Wednesday, July 8, 2009

Todd Zywicki Argues Against A Financial Products Safety Panel

Todd Zywicki thinks that the a Financial Products Safety Panel will lead to the demise of all the great financial innovations that we currently enjoy.

Here are a few excerpts from his column:

Virtually every credit product is valuable to some consumers. Low-documentation loans are a boon for homeowners with a lot of equity who want to refinance their mortgages (even as they are a dangerous thing to offer speculators)

What he doesn't address here is the fact that the costs (systemic risk, foreclosure, personal bankruptcy, etc) incurred by low/no-doc loans may outweigh the benefit of allowing some people to refinance their mortgage in certain limited situations. Nor does he consider the fact that it might be possible to allow the loans in certain situations, but not in other. A regulatory agency might be useful for making these decisions. Maybe a consumer financial product safety commission?

He then goes on to talk about the evils of banning pre-payment penalties, as though this was the main contributor to the financial crisis. I do not believe it was.

European home values have also fallen. But foreclosure rates are lower in Europe partly because homeowners there haven't stripped their homes of equity to the same extent. Similarly, adjustable-rate mortgages are standard in Europe and have been very common at times in the United States. It was the Federal Reserve's erratic monetary policy that made adjustable-rate mortgages here "explode," not the loans themselves.

Also a problem was the fact that unregulated lenders actively sold loans to consumers who could not afford them, fueling a real estate bubble that was bound to burst. No doubt Zywicki would fault borrowers, and admonish them to act more rationally, which is a little like asking a dog to be more like a cat. Maybe a consumer financial product safety commission could help.

This obsession with simplicity threatens innovation as well as competition. Thirty years ago credit cards were exceedingly simple. They charged high annual fees just to own them (often $40-$50), high fixed interest rates (approaching 20%), and offered no cash rebates.

Today credit cards are more complex, but they are also better. They offer no annual fees for no-frills cards, flexible interest rates, and more benefits. Competition is fierce and consumers have a wide range of choices.

One wonders whether the credit card revolution would have been possible under a consumer financial product safety commission.

Here he is trying to argue that financial innovation in credit cards has been a good thing. We now have credit cards rules that are, frankly, impossible for the consumer to understand, exorbitant penalties, zero meaningful disclosure, and card companies that will try to talk 18 year olds with no jobs into going deeply into debt. The management doesn't care about future defaults, because they will have already collected their bonuses. But hey, we get airline miles and sometimes don't have to pay a fee!

Again, in order for people to make good choices, they need to have good information. Complexity obscures information. Here's a financial innovation: Require simple credit card rules, so that people can make an informed choice about their card without having to hire a lawyer. What entity might be able to do this? Maybe a consumer financial product safety commission?

Our current problems are caused by misaligned incentives and the rational response of consumers and lenders to those incentives. It's not a crisis of consumer protection. A new agency premised on the erroneous belief what consumers need is to be protected from themselves is likely to do more harm than good.

Rational response? I know that neo-classical economics (and its notion that people act rationally, carefully weighing the costs and benefits of each decision) is a hard habit to shake, but it's very difficult to argue that people have been acting rationally.

We want people to make better choices. In order to make better choices, they need better information. Hidden in the enormous information asymmetry between consumers and huge corporate lenders is a perfect opportunity for credit card companies to take consumers for all that they have. These companies have access to government and power that the consumer can not possibly imagine. They have hordes of lawyers and marketers, all of whom are fixated on making sure that they get as much money from borrowers as they can. In this environment, setting rules to address this disparity is a good thing.

Do you know what might really help in addressing it? Corporate tax breaks!

Just kidding. Actually, a consumer financial product safety commission would be a good start.

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