Imagine that a few years ago, at a time when you were renting your home, a fast-talking lender had approached you and explained how you could afford to buy your first house. The monthly payments seemed affordable.
At the closing, you were swamped with forms, dutifully signing where you were told. Recently you discovered that one of the forms you didn't read at the closing explained how your monthly payments would rise three years after the closing. Now that those years have passed, you can't afford the payments. You have defaulted, and now face the prospect of losing your home.
Now suppose that the process had been completely different. Well before signing the papers, you had to watch a video warning you about the pain foreclosure brings. You were required to work through a budget that took into account the increase in your mortgage payments and helped you understand how much money you would have to meet your other expenses after you made your mortgage payments. A credit counselor explained the consequences of taking out the loan and countered the influence of the fast-talking lender. Might you have decided against taking out the loan? And if millions of other borrowers had had a similar experience, might we now not be in the crisis we are in?
Ideally, policy-makers will adopt new rules that would cause lenders and borrowers to agree only to those loans that will be repaid on time, and indeed the federal government is requiring lenders to consider the ability of borrowers to repay. But that may not be enough. Presumably, those holding the loans now in default also thought that borrowers would be able to make their payments. Policy-makers would do well to remember that the people now losing their homes had believed they would be better off by incurring the loans. Accordingly, policy-makers should also pursue rules that would help consumers understand the risks of such borrowing.
Our current system for informing borrowers of the risks they are taking is based on the Truth in Lending Act ("TILA"), enacted in 1968. The TILA disclosures obviously were of little aid to those caught in the mortgage crisis. The reasons may be many: Some consumers may not learn well from documents, while others may have been confused by the mountain of paperwork. Still others may have been deceived; thus, a predatory lender at a 1998 congressional hearing testified that he "can get around any figure on any loan sheet."
Policy-makers have responded by tinkering with the timing and content of some disclosures. But changing the written disclosures smacks of homeopathic medicine: the cure for written disclosures that failed is more disclosure. We know that some people learn well by reading, but that others learn better in other ways, and we should not ignore those other ways.
Instead, we should update our 40-year-old system for helping borrowers understand what they are doing. Policy-makers should make the risks of default clearer to borrowers by using modern technology like videos and computers. Instead of expecting borrowers to understand their payment obligations from passive reading, Congress should use methods that will force borrowers to understand the consequences of their actions. To be sure, these measures will increase the cost of borrowing, but they are far less costly than bailouts-and doesn't it make sense for consumers to understand the ramifications of what may be the largest payment obligation they ever assume?
While it may seem that memories of the current crisis would make such measures unnecessary, we cannot count on that. It would be just as much a mistake to assume that the current crisis will prevent unwise borrowing as it would have been to expect that the 1987 stock market crash would prevent later stock market bubbles-which of course it did not do. In 10 years or so, today's children will consider taking out mortgages. They deserve the tools to make better choices than their parents did.
Jeff Sovern is professor of law at St. John's University School of Law and co-coordinator of the Consumer Law and Policy Blog at www.clpblog.org