Behaviorally Informed Home Mortgage Credit Regulation Draft 4 / 15 / 2008

Choosing a mortgage is one of the biggest financial decisions an American consumer will make. Yet it can be a complicated one, especially in today’s environment where mortgages vary in dimensions and unique features. This complexity has raised regulatory issues. Should some features be regulated? Should product disclosure be regulated? And most basic of all, is there a rationale for regulation or will the market solve the problem? Current regulation of home mortgages is largely stuck in two competing models of regulation—disclosure and usury or product restrictions. This paper seeks to use insights from both psychology and economics to provide a framework for understanding both these models as well as to suggest fundamentally new models. Disclosure regulation, embodied in the Truth in Lending Act, presumes one market failure: the market will fail to produce a clear and comparable disclosure of all product information needed by consumers. That is, TILA responds, potentially, to two types of problems: First, firms will not reveal all information that borrowers should understand and analyze to make determinations regarding taking out a loan. Second, firms will not reveal information in a way to facilitate comparability across products. The first concern speaks to consumer understanding, “solving” the problem with information;