Can We Really Protect Consumer Finances?

Todd Zywicki is a law professor at George Mason who specializes in bankruptcy and similar consumer financial law.  I learned to fear Zywicki when I pooh-poohed his prediction that the 2005 bankruptcy reform would permanently reduce the rate of filings; the latest data we have shows that despite the downturn, filings are still lower than they were in 2004.

He's got an interview up with Nick Gillespie of Reason on the proposed Consumer Financial Protection Agency.

He's probably more sanguine than I am about the wonders of credit cards.  But his basic point is correct:  a consumer financial protection agency is not going to do much to help consumers.  It is true that people don't always understand all the terms in their credit card contracts or mortgages.  The problem is, it is almost never the tricky hidden terms of those loans that get people into trouble.  People get into trouble because hyperbolic discounting, or an insurmountable crisis, leads them to borrow more money than they can reasonably pay back.  By the time a 5% increase in your credit card interest rate spells financial ruin, you've been in deep trouble for several years.

For some people this is an argument for laws that make it unprofitable to loan money to people who are likely to default, aka those living on marginal incomes.  The problem is, there are two groups of people among the poor:  those who will be made better off by credit, and those who will be made worse off.  Judging from the bankruptcy statistics, the former group is larger.  And there is no way to distinguish between them.  The alternate forms of credit that poor people have traditionally used, like pawn shops and loan sharks, are worse than Bank of America.

So if the CFPA confines itself to ensuring full disclosure, this will not much help consumers, because the terms that matter are already disclosed, i.e that you are borrowing money and will have to pay it back with a high rate of interest.  If it goes farther, this will probably not result in a net improvement in welfare, because poor people who really need credit will have to hock their belongings or go to loan sharks who will ding up much more than your credit rating if you default.