Maybe We Should All Be More Like Vermont

I am a little surprised to see myself write this, but perhaps all states should be more like Vermont -- when it comes to their banks' mortgage origination practices. A fascinating article in today's Wall Street Journal explains that in Vermont, the mortgage industry has felt no pain. But it also didn't see the kind of expansionary growth that now troubled states like California and Florida saw. Vermont's style for mortgage regulation might bother some, but the practices should be common sense for banks anyway.

The WSJ's explains:

Vermont's strict mortgage-lending laws largely prevented the state's residents from signing the types of dubious home loans written in other markets across the country. Its 1990s legislation made mortgage lenders warn customers when their rates were relatively high, and put the brokers who arranged loans on the hook if their customers defaulted. Now, by at least one measure, the state has the lowest foreclosure rate in the U.S.

I don't have much problem with the idea that mortgage brokers should have some skin in the game. This likely would have prevented their origination of so many wacky subprime mortgages in other states. I also don't see much harm in providing those who apply for mortgages with more information about how their rates compare to industry averages. The regulations described above seem pretty uncontroversial to me.

But the some lament the effect of these regulations:

It came at a cost. The rules also kept some Vermonters like Ms. Todd from buying homes, keeping this rural corner of New England on the sidelines of the housing boom and the economic bonanza that came with it. Vermont's 10-year growth trails the national average.

They began with Ms. Todd's story. She wanted a mortgage, but was self-employed. Banks weren't comfortable with her "unreliable" income stream. She also did not want to pony anything up for a down payment. While they portray her story as a problematic one throughout the article, in the very last sentence, she admits that conservative bank policies were right to force her to wait until she could more easily afford a mortgage. She eventually got one, when she could actually afford it:

"Five years ago if I'd gotten the loan," she said, "I would have been in over my head now."

I would point anyone annoyed with strict requirements for obtaining a mortgage to the fact that getting a mortgage is a privilege, not a right. This woman clearly did not need to live on the streets because she was self-employed; she was just forced to rent. Surely, there are worse fates than renting. After all, while renting, she saved up and eventually a bank was happy to give her a mortgage with a hefty down payment.

It's interesting to compare Vermont and Florida, because the two states have something in common: two of their major industries are agriculture and tourism. The two states also have a very significant difference: their attitude towards real estate. I explained all of Florida's problems yesterday. Vermont can't relate.

Why might Vermont have wanted to be more like Florida? The WSJ explains:

Critics say such rules put a brake on growth. Vermont politicians are "patting themselves on the back because we saved ourselves from this catastrophe," said Joel Schwartz, director of the economic development office for St. Johnsbury, a town in northeast Vermont. But developers and others "can't march into the state and start doing business."

Right. But that growth is fake. Just ask Florida. Unless new industry or technology accompanies those developers, then there's no reason to believe that, suddenly, people would be able to afford nicer or more expensive homes. So long as real estate growth drives its own boom, it creates a bubble. On the other hand, if new industry does enter a place like Vermont, real estate growth will necessarily follow. The WSJ illustrates this well in a neat interactive chart. Here's the comparison of change in GDP for Florida and Vermont:

gdp fl vermont.PNG

Expect that orange line to stay below the gray one for the next few years. Now compare that graphic to this one, which shows the change in personal income for the two states:

income fl vermont.PNG

As you can see, the incomes didn't change drastically in either state, so Florida's real estate boom must have been a bubble. Finally, just for fun, here are the foreclosure rate changes for the two:

foreclose fl vermont.PNG

An economist puts it well in the WSJ article:

Jeffrey Carr, Vermont's state economist, defends the state's market guardrails. "The critics of the regulatory environment would say, 'Great, you prevented the car accident by never getting in the car,'" he said. "We got in the car, and we went the speed limit instead of going 70 in a 35-mile-an-hour zone."

I really don't know why banks were so quick to produce the real estate bubble trance inducing Kool-Aid, and then consume it themselves. This quote from the WSJ article states the effect of Vermont's policies:

"We generally do often lag the national economy -- both up and down," said Republican Gov. James Douglas. "We don't benefit from the boom times, but we don't fall as deeply into the abyss when things get tough."

In other words -- Surprise!! -- conservative monetary constraint prevents bubble economies. This might seem like a moment to thank Captain Obvious, but banks clearly never got the memo. If they had, then Washington wouldn't be trying to dream up new ways to regulate them into submission. And that's the worry. Not that Washington might offer up a handful of reasonable market constraints like those the WSJ article explains, but that it will go way overboard and over-regulate the market. Unfortunately, banks only have themselves to blame. Had they behaved more responsibly, then the call for new regulation would be a weak one.