GOPideas... ideas done right

As Congress begins to debate financial reform and starts batting around highly complex regulations, various regulatory structures, new departments and more government, conservatives would be wise to point to Texas as an example of how simple, but strong, regulation can eliminate the need for massive government intervention while simultaneously protecting the banking system.

Paul Wiseman of USA Today has a great piece outlining the reasons why Texas has fared far better in the housing downturn (and economy as a whole) over the last two years. Not surprisingly, those two factors are related: Texans did not splurge on real estate, so no bubble was created, which led to no bust. Those partial to Texans (like myself) may argue that Texans are just smarter than everyone else, but the story is far more complex --- and complex in ways that Republicans may not wish to admit (but should).

Specifically in 2003, Texas voters legalized home equity loans, a “financial innovation” that played a significant role in the housing bust. Home equity loans allow homeowners to borrow against the equity (what the house is worth versus what they owe on it) and use that money for other purposes. These loans were easily abused in the housing bubble because inflated appraisals increased the amount of equity attributed to the borrower, against which s/he could borrow against. When the market went bust, the house decreased in value, leaving the homeowner owing more than the house is worth.

However, the home equity loans that were legalized were limited to 80% of the home’s value and only one loan could be taken out per house. This ensured that borrowers had an equity cushion if prices began to fall and that homeowners could not game the system. In addition to these laws, Texas also limits balloon payments, bans pre-payment penalties and has strict regulations on negative amortization loans. In other words, the cowboy capitalism of Texas has a place for strict regulations on the private sector --- and those strict regulations likely saved Texas from being a part of the housing bust.

Instead of attempting to amend the current financial regulatory bills being advanced by Chris Dodd and Barney Frank (which include of a host of new government employees), Republicans can offer a simple slate of common sense reforms, such as a limit on the amount of equity an owner can borrow against. If that seems to restrictive Republicans can instead mandate that Fannie and Freddie (wards of the state) cannot purchase loans on properties in states that do not have such restrictions. (In reality, this would dry up the securitization market for loans from those states, effectively ensuring that states would either need to comply or watch interest rates spike.) 

Thus, the mortgage market would be stabilized, discipline would be brought to the Fannie and Freddie and the country would be on a sustainable course. Yes, some people who want mortgages would not be able to get them and, yes, some people who would want to write mortgages would not be able to write them. Thus, one could argue that regulation is causing (economic) inefficiency. True. However, we have seen the downside of such efficiency: a market rampant with moral hazards borne of information asymmetry and/or ignorance --- all leading to a financial disaster.