One significant step toward putting the US economy back on its feet would be to for the government to treat borrowers like adults. It’s a novel idea, huh? And one that’s likely to fall on deaf ears up on Capitol Hill. But we firmly believe here at Notes that it is a prerequisite of any real economic recovery in the US.

“Imagine a man in California,” writes Todd Zywicki, a professor at George Mason University School of Law, “who speculated in real estate at the height of the housing bubble. He bought a house with no money down and an adjustable-rate mortgage. But before he could flip that house for a profit, the market collapsed. He then owed more than his house was worth, but he knew that under his state’s laws it would be impossible for his bank to sue him for the balance of his loan if he abandoned the house to foreclosure.

“What is this man likely to do?”

The answer is simple: he defaults, thanks to California’s default-friendly laws.

This has led Team Obama to propose new regulation that would supposedly protect consumers from predatory lenders and dangerous loans. But do consumers, or speculators, for that matter, need such protection? Probably not says Zywicki…

Virtually every credit product is valuable to some consumers. Low-documentation loans are a boon for homeowners with a lot of equity who want to refinance their mortgages (even as they are a dangerous thing to offer speculators). […]Treating all consumers as hapless victims rather than recognizing that many consumers rationally respond to incentives is a recipe for unintended consequences. It can lead to counterproductive regulation that makes loans more expensive and harder to get. […]

Instead of a new consumer financial products safety commission, Washington should revise the disclosures it mandates for mortgages, its tax and other incentives that encourage overinvestment in housing, and the incentives for homeowners to walk away from their homes. Our current problems are caused by misaligned incentives and the rational response of consumers and lenders to those incentives. It’s not a crisis of consumer protection. A new agency premised on the erroneous belief what consumers need is to be protected from themselves is likely to do more harm than good.