Insolvency And Consumer Protection (House Testimony Today)

Congressman Brad Miller has some interesting ideas about how to respond to the financial crisis; not exactly on the same page as Treasury.  He’s called a hearing for this morning to talk about, in the first instance, how to assess insolvency in the banking system – and what to do about it (he chairs the Investigations and Oversight subcommittee of the House Committee on Science and Technology.)  But my guess is that the conversation will cover considerably more ground, including his idea that we establish a Financial Products Safety Commission.  (A full preview is now available at our joint venture with the Washington Post.)

The basic notion behind this commission is that consumers were taken advantage of by unscrupulous lenders.  Of course, you could also say that consumers fooled themselves, but if that is pervasive and has systemic implications then we need to take it on.  In his recent testimony before the Joint Economic Committee, Joe Stiglitz emphasized the need for more consumer protection, and this idea is also strongly advocated by Elizabeth Warren – against the odds, she continues to make some progress.

On the other hand, perhaps we already have enough consumer protection-type agencies?  Would it be better to focus our efforts on overseeing and constraining the behavior of lenders and everyone else in the credit production and distribution chain?  There’s plenty of education and information available about financial products (or not), but somehow that doesn’t get through to people when they need it.  How should consumer protection be conceptualized, designed, and implemented in this space?

Over on The Hearing this morning, you can vote for or against the Financial Products Safety Commission – or send it back to Congress, the experts, and the lobbyists for more discussion.  Any opinions written up in your comments there (or here) may be taken down and used to construct a more sensible national debate.

By Simon Johnson

22 thoughts on “Insolvency And Consumer Protection (House Testimony Today)

  1. The last things we need is a Financial Products Safety Commission. Credit card companies and lending institutions did what any for-profit company should do; they aggressively marketed their products and services. No payments until 2048, zero percent interest for the next 112 years, and other come-ons were very enticing to many consumers. However, crack cocaine sells in the same manner. Entice the buyer with a little taste, and you know they’ll get hooked.

    The government does not need another bureaucratic agency to protect us from ourