On July 28, Richard Thaler, an economist whom I had criticized in an op-ed about the proposed Consumer Financial Protection Agency ("Treating Financial Consumers as Consenting Adults," Wall Street Journal, July 23, 2009, p. A15--and see also my blog entry of July 7 about the proposed agency), responded to my criticism; his response can be read at www.pbs.org/newshour/businessdesk/2009/07/thaler-responds-to-posner-on-c.html. The response is temperate, but unconvincing.
Thaler, whom I had identified in my op-ed as the (or an) eminence grise behind the proposed consumer financial protection agency, begins his response by telling the sad story of the death of a friend's infant as the result of a defectively assembled crib. Thaler argues that instructions on the proper assembly of the crib would not have been likely to prevent the accident, because people notoriously fail to read instructions. He concludes "that cribs should be designed to be fail-safe in the sense that they should not be dangerous even if the user has not read the instructions."
I agree. But I do not agree that the example shows that we need an agency empowered to forbid people to buy houses with mortgages that the agency deems unsafe because of the terms of the mortgage, even if those terms are explained to the prospective buyer fully and accurately. Thaler asks rhetorically whether mortgages and credit cards are "all that different" from cribs. They are. Death is a more costly consequence of misunderstanding than taking on a mortgage that proves to be onerous and may as a result be defaulted, and so a risk of death warrants stronger preventive measures. Moreover, the menace of a misassembled crib, as of other defects in physical products, is hidden; and even if instructions are clear, many people are not good at following instructions. In contrast, a financial product is identical to its description. If you tell a person the terms of a mortgage, you have told him everything he needs to know in order to decide whether to accept them, except his personal financial circumstances--whether he can afford the mortgage--and he should know those circumstances better than anyone.
Thaler deems it "seriously misleading" that I assume the proposed agency would create only one "plain vanilla" form that a mortgage broker or banker would have to show a prospective mortgagor; he is sure "that it is reasonable to assume that there would be a fixed-rate and some type of adjustable-rate mortgage in the mix." I'm not so sure, because I can imagine the agency deciding that adjustable-rate mortgages are traps for the unwary. But if anything, the more forms the agency required the mortgage broker or banker to show the prospective mortgagor, the more confused the latter would be. There would be (according to Thaler) two or more "official" forms to choose between, which in turn are to be compared with the "unofficial" form or forms tendered by the broker or banker.
When last fall my wife and I increased the limit of our modest home-equity line of credit, the banker required us to sign an astonishing collection of forms. Neither of us read them. That is a typical consequence of government's mandating multiple warnings.
Thaler acknowledges past mistakes concerning investment. He says: "for many years I did advocate that young investors should consider putting all their money in stocks, and I followed that advice myself until 2000" (by which time, however, he was in his mid-fifties), but he says that since "I do not claim to be infallible, what does this have to do with whether we should try to help people make better choices?...We have fields that we know well, but are amateurs in most other domains." Well, Thaler is not an amateur in investments: he is a money manager. He is the type of expert one might imagine running the Consumer Financial Protection Agency. His acknowledged mistake about the advantages of an all-stock portfolio was the product of one of the cognitive quirks that behavioral economists, of which he is one of the most prominent, argue that we are subject to: namely the belief that the past is a secure guide to the future, which is the kind of thinking that got the banking industry in deep trouble. It is not actually an irrational belief; often there is no better guide to the future; but if behavioral economists don't do any better planning for the future than the rest of us, how likely is it that they can design financial instruments that will avert a housing or credit bubble?
Actually, I would be rather comforted if I thought that Thaler would be the chairman of the new agency. I imagine that whoever is appointed (assuming the agency is created) will be more paternalistic than he, and will introduce more turmoil and confusion into the consumer financial products industry than he would be inclined to do.
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