(photo credit: Courtesy)
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
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.
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
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.
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
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
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
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
Asher Meir is research director at
the Business Ethics Center of Jerusalem, an independent institute in the
Jerusalem College of Technology (Machon Lev).