s saying that so definitively? Elizabeth Warren and the like posit that regulating such predatory behavior could help prevent crises—in combination with other tough measures like transparency, derivatives regulation, and stricter leverage ratios. To say otherwise is just misleading.

But it’s just, well, dumb to say that a banker is dumb because he puts the screws to a customer who then can’t pay, as we’ll see below. And Lowenstein veers dangerously toward implying that he doesn’t believe in predatory lending, which would put him in the cloistered company of (gasp!) CNBC’s Melissa Francis and Larry Kudlow. Read that again:

Since mortgage bankers make money from loans, it’s tempting to think of them as parasites that prey on customers. But there is no such thing as a smart bank with a dumb customer; if the loan turns sour, the banker was dumb, too.

So a dumb banker can’t be a parasite preying on customers? Since when do predators have to have 150 IQ’s? Also, a smart banker can’t prey on a smart person, leveraging his know-how to put them over a barrel? Look it’s wrong to imply that there are no information asymmetries between bankers and even intelligent consumers (and no, this to-be-sure graph followed by a “yet” doesn’t cut it: “This isn’t to deny that many subprime loans were exploitative, and that customers often didn’t understand repayment terms. Nor is it a bad idea to police banks, preventing them, for instance, from charging unreasonable fees.”) Barry Ritholtz, in the course of arguing for a strong Consumer Financial Protection Agency, wrote this the other day about a typical bubble-era cocktail-party conversation :

Home-Buyer: We got a great deal on our new mortgage.
Me: Did you do a 30 year fixed or something more exotic?
HB: 30 year fixed — at 4.5% !
BR:  Sorry, but that’s not 30 year fixed — rates are 6.5% today. That’s probably a 2/28, with a reset in 200X.
HB: No, we definitely asked for a 30 year fixed.
BR:  Well, that’s not what you got — its impossible to get that loan at that rate today.
HB: We’re good negotiators.
BR: Mortgage rates are set by the bond market. Banks charge a mark up ABOVE the rates that they can borrow money. They can’t get 30 year money at 4.5%, so you can’t get 4.5%.  There is only so much negotiating you can do with the bond market.
HB: Well, its definitely a 30 year fixed.
BR: Please make the pain stop …

I’m pretty sure Ritholtz doesn’t make a habit of hanging around with stone-cold idiots.

As for Lowenstein’s simplistic argument that lending to a “dumb” customer who defaults means a banker is stupid—well, it doesn’t hold water. For one, the banker is/was playing in a heads-I-win-tail-I-don’t-lose environment. His incentives are aligned to press his luck and keep dancing until the music stops. If the loans go bad and his bank fails, who’s going to take it out of his hide?

The point of the game was to originate mortgages to distribute to somebody else, not to hold these loans on their balance sheets. The banks got so greedy that many of them got stuck with large amounts of toxic assets they’d thought they could foist on others. That behavior may have been wrong, but it wasn’t necessarily dumb. There were a lot of non-bank actors involved, too, and they acted perfectly rationally—if unethically and immorally (and let’s not forget: illegally!).

There’s other nonsense in here. Like this:

In short, the root cause of the meltdown wasn’t that customers borrowed too much; it’s that banks lent too much.

Somebody has to borrow for somebody to lend, you know.


We should remember that for every mortgage customer that was hosed, others were willingly grabbing all the unsound mortgages they could get.

So screw those who got screwed! That’s the old blame-the-homeowners chestnut modified to acknowledge the preyed-upon but put them down the list of priorities—as if they were on top anyway.

All this twisted logic begets a twisted conclusion:

Rather than stop lenders from hurting consumers, the first priority should be to keep the banks from harming themselves.

No, that’s wrong, and it’s captured thinking. The point of a banking system in an economy is to serve consumers, not to serve itself profits. They’ve knifed consumers with near-impunity for too long. Suggesting that the stability of the financial system should be prioritized over protecting consumers is wrong—and a false choice.

What a mess.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.