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FEATURE The Regulation Race Why new research on the world's emerging markets may be the key to understanding and evaluating the risky effects of fast-changing regulation in lending. By Mark Lieberman I regulators face in judging the effectiveness of new controls or rules for the mortgage market without stopping the industry entirely. and Benjamin Ranish of Harvard and Tarun Ramadorai of Oxford developed a different approach: studying the effectiveness of regulations not on the mature, U.S. mortgage market but on the developing market in India. Their finding? "Regulation may have contributed to a surge in delinquencies during the early 2000s, that subsidies for low-cost housing distorted the efficient markets relationship between interest rates and subsequent delinquencies, and that changes to the definition of non-perform- ing assets impacted behavior in response to early evidence of payment delinquencies." The three researchers were Economists John Y. Campbell looking specifically at how regu- lation influences mortgage risk. It does in the U.S., according to Paul Imura, chief marketing officer at ISGN. magine trying to study the undercarriage of a car while it was moving to determine the effect of different types of shock absorbers. Impossible? But that's precisely the challenge to disentangle regulatory effects from other factors that may af- fect household mortgage choice across countries. But, they added, "it is hard Examining India M fective at preventing the next catastrophic housing crisis," Imura said. "Our challenge is finding the right balance between consumer protection versus the ability for the capital markets to meet the ongoing housing finance needs of 330 million Americans. As the cost to originate and service a mortgage loan has gone up dramatically since the hous- ing crisis, the need for the right level of regulation has never been more critical. Minimum capital standards and regulation around consumer disclosure will ulti- mately help our market grow in a sustainable manner over time." Campell, Ranish, and "Regulation can be quite ef- of financial institutions: banks and housing finance companies (HFCs). Banks are regulated by the Reserve Bank of India (RBI), while housing finance companies are regulated by the National Housing Bank (NHB), but most regulations apply in fairly similar form to the two types of institutions, Campell, Ranish, and Ramadorai said. They selected India as their ortgages in India are originated by two types variation in default rates and interest rates, and regulatory changes in the incentives to originate mortgages in general and small loans in particular." The researchers analyzed more than 1.2 million mortgages— written in India by banks and finance companies—between 1995 and 2010 to understand both the macroeconomic and microeco- nomic factors affecting mortgage rate setting and delinquencies. These data, they said, reveal Ramadorai said government involvement in mortgage markets varies across countries, which, they said, "explains at least some of the cross-country variation in housing finance." veloping housing finance system has coped with significant "laboratory" rather than the United States because "devel- oped countries tend to have fairly stable systems of financial regulation, so one rarely has the opportunity to track the effects of sharp regulatory changes. Slow changes, such as those that occurred in the U.S. during the early and mid-2000s, may well be important but it is hard to show this convincingly." In India, they said "a fast-de- quencies in the early 2000s, even after controlling for demographic information, loan characteristics, and macroeconomic shocks, con- nected "to a number of regulatory changes which encouraged mort- gage lending at that time." They described this link "as strong, albeit circumstantial evidence for regulatory effects on mortgage defaults." A higher propensity of small and micro loans "particularly favored by the Indian regulatory environment" to default, which the study showed related to "implicit subsidies for such loans." A "significant and somewhat abrupt decline in three-month payment delinquencies beginning in early 2004" after the regula- tory definition of non-performing THE M REPORT | 35 "three interesting findings" relating to regulation of mortgage risk. A significant spike in delin-