The Behavioral Law and Economics of Fixed-Rate Mortgages (and Other Just-So Stories)

Abstract

A major cause of the recent financial crisis was the tradi-tional American mortgage, which is distinctive for the fol-lowing features: it is a thirty-year, self-amortizing loan with an unlimited right to prepay. The United States is unique in the world for standardizing on a mortgage product with these features. Yet not only have a majority of the foreclosures that occurred during the financial crisis been fixed-rate mortgages, the fixed-interest-rate characteristics have undermined ef-forts by the Federal Reserve and government to assist recov-ery of the housing market. Moreover, the long fixed-rate term and ability to refinance are highly expensive and suboptimal features for many consumers. Nevertheless, many consumers persist in purchasing this mortgage. Drawing on the method-ology of behavioral law and economics, this article provides rationalizations for how behavioral law and economics can explain the persistence of a product that is so harmful to many consumers and to the economy at large. The article then draws conclusions about what this analysis means for the behavioral law and economics research program