Given the turmoil in the subprime mortgage market it is inevitable that legislatures and regulators are going to be considering new regulations.
One area in which that market certainly could work better would be with respect to the comprehensibility of disclosures to consumers. In that vein I commend to readers and regulators an excellent new study just out from the Bureau of Economics at the Federal Trade Commission on “Improving Mortgage Disclosures.” The report is available here.
The report has a number of interesting findings. Most interesting to me are:
-Prime and subprime borrowers seem to be equally able (or more precisely unable) to comprehend their mortgage disclosures. In a test about the content of their loans, prime borrowers could only answer 62.0% of the questions correctly and subprime borrowers could answer 59.6% correctly. So subprime borrowers in general do not appear to be any dumber or unable to comprehend their loan terms than prime borrowers.
-More complex loans lead to more errors in understanding loan terms. The disclosures in the study were based on those currently mandated by various federal laws and regulations.
-Better disclosures are possible: As part of the study, the FTC staff worked up some prototype improved disclosures based on economic theory and experience at the FTC enforcement actions against deceptive lending practices. Using the prototype disclosures, comprehension of lending terms rose from an average of 61% correct to 80% correct.
-The increase in comprehension with the prototype disclosures was greatest for more complex loans.
The overall takeaway of the FTC study is both dispiriting and encouraging. Dispiriting in that current disclosure regulations lead to consumer confusion and mistakes about the terms of the mortgages that they are entering into. Encouraging in that improved disclosures are in fact possible that could substantially increase consumer comprehension and reduce mistakes, especially in that it seems that there are no systematic differences in the abilities of prime and subprime borrowers to understand the terms of their loans.
Yesterday I did a lecture for Capitol Hill staff on subprime lending through the Mercatus Center’s Capitol Hill Campus program. I summarize the FTC study toward the end of my Powerpoint presentation that I gave yesterday at slides 35-37.