20% Down is a Good Regulation

20% DOWN IS A GOOD REGULATION

29 JULY 2011 BY CULLEN ROCHE
Note: What’s your opinion should this be a law?

There are times when regulation just makes sense.  Now, in general, I despise regulation (where I tend to make an exception is with regards to the financial industry).  Being an entrepreneur, I loathe the endless stack of paperwork that I need to fill out just to run a business in this country and the various hoops I need to jump through just to get things done.  I know I am not alone in this regard as the hoops are many across most industries these days.  I understand that there are reasons for these rules and regulations, but it’s difficult to argue that the USA is not excessively litigious in general.

That said, there are broad rules that just make sense.  A good analogy here is speed limits.  If you don’t have speed limits then certain people take excessive risks that endanger the many.  By reducing the average speed of drivers and actively enforcing this rule, we actually generate a higher risk/adjusted return on life.  We get to places a bit slower, but more of us get to live.  The economy is analogous.  If there are rules and regulations that can be implemented that help to avoid massive volatility in the business cycle (thus reducing our risk adjusted returns on life) then we should be proactive in implementing those measures.

I think down payments on homes applies.  TheStreet.com is reporting that the 20% down law is under consideration:

“Hopeful homebuyers may soon need to shell out more money upfront before being approved for a mortgage.

The public comment period concludes Monday for potential mortgage-related provisions spawned by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Among the potential outcomes is that homebuyers could be required to front a higher down payment – as much as 20% — before they can legally qualify for a mortgage loan.

In past decades, a 20% or more down payment was standard. The lower the down payment, according to conventional wisdom and ongoing research, the greater the risk of default.

As housing prices soared and mortgage lenders dove head-first into what would be the subprime crisis, that common practice fell by the wayside. You may pay more in interest, closing costs or PMI, but just 5% down is enough for many banks and lenders. FHA loans, insured by the government, typically require only a 3.5% down payment.”

I can’t be certain that a 20% down law would have eliminated the housing bubble, but I think it’s safe to say that a lot of speculative and/or high risk buyers would have been priced out of the market if this were the law of the land.   Preemptive laws such as this one help to protect us all by smoothing the business cycle and helping to avoid these sorts of financial crises.   It just makes sense – when you’re taking out debt that is several times your annual income you should be required to put down substantial collateral.   There’s good regulation and bad regulation.  In my opinion, this is good regulation that helps to increase the risk adjusted returns on all of our lives.

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