When Is Regulation Excessive?

March 13, 2017

President Trump believes that Federal regulation is excessive and has directed that task forces be set up at each Federal agency to supervise and monitor the process of finding regulations to cut. To my knowledge, he has not provided any guidance to the agencies on how to do this, so I decided to do it for him in this article. 

Step 1: Define the Objective:

Counting the number of regulations is useless, what matters is whether the objectives of regulation are being achieved. Regulation is excessive when it does not accomplish its objective, or when the cost of accomplishing the objective through regulation is excessive, or when there is an alternative to regulation that is less costly.

The objectives vary from agency to agency. My interest is in financial regulation. This includes the market for home mortgages, which I will use for my illustrations. The agencies with regulatory responsibilities in this market include HUD/FHA, the Consumer Financial Protection Bureau (CFPB), the Federal Housing Finance Agency, Fannie Mae and Freddie Mac.

I will illustrate with two objectives, both of which are designed to empower the “little guy.”

1.     Reduce barriers to effective mortgage shopping.

 2.    Reduce mortgage transactions costs.

Step 2:  Identify Remediable Deficiencies

The major focus of the agencies in assessing their regulations should be to identify the major deficiencies that are preventing their objectives from being realized.  For the mortgage-related agencies, Step 2 would include the following deficiencies bearing on the two objectives cited above.

1.  Lender control of appraisals makes them non-portable and lengthens transaction periods, both of which impede the ability of borrowers to shop effectively.

2.  The cost of title insurance paid by borrowers is excessive relative to the costs incurred in assessing the validity of titles.  

Step 3: Assess Existing and Alternative Regulations

I will illustrate with the two objectives and deficiencies cited above.

The Difficulty in Shopping: The core problem potential borrowers face in shopping for a mortgage is that critically important information bearing on its price, including the value of the property, is not available to them until after they have applied for a loan and paid for an appraisal. For a borrower to withdraw at this point in order to begin again with another lender is difficult, costly and time-consuming, so few do it.

Relevant Existing Regulations: The regulations applicable to appraisals are a major source of the problem. While borrowers pay for appraisals, the regulations place responsibility and control with lenders, who order them after a borrower has applied. This lengthens the period the borrower must wait for the information needed to shop, and it also means that the borrower who withdraws from the process must pay for a new appraisal and wait out the results once again.

A Better Regulatory Approach: If regulations obliged lenders to accept an appraisal ordered by a borrower from any approved appraisal management company, the borrower would at last have the capacity to shop for the best deal. With an appraisal in hand, the shopper could invite multiple lenders to make a firm offer at a specified date and time.

Making appraisals portable is one of the simplest and most effective ways to empower consumers. Bringing that about would require replacement of one set of regulations with another set.

 The Excessive Price of Title Insurance: Assuring good title is necessary for an effective housing and mortgage market, but title insurance is not necessary for that purpose. Denmark has a reliable system of recording titles but no title insurance.

Relevant Existing Law: Existing law allows lenders to shift to the borrower the cost of title insurance that protects the lender. This prevents the efficient application of existing technology that would reduce the cost of assuring good titles to a small fraction of the cost of title insurance. The problem is that lenders have no financial incentive to shift to a more efficient system – in fact, many have a financial interest in the title agencies to which they refer customers.

A Better Regulatory Approach: If the law required lenders to pay for title insurance themselves, passing the cost to the borrower in the price of the mortgage, lenders would have an incentive to drive down the cost rather than to share in the revenue. The result would be a precipitous decline in the cost of title insurance, and eventually the replacement of the industry with an automated system open to all market participants.

If this new and very simple regulation applied to mortgage insurance as well as title insurance, which should be the case, it would make a large set of existing regulations obsolete. These are the regulations that apply to referral fees, which deal with such weighty matters as whether a birthday present from a title agent or a mortgage insurance salesperson, to a lender, constitutes a prohibited referral fee. Good riddance.

Concluding Comment

The President says he wants to reduce the number of regulations.  I interpret that to mean that he wants to replace regulations that are directed toward worthy objectives but don’t work with regulations that do work, and I have given some examples. Regulations that ought to be scrapped rather than replaced will be discussed in another article.  


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