Getting Serious About Foolish Decisions
Posted by Jeff Lipshaw
Sometimes a little facetiousness is all you need to provoke a meaningful discussion. A couple days ago, I commented on Elizabeth Warren’s idea for a financial product safety commission. Apparently I made the mistake of thinking it was all about variable rate loans when in fact Professor Warren’s concerns go more generally to the tricks that providers of consumer financial products bury in the fine print.
To support her point, I provided this anecdote. We never run a balance on our credit cards, but use them for convenience and the “free float.” We once mistakenly underpaid a $3,000 credit card bill by about $10, and got charged interest from the date of incurrence because that is the normal provision if you run a credit balance, and you get a waiver by paying the WHOLE bill within the normal “free float” period. I can’t remember who I had to call to get the interest charge removed, but I did by arguing that the provision was obviously not suited to a mistake, because the charge kicked in if you missed a $10,000 payment by $1, effectively costing you some uber-Mafia-like charge on the couple bucks. Indeed, to her point, I argued that the agreement was “defective” in failing to distinguish between a mistake and the conscious incurrence of debt.
Granting the “information asymmetries” that make markets less than perfect, and rational choice less than fully rational, the discussion comes down to whether having a federal commission to regulate consumer financial products makes more sense than other ways of tweaking the market. I noted the similarities of insurance products to credit products, and wondered whether years of regulation by insurance commissions have improved things. I think generally markets get it right more often than regulators do (I cut my teeth as a baby lawyer litigating in the Department of Energy’s Office of Hearings and Appeals under the Mandatory Petroleum Allocation Regulations in the late 1970s), but I’m not fanatic about it: sometimes the markets don’t work for all the reasons the behavioral economists have observed. In that vein, Peter Huang had a comment on the previous post (at MoneyLaw) about Nudge, the recent work by Richard Thaler and Cass Sunstein, suggesting that all you really want to do is tweak or nudge the market with a little bit of paternalism (not a lot), usually by changing the defaults, but not eliminating choice.
Professor Warren tells me that the Consumers Union model for financial products doesn’t work, because the products are too easy to change, and still too hard to figure out. (She and Oren Bar-Gil have a piece coming out soon on it, and, by my sneak peek, it makes an impressive case for the existence of a problem, even if I have reservation about the proposal for a solution.) I agree with the idea (first articulated by Arthur Leff) that a financial instrument is more like a thing or a product than like a contract. And I recognize I’m probably not a typical consumer. I like the information I get from EnergyStar on appliances, and the data on sodium, calories, soluble fiber, and cholesterol now on food packaging. I think washing down a 600 calorie Sonic mini-cinnamon bun with a super-sweet 1,000 calorie mocha latte is disgusting (I think that’s what was being advertised yesterday), but I would rather have information about it than have it banned. I am still skeptical that credit agreement-toaster analogy holds (i.e. getting disclosure on the financial products is like getting an unfathomable wiring diagram). Electrical fires are always dangerous, but some people can handle cinnamon buns with very sweet coffee, and even the provision in my credit card agreement may make sense if you are running a large balance (why should you get free credit as the default rule?).
If a commission is more likely to produce efficient market-nudging, that’s something to consider. But regulatory systems usually have to choose among the disclosure model (federal securities law), the pre-approval model (state insurance regulation) or the product recall model (NHTSA and the CPSC). I’m more than a little concerned that this idea will naturally tend toward the latter two, with the law of unintended consequences taking over at some point.