Maybe Consumers Shouldn't Always Be Confident

Economist Simon Johnson has a post today on the New York Times Economix blog. He argues that banks and their lobbyists should be supporting a Consumer Financial Protection Agency. Such an agency would look at financial products, like wacky subprime mortgages, and determine whether or not they're safe for consumers. It would be kind of like what the FDA does for drugs. I think his assertion is right, but I think the broader public should not support it.

First, let's take Johnson's argument that banks should like such an agency. He says that consumer confidence is low right now for financial products, given how many people have been burned. Here's an analogy he then makes:

What happens when there is a scare regarding food contamination in the United States or globally? People buy less of that food until the government assures them that: 1) we now understand the cause of the problem; and 2) it will not happen again.

He says that the same should happen with financial products. That would help consumer confidence and banks would ultimately make more money because people wouldn't be scared of their products. That makes sense.

But I think there's a broader point to be made: maybe consumer should be wary of financial products they don't understand. Think about drugs and the FDA instead. Just because a drug is deemed "safe" doesn't mean everyone can/should take it. That's what doctors are for. Unfortunately, mortgage brokers and credit card companies don't have the same kind of fiduciary duty that doctors have to direct consumers to the products that are safe for their situation.

I think consumers would be a lot better off if they permanently had lower confidence in financial products. If that were the case a several years ago, it might have caused them to think twice before signing that negative amortization mortgage. Consumers aren't scared about the safe products, like regular mortgages, they're scared of stuff they don't understand. They should be.

I'm also completely unconvinced that, if a Consumer Financial Protection Agency were in place from 2000 to 2006 anything would be very different. Virtually everyone -- including the government -- thought subprime mortgages were perfectly okay. I expect that they would have even received the CFPA stamp of approval if it had existed. What causes crises like the one we're in is that people are vastly wrong about something that they were very confident about. Without a crystal ball, you can't really escape that, no matter how much you regulate.

Creation of a CFPA, as a means to restore confidence in financial products, doesn't let the market do its job. It's that wariness that will prevent people from making the same mistake again. By the government telling them that certain financial products are safe will just confuse that fear. That might be good for banks, but it's bad for everybody else.