What Good Will the Consumer Financial Protection Bureau Do?

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James Surowiecki argues that bankers should welcome the CFPB, Elizabeth Warren's brainchild, as a possible source of salvation rather than ruination.  

While some bankers accept the need for consumer protection, they maintain that the C.F.P.B. will go too far and end up strangling financial innovation. But, over the past century or so, new regulatory initiatives have inevitably been greeted with predictions of doom from the very businesses they eventually helped. Meatpackers hated the Meat Inspection Act of 1906, but it rescued the industry from the aftereffects of the publication of "The Jungle." Wall Street said that the creation of the S.E.C. would demolish stock trading, but the commission helped make the U.S. the world's most liquid and trusted stock market. And bankers thought that the F.D.I.C. would sabotage their industry, but it transformed it by effectively ending bank runs. History suggests that business doesn't always know what's good for it. And, at a time when Americans profoundly distrust the financial industry, a Warren-led C.F.P.B. could turn out to be the friend that the banks never knew they needed.

I'm second to none in my appreciation for the FDIC, but this is an excessively rosy reading of regulatory history.  The regulations that gave us the FDIC and the SEC also gave us a number of stupider regulations, like centrally fixed interest rates for savings accounts, and the infamous Regulation Q, which fixed the interest rates on checking accounts (demand deposits) at 0.0%.  Among other things, the interest rate regulations played a major role in the Savings and Loan Crisis, and they led to the creation of money market accounts, which operated outside of the FDIC system, and played a major role in our most recent financial disaster; a run on the money markets was ultimately what seems to have convinced the government to start spraying money into the financial system with a firehose.

This is not to say that Regulation is Teh Stupid, but that some regulations are stupid and some are not.  You cannot defend the Consumer Financial Protection Bureau by arguing that some regulation at some point in history worked (any more than you can indict a regulation on such thin grounds).  If the examples are similar enough they may be admitted into evidence by the defense or the prosecution, but ultimately, the regulation has to win the case on its own merits.

And so I ask the obvious question that still sort of eludes me: what exactly is this thing going to do?  The examples that Surowiecki offers are not exactly thrilling.

The core principle of Warren's work is also a cornerstone of economic theory: well-informed consumers make for vigorous competition and efficient markets. That idea is embodied in the design of the new agency, which focusses on improving the information that consumers get from banks and other financial institutions, so that they can do the kind of comparison shopping that makes the markets for other consumer products work so well. As things stand, many Americans are ill informed about financial products. The typical mortgage or credit-card agreement features page after page of legalese--what bankers call "mice type"--in which the numbers that really matter are obscured by a welter of irrelevant data. There's plenty of misinformation, too: surveys find that a sizable percentage of mortgage borrowers believe that their lenders are legally obliged to offer them the best possible rate. Since borrowers are often unaware of how much they're actually paying and why, the market for financial products doesn't work as well as most markets do. And the consequences of this are not trivial. The housing bubble was a collective frenzy, but it was made much worse by the fact that millions of borrowers were making poorly informed decisions about the debt they were taking on. If people had known more, they might well have borrowed less.

You might think that businesses offering better products would have an incentive to make sure that potential customers were able to distinguish between ripoffs and good deals, but it's not that easy. As the law and economics scholars Richard Hynes and Eric Posner have found, when consumer ignorance is "severe enough" there's "a limit to how much explaining a creditor can do before losing the attention of its customers." In an interview in 2009, Warren told me about her own experience with this problem. She talked to a number of banks about introducing a credit card with a higher up-front interest rate but lower penalty fees--a cost-effective arrangement for many people. But the idea went nowhere, because research suggested that there was no way to convince consumers that it was a good deal. In a world where marketing is all about the lowest teaser A.P.R., all businesses have to play the same game, and you end up with a race to the bottom. Look at the housing bubble: any mortgage broker who told customers that he was being paid to push them into certain kinds of mortgages would have lost business, while financial institutions that initially avoided things like no-income-verification mortgages eventually felt compelled to offer them.

The C.F.P.B. hopes to change this, largely by insuring that consumers will be told the true terms of a deal, in a simple and clear fashion.
Advocates for the CFPB like to talk up transparency. Who's against transparency?  But when you dig down a little, the problems that they're talking about aren't really solved by transparency.  Take the high-annual-fee credit cards, or the lousy mortgages: these were things around which there was already quite a lot of transparency.  Too much transparency, in fact.  When we signed our mortgage last October, I shocked the hell out of everyone there by reading everything.  I'm a financial reporter.  I doubt I understood most of it.  I signed anyway.  

Most people don't even do that.  So we frequently hear that there's too much information, now, and we need to simplify: better transparency, instead of just more.  But long before the crisis we required simplified disclosures for both mortgages and credit cards; you got a sheet saying what your annual rate was, the minimum monthly payment, etc.  Where the loan was adjustable, people had to be told that their rate could adjust.  They didn't read it. Or they didn't understand it.  Or they figured they'd pay of the car or refinance the house long before that happened.

The problem isn't that banks don't have the right disclosure form for high-annual fee credit cards; it's that people don't want them.  Maybe they shouldn't want them.  Maybe we should only get the things that Elizabeth Warren wants to give us.  But now we're not talking about transparency.  We're talking about the Consumer Financial Protection Bureau "protecting" you right out of financial products that the paternalistic technocrats don't think will be good for you.  And that's problematic, both because it assumes that people are kind of like children, and because that protection often carries a high price.  Usury Laws used to "protect" poor people from very expensive loans; they are often spoken of fondly by consumer advocates ruminating about payday lenders.  The laws protected them so well that many of them couldn't get loans at all, and had to pawn their stuff, borrow from friends and family, or hit up a loan shark.

There's also the fact that adding any regulatory layer inherently advantages incumbents over newcomers; it's hard to enter a new market that requires an immensely expensive compliance department just to open the doors.  That has its advantages--firms are stodgier, more easily regulated, and less likely to get into trouble the way they did in 2008.  It also has a lot of drawbacks.  Such banking services are expensive for both depositors and borrowers.  They're also not necessarily as worried about efficient capital allocation, since excessive profits tend to attract the beady eyes of the regulators, so there's a risk that profits will be distributed as things that managers and shareholders can consume, like junkets and loans for friends and family members, rather than compensation or dividends.

This is not to claim that the CFPB will be a disaster.  I have no idea what it will be like, because the goals (transparency! options!) do not really seem to match the problems they are trying to fix (consumers taking out loans they will one day regret).  So it's far from clear to me what this agency is actually going to spend its time doing.

It seems to me that the most likely outcome is a fairly useless agency that spends a lot of time playing with disclosure documents, and occasionally yells at banks about penalty fees, maybe requires banks to offer these plain vanilla loans of which Warren is so fond . . .  but shies away from doing anything which will actually restrict credit availability.  This agency won't do much harm, but of course, it's hard to see how it could do much good, either.  A more ambitious agency, one willing to risk a fiery backlash from Congress, might achieve good things.  (I can't say what, exactly, but I concede the possibility.)  On the other hand, that agency has more power to do active damage.

That's why I'm not yelling about the CFPB, pro or con.  I've yet to see a compelling case for huge market failures that the CFPB should rectify, will have the legal authority to rectify, and plans to rectify.  (If you're winding up about the foreclosure mess, for example, please show me where the CFPB gets to pluck foreclosure actions out of the state courts where they are adjudicated.)  I think it will be another modestly expensive and mostly vestigial organ of government.  I can't really get worked up about it, any more than I can get mad at my appendix.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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