Ethics@Work: Benevolent or meddling?

Some think Bank of Israel’s new directives are too intrusive.

By ASHER MEIR
The Bank of Israel on Wednesday issued a new directive that will allow only a third of mortgage loans to be made at variable interest rates, which rise and fall with the general level of interest in the economy. The bank expressed concern over “possibility that the interest rate will rise and will markedly increase borrowers’ monthly mortgage payments, to an extent that will impact on their repayment ability.”
Right now interest rates are low, but if they rise, people could suddenly find themselves with much higher monthly payments.
In response to the announcement, a representative of one of the investment houses published a critical essay accusing the Bank of Israel of interfering with economic liberty, in particular freedom of contract.
In all other areas of commerce, we let citizens decide for themselves if a product is too expensive or the conditions too risky. Why should mortgages be different? Is the step indeed an interference with economic freedom? If so, can this restriction be justified? To clarify this question, we need to examine several policy goals the step is meant to accomplish.
One of the goals is simply to cool down the mortgage market. For a long time the Bank of Israel has been concerned that the continuing rise of housing prices reflects a bubble that could suddenly burst, leaving many people unable to pay their debts or expenses. This can harm the economy and the stability of the financial system.
However, limiting variable-rate mortgages is only one way of achieving this goal. The simplest way to cool down demand is merely to raise interest rates across the board. Another approach is to directly limit the amount people can borrow by raising the required down payment.
Another concern is not the benefit of the borrowers themselves, but rather the stability of the system as a whole.
The bank announcement hinted at this by referring to these mortgages as “an inherent risk to borrowers, and consequently to the overall banking system.”
Even if the bank is willing to let customers bear the risks of their own mistakes, it might not want to let the entire financial system suffer those risks.
What about protecting people from their own mistakes? This practice is often called “paternalism,” meaning the government is acting like a parent.
There are two reasons to be suspicious of the government trying to act on our behalf when we can act on our own: First of all, why should the government think we don’t know what’s in our own interest? Second, if we don’t know how to pursue our own interest, why should we assume that the government knows any better? These considerations may apply to a greater or lesser extent depending on the situation. When consumers have good information about the product, and when they have a lot of variation in their own characteristics, then it should be assumed that they, and only they, know how to make the best buying decisions to match the product and their own needs. No expert can tell me what kind of food is most satisfying to me.
But when consumers have poor information about the product compared to experts, and when people are rather similar in their characteristics, then there is more justification for intervention. People are not very good at distinguishing skilled physicians from quacks, and most people want the same thing in a doctor: expert advice – so everyone expects the government to license doctors.
Based on the first criterion, adjustable-rate mortgages are a good candidate for regulation. Most people get a mortgage only once in their lives.It is safe to assume that most people who are getting adjustable-rate mortgages have never taken one out before, and of those who have, many have never experienced a sharp and sudden rise in interest rates. In this case, experts really do have more knowledge than many consumers.
Based on the second criterion, the decision is less clear-cut. The income variability of different individuals can be quite different.
If a person’s income is mostly from interest income, then his income will increase along with his mortgage payments.
On the whole, there is a good case to be made for paternalism when it comes to variable-rate mortgages in a period of historically low interest rates, and hence mortgage repayments. Undoubtedly there is some intrusion on freedom of contract, but within the context of the many policy objectives at stake here, the intrusion seems proportionate.
ethics-at-work@besr.org
Asher Meir is research director at the Business Ethics Center of Jerusalem, an independent institute in the Jerusalem College of Technology (Machon Lev).