Tag Archives: consumer protection

Regulating Rationally for Consumers

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Alan Schwartz has posted Regulating for Rationality to SSRN. The abstract reads,

Traditional consumer protection law responds with various forms of disclosure to market imperfections that are the consequence of consumers being imperfectly informed or unsophisticated. This regulation assumes that consumers can rationally act on the information that it is disclosure’s goal to produce. Experimental results in psychology and behavorial economics question this rationality premise. The numerous reasoning defects consumers exhibit in the experiments would vitiate disclosure solutions if those defects also presented in markets. To assume that consumers behave as badly in markets as they do in the lab implies new regulatory responses. This Essay sets out the novel and difficult challenges that such “regulating for rationality” — intervening to cure or to overcome cognitive error — poses for regulators. Much of the novelty exists because the contracting choices of rational and irrational consumers often are observationally equivalent: both consumer types prefer the same contracts. Hence, the regulator seldom can infer from contract terms themselves that reasoning errors produced those terms. Rather, the regulator needs a theory of cognitive function that would permit him to predict when actual consumers would make the mistakes that laboratory subjects make: that is, to know which fraction of observed contracts are the product of bias rather than rational choice.

The difficulties exist because the psychologists lack such a theory. Hence, cognitive based regulatory interventions often are poorly grounded. A particular concern is that consumers suffer from numerous biases, and not every consumer suffers from the same ones. Current theory cannot tell how these biases interact within the person and how markets aggregate differing biased consumer preferences. The Essay then makes three further claims. First, regulating for rationality should be more evidence based than regulating for traditional market imperfections: in the absence of a theory the regulator needs to see what actual people do. Second, when the facts are unobtainable or ambiguous regulators should assume that bias did not affect the consumer’s contracting choice because the assumption is autonomy preserving, administerable and coherent. Third, disclosure regulation can ameliorate some reasoning errors. Hence, abandoning disclosure strategies in favor of substantive regulation sometimes would be premature.

This essay adds to a growing literature that challenges the ability of regulators to effectively incorporate the lessons of behavioral economics into consumer protection regimes. I take no position at this time on the particular claims of this essay, but I certainly think that the Consumer Financial Protection Bureau should grapple with this growing body of literature. The only thing worse than no consumer protection regime at all, would be one that was designed all wrong.

Reiss on Privatization of Fannie and Freddie

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BadCredit.org profiled an article of mine in Brooklaw Professor Pushes for Privatization of Fannie Mae/Freddie Mac. The profile opens,

Since the end of the Great Recession, policymakers, academics and economists have been struggling with a very difficult question — what should we do with Fannie Mae and Freddie Mac? Should the government continue its role in providing mortgage credit to millions of American?

Fordham University Associate Professor of Law and Ethics Brent J. Horton made a proposal in his forthcoming paper “For the Protection of Investors and the Public: Why Fannie Mae’s Mortgage-Backed Securities Should Be Subject to the Disclosure Requirements of the Securities Act of 1933“:

“The best way to reduce risk taking at Fannie Mae is to subject its MBS offerings to the disclosure requirements of the Securities Act of 1933,” Horton writes.

However, Brooklyn Law School Professor of Law David Reiss believes “the problems inherent in Fannie Mae’s structure are greater than those that increased disclosure can address.”

In his response, titled “Who Should Be Providing Mortgage Credit to American Households?” Reiss points to increased privatization as one way to address the question of what to do with Fannie Mae and Freddi Mac.

Reiss on Who Should Be Providing Mortgage Credit to American Households?

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I have posted a short Response, Who Should Be Providing Mortgage Credit to American Households?, to SSRN (as well as to BePress).  The abstract reads,

Who should be providing mortgage credit to American households? Given that the residential mortgage market is a ten-trillion-dollar one, the answer we come up with had better be right, or we may suffer another brutal financial crisis sooner than we would like. Indeed, the stakes are as high as they were in the Great Depression when the foundation of our current system was first laid down. Unfortunately, the housing finance experts of the 1930s seemed to have a greater clarity of purpose when designing their housing finance system. Part of the problem today is that debates over the housing finance system have been muddled by broader ideological battles and entrenched special interests, as well as by plain old inertia and the fear of change. It is worth taking a step back to evaluate the full range of options available to us, as the course we decide upon will shape the housing market for generations to come. This is a Response to Brent Horton, For the Protection of Investors and the Public: Why Fannie Mae’s Mortgage-Backed Securities Should Be Subject to the Disclosure Requirements of the Securities Act of 1933, 89 Tulane L. Rev. __ (forthcoming 2014-2015).

