Unless you’ve been seriously out of touch for the last few months, you already know that behavioural economics is all the rage. Journalists like it because it sometimes produces surprising and counter-intuitive results that make good stories. (And, admittedly, old fashioned rational maximizing is a bit boring.) The politically liberal like it because it often provides rationales for government intervention. The innumerate like it because there seems to be less maths involved.
Even I want to like it. But try as I might, I just can’t hop aboard this particular band-wagon.
I’ve already discussed one important flaw in the intellectual worldview of the Behavioralists. They tend to be very good at spotting flaws in market process but very poor at understanding flaws in government processes. To them, irrational market behaviour needs to be supplemented by government action. But why should anyone suppose that government isn’t afflicted by the same, if not worse, types of irrationality that affect people. For a group of people who pride themselves on paying attention to the way “real people” behave, this double-standard is seriously disappointing.
But it’s not just that they misunderstand government. They also don’t seem to understand markets very well. Take this column by Richard S. Thaler, whose bio in the New York Times tells us he is “a professor of economics and behavioural science at the Booth School of Business at the University of Chicago.” Oh, and he is the co-author, with Cass R. Sunstein, of “Nudge: Improving Decisions About Health, Wealth and Happiness.” Even better he has informally advised the Obama administration. He is, in short, one of the grand poobahs of behavioural Econ.
His column in the Times praises a simpler time for mortgages. You know the story: everyone had a 30 year fixed mortgage, defaults were low, kids played in the yard, mum wasn’t as uppity and dad had a martini in his hand the minute he crossed the threshold of home. Well, OK, maybe I threw those last items in myself but that’s the idea: mortgage nostalgia. And while he doesn’t exacty call for a retreat to one-size fits all mortgages, Thaler proposes warning labels and other reforms he thinks will protect the unsophisticated from getting involved in complex mortgages they don’t understand.
Here’s the problem: Thaler thinks he’s protecting the unsophisticated but his dreamy Golden Era of simple mortgages actually exploited unsophisticated borrowers in a way that enriched banks. You see, under the old mortgage regime, low-income borrowers tended to exhibit what the bankers called “low-prepayment risk.” This was code for the idea that bankers could make more money from the poor because they wouldn’t refinance their home loans, even when interest rates dropped and big savings were available. The poor just kept on paying their old mortgages at the higher rates.
His reforms threaten to bring back this era of exploitation, re-introducing the class division that reigned in the past. The sophisticated people will be able to access mortgages that allow them to take advantage of low rates, while the huddled masses will toil once again as the “low-prepayment risk” engines of profits they once were.
This basic fact of mortgage lending seems completely lost on Thaler. He doesn’t really seem to have spent any time at all examining the different ways real people pay their mortgages. And for a poo-bah who fancies himself an expert in “the study of Humans in markets” this very close to an unforgivable oversight.
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