Wednesday, October 14, 2009

Consumer Financial Protection and Paternalism

Megan McArdle cautions that Paternalism is Still a Problem and cites the Consumer Financial Protection Agency as an example of this continuing danger. She cites an argument that the new paternalists
argue that government-appointed experts should limit the choices available to consumers in order to prevent them from making poor decisions because of ignorance or cognitive bias. After all, they claim, experts are likely to know better than ordinary consumers which products are too risky for us to use.
But, so the argument goes, these same experts have no way to measure the benefits to consumers that are lost by limiting or banning certain choices. Unable to compare the costs and benefits, these experts have no business making such decisions. At least that's what McArdle thinks.

The immediate problem I see with this is that some of the recent financial innovations had absolutely no benefit to either of the parties to the transaction, and that is something that experts (and even some non-experts) could determine from the outset. Take, for example, those so-called NINJA (no income, no job or assets) loans that were made. People who bought homes they had no way to pay for are now left in foreclosure and lenders are left with a bad loan on their books. The only people that may have benefited would have been intermediaries that arranged the transaction for a fee.

This is like a game of musical chairs, but instead of taking away one chair, you take away all of them. The only way not to lose is to simply walk out of the game. Unfortunately for the homeowner and the lender, neither are able to simply walk away. Why can't we outlaw these types of products? Whose welfare is being reduced by these types of loans no longer being available?

The CFPA is an idea that has been championed by Elizabeth Warren, and one that I think has merit. But at the same time, I too worry about our continued enfeeblement at the hands of the government.

But in this case, there are simply some financial products that do not enhance welfare and due to their potential for damaging consequences, should not be permitted. If you don't like the idea of banning certain financial products, perhaps we could apply a doctrine of strict liability to producers of such potentially harmful goods.

Beyond the scope of the products that can be identified as non-beneficial, application of the CFPA's power to ban certain products is more problematic. An alternative might be to give the CFPA the power to review and analyze all financial products prior to their sale to the public. The CFPA could then produce an analysis of the product that would have to be provided to the consumer. Obviously, this is similar to disclosure laws we have now, but if the CFPA has as its goal consumer protection I believe the disclosures would take a much more understnadable and useful form.

Proponents of the CFPA might argue that without true regulatory power it would be meaningless, but I don't buy this. In these days knowledge is power. Any move that increases the ability of consumers to understand the transactions they undertake is a step in the right direction.

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