Alex J. Pollock explains that mortgage disclosures need to be simplified to help borrowers understand whether or not they can afford their mortgage loan. He explains how his one-page mortgage form would achieve this.

Resident Fellow Alex J. Pollock

Thank you, and special thanks to the FTC for holding this exceptionally interesting and useful discussion.

My talk is about the Pollock one-page form. Here it is [available at www.aei.org/Pollock]. One of our colleagues at lunch said, "Well, I suppose you are going to talk about the infamous one-page form." I said, "Naturally, but I think of it as the famous one-page form."

The thing which is really most important, in my mind, for a borrower as well as for a lender, is "Am I likely to be able to pay this loan?" Let's give that an early and high degree of focus. I am interested less in getting people to choose what might be the perfect mortgage for them and instead prefer to focus on, "Can I afford this mortgage I am talking about?"

Susan Kleimann has pointed out that it is easy to make something that is easy to read and visually compelling, but the question is: can you also make it understandable and clear? That would definitely be the goal we are after. Another of her points is: "Decide on the desired action for the document." Do not do anything until you know what you want consumers to do with the information.

Well, here is my idea about what I want consumers to do with the information: think about whether they can afford this loan. Their goal is, in other words, to underwrite themselves. Of course, the lender is going to underwrite the borrower. With a reasonable degree of probability, under a reasonable range of circumstances, is the borrower going to pay and is the probability of default affordable to me? That is the lender's question when underwriting the borrower. The borrower should be asking the same question about their own situation. Underwriting themselves is the goal, and that is more an active idea than a passive idea.

By itself, getting information is a passive idea. We really want to give them these disclosures--in my case, give the one-page form--in order to cause the action of underwriting themselves. It seems to me that this is more important than choosing which of the dozens of possible mortgages might be the best.

Considering the role of house prices in our current crisis, a bubble is, by definition, an interaction of prices going beyond their sustainable levels with credit expanding to allow those prices temporarily to be paid. The rise of the prices induces further flows of credit, which inflates the bubble. There is a lot of procyclical behavior, a lot of procyclical product development, and procyclical decision-making. That is why we have cycles.

Looking through the cycles, as a matter of philosophy, my position is that people ought to be able to take financial risks. It is not the government's or anybody else's job to tell them they cannot take risks. But when taking these risks, they ought to know what risks they are taking. Correspondingly, lenders ought to be able to make risky loans, but they ought to be required to tell the truth in a straightforward way about the nature of the risk from the point of view of the borrower.

Think about the risk of getting a mortgage and buying a house. It is an important risk. But relative to some other things we can consider--say sailing on the ship that brought our immigrant ancestors in steerage class and launching into life in the new world--the  risks we are talking about today are pretty minor. How about like my great-grandfather getting on his wagon and launching off to homestead a farm in the wilderness? We are talking about pretty modest risks compared to that.

America is about the ability to take risks, but it would be good to make the risk taking as informed as possible. The way to do that is to give less but focused information rather than an excess: the relevant information about underwriting yourself and whether can you afford this loan.

I hope you get a chance to look at the one-page form, which is my attempt to do this. It starts off with the notion, as we all agree, that complete information, as we try to give it in current mortgage disclosures, is the same as giving no information. The more we try to make the information complete, and therefore complex, the more we succeed in effectively zero information transfer and just baffling people. The Mortgage Bankers Association tells me the average closing package now is 80 to 85 pages of things in small type and confusing language. If we make them then sign something that says "I have read and understand this information," what we are forcing them to do is lie--because, of course, they have neither read nor understood the information. If you get down to the bottom of my one-page form it says, "Do not sign this if you don't understand it." This may not cause you to always understand it, but is a more honest way to approach it.

Another thing about disclosures: because of regulatory systems and possible litigation, disclosures come to serve the purposes of lenders rather than serve the purposes of the customers. The disclosures get developed in order to protect the lenders from legal liability and regulatory action as opposed to helping the consumers. Among the few objections I have gotten to the one-page form approach are from lawyers who represent lenders. They are afraid that by having to make estimates –you have to make estimates to do this right--you may be creating some new kind of lender liability which, naturally, they do not want. Therefore, the safe harbor idea I will mention later is an important factor.

The other thing is timing. To get the best disclosure in the world is useless if you get it at the mortgage closing. Everything is decided by then. It is useless if you get it two days before the mortgage closing. It has to be soon enough in the process where you actually can make a decision that is meaningful. So: as soon as possible--I am suggesting upon approval of the mortgage by the lender. That is because at that point the lender has all the information it needs to underwrite you, and it can therefore share that information with you so you can underwrite yourself.