Reiss on The Future of the Private Label Securities Market

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I have posted The Future of the Private Label Securities Market to SSRN (as well as to BePress). I wrote this in response to the Department of Treasury’s request for input on this topic. The abstract reads,

The PLS market, like all markets, cycles from greed to fear, from boom to bust. The mortgage market is still in the fear part of the cycle and recent government interventions in it have, undoubtedly, added to that fear. In recent days, there has been a lot of industry pushback against the government’s approach, including threats to pull out of various sectors. But the government should not chart its course based on today’s news reports. Rather, it should identify fundamentals and stick to them. In particular, its regulatory approach should reflect an attempt to align incentives of market actors with government policies regarding appropriate underwriting and sustainable access to credit. The market will adapt to these constraints. These constraints should then help the market remain healthy throughout the entire business cycle.

Good Data Makes Good Mortgages

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The CFPB issued a proposed rule about increasing the quality of information that lenders report about mortgage applications. The press release regarding the proposed rule states that these changes will ease the reporting burden on lenders, and that may very well be true. But the contested part of these rules relate to the type of information to be collected:

  • Improving market information: In the Dodd-Frank Act, Congress directed the Bureau to update HMDA regulations by having lenders report specific new information that could help identify potential discriminatory lending practices and other issues in the marketplace. This new information includes, for example: the property value; term of the loan; total points and fees; the duration of any teaser or introductory interest rates; and the applicant’s or borrower’s age and credit score.
  • Monitoring access to credit: The Bureau is proposing that financial institutions provide more information about underwriting and pricing, such as an applicant’s debt-to-income ratio, the interest rate of the loan, and the total discount points charged for the loan. This information would help regulators determine how the Ability-to-Repay rule is impacting the market, and would also help the Bureau monitor developments in specific markets such as multi-family housing, affordable housing, and manufactured housing. The proposed rule would also require that covered lenders report, with some exceptions, all loans related to dwellings, including reverse mortgages and open-end lines of credit.

Lenders are not going to like this, because this new information may be used against them in a variety of ways — in Fair Housing lawsuits, by the CFPB in enforcement actions, by members of Congress seeking to increase credit access to various constituencies.

I like this because regulators and academic researchers have been hamstrung by limited and stale data on the fast-moving mortgage market. The mortgage market is often driven by the short-term profit-seeking of private actors and by special interests pushing their agendas with the Executive and Legislative Branches.  Good data can inform good decision-making that can ensure that the housing finance system is vibrant and provides sustainable credit for households over the long term.

Comments on the proposed rule are due by October 22, 2014.

 

Financial Literacy Rehash

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The Consumer Financial Protection Bureau released its second Financial Literacy Annual Report. In blogging about last year’s report, I noted that the CFPB assumed that financial education worked more than research had shown it to work. Unfortunately, this report seems to be mostly a rehash (in many cases an extensive word-for-word rehash) of last year’s (pace Senator Walsh). From what I could tell, the only significant new financial education research that the CFPB has undertaken since last year is its “rules of thumb” project.

“Rules of thumb” are a decision-making and education technique that uses practical, easily-implemented guidelines for making decisions. Existing research has found rules of thumb to be a successful technique for improving decision making in many areas, and more successful than comprehensive education in some instances. Thus, rules of thumb could be a cost-effective method to improve consumer decision making. However, little research exists examining the effectiveness of rules of thumb for financial decision making.

Accordingly, in 2014 the Bureau began a research project to study the effectiveness of rules-of-thumb-based approaches aimed at helping consumers decrease their credit card debt. Rules-of-thumb-based education may be particularly appropriate for improving consumer literacy about credit card use, as credit card decisions are repetitive and frequent. We have finished the first phase of the project to understand how to create rules of thumb, when they are most useful, and how they can be implemented to ensure maximum success. The second phase of the project will test a set of rules of thumb aimed at helping consumers decrease their credit card debt. When we release the final results, which are expected in 2015, we expect that this project will increase knowledge of the efficacy of a rules-of-thumb approach to financial education both within the CFPB and among a range of external stakeholders who serve consumers. (72-73, footnote omitted)

This seems like a great project for the CFPB to undertake. But the rest of its efforts to improve its understanding about the efficacy of financial literacy leaves me under, underwhelmed, particularly because the rule-of-thumb project is limited to just one consumer financial product, credit cards.

Armed, Unarmed or Harmed by Knowledge?

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I posted Armed, Unarmed or Harmed by Knowledge? A Comment on the FHA’s Housing Counseling Pilot Program to SSRN (and to BePress). The abstract reads,

The FHA has requested input on its Homeowners Armed with Knowledge (HAWK) for New Homebuyers pilot program. This comment letter argues that housing counseling is not a proven solution to the problem it is meant to solve, excessive defaults by FHA borrowers. HAWK is a traditional housing counseling program but the scholarly literature casts into doubt the efficacy of such programs. It would be better to take time to research which counseling strategies, if any, are proven to be effective. This is true for the FHA but also for other government agencies, such as the Consumer Financial Protection Bureau, that have devoted significant resources to unproven financial counseling programs.

This comment was submitted to the FHA in response to its request for input on its Homeowners Armed with Knowledge (HAWK) for New Homebuyers program.

Regular readers of this blog will be familiar with my take on this topic as the comment is adapted from blog posts that have addressed various financial education topics.