The story of the one-page form is that a little more than a year ago I was testifying to a subcommittee of the House Financial Services Committee. I made the points that we all agree on: how too much information is the equivalent to no information, that we have all these confusing pounds of paper. I said, we ought to be able to get the things that are really relevant on one page. A couple of the Congressmen said, "That is a great idea, we ought to do that."

So I then went back to AEI, sat down at my desk, and said, "Okay, why don't you see if you can actually do it?" I set myself the following limitations: It has to be on one page and you cannot make the one page by making the type smaller. Of course, as we all discover, it is harder to actually do it than to say that somebody else should do it. I went through a lot of iterations. I went around talking, especially to young people at AEI, saying, "What do you think about this, does that make sense to you?" When you do this, you always realize that when you get used to any trade, you lose the sense of what a specialized vocabulary you deal in and how obscure that vocabulary is to other people.

Among the other people I tried it out on were my own children. One is still in college, three are out. They are all magna cum laude graduates. One of the things, especially my daughters said, was "Dad, this is full of words we do not understand." (They obviously did not study finance.)

So, I did decide that you had to have, along with the form, what turned out to be a one and a half page set of (I hope) common language and avuncular descriptions of what the terms mean. I also pictured these pages on a screen where you could click and have the terms explained.

Having done all this (with my own highly informal market testing and intuition), what does it take to underwrite yourself? In the first place this form requires a key action-oriented disclosure, which you do not find in any other disclosures: your income. You'll find in capital letters on the form, "This is the income on which we are basing this loan."

Now, we know about liars' loans. If you were lying about your income, this gives you a chance to reconsider your lie--or maybe your generous estimate. But if somebody else was lying about your income for you, this gives you a chance to fix it.

Somebody said this morning that people do not understand interest rates but they do understand payments. So, this is your payment. Not just your loan payment. Your total payment, "PITI," as they say: principal, interest, taxes, and insurance (and we ought to throw in mortgage insurance premiums, if any, as well).

How much a month; how much a month at the introductory rate, if there is one; and how much when the loan resets at its fully indexed level? We also want to tell you--and this was a suggestion of one of my family member market tests--what the maximum possible rate on your loan is. Okay, this is going to start off at 6 percent. How high can it go? Give me the worst case scenario. 14 percent? Well, I want to think about that. How likely is 14 percent?

So the full payment: principal, insurance, taxes, and insurance, whether or not your insurance and taxes are being escrowed; and how much in dollars in the beginning and after reset.

Then: what percent that is of your income.

Is there a prepayment fee? We heard this morning from the great research that the FTC did that two-thirds of the people cannot tell if they have one or not. We ought to make it easy to know. Also, what is the check you will have to write at closing for points and closing costs?

When this one-page form was introduced into the House of Representatives, interestingly enough there was a debate among some elected representatives of the people over whether the borrower should sign. I think that both the borrower and the lending institution should sign--not the broker, but the organization actually making and underwriting the loan. Some Congressmen on the leftish side of the spectrum said, "If you make the people sign, you are saying that the borrower should have some responsibility." Yes, I am.

In providing this information, I suggest a safe harbor. Some things are estimates, notably insurance payments and taxes. If you give the estimates to the borrower, and they are the same estimates used in underwriting the loan by the lender, then that should be a safe harbor.

Senator Schumer introduced a one-page form bill a few months ago. The City of Washington, D.C. actually has made a form very much like this mandatory for adjustable rate loans. This, by the way, was an unusual alliance: the Washington, D.C. City Council and the American Enterprise Institute. Soon, we are going to be able to do some research on the Washington, D.C. experience.

Now, Jan and Jim had this wonderful line in their presentation this morning: disclosures that make sense to well-intentioned bureaucrats often bewilder consumers and, of course, that also goes for well-intentioned fellows of the American Enterprise Institute. So, we do want to keep learning. A big mistake is to do something only once. The magic of markets is you try it out, and you keep learning and keep getting it improved.

The key idea is a one-page form focused on whether you can afford this loan. If you want to take a risk, go ahead as long as you understand the risk you are taking. I have nothing against people who want to eat oatmeal three times a day for three years so they can have the house of their dreams. But they'd better understand what they are signing up for.

There is a further possible use. I picture high school personal finance classes with this form or something like it, with students learning that when you are getting a mortgage some day, you'll fill out this form about the mortgage. It will tell you a lot about whether or not you can afford it. Who fills it out? It would be wonderful to have not only lenders able to complete such a form, but if the borrowers themselves knew how to complete the form on their own behalf, in an active role of underwriting themselves.

In sum, I think the one-page form is a nonpartisan or an omni-partisan idea and it ought to be implemented whatever else in the mortgage area is done or not done.

Alex J. Pollock is a resident fellow at AEI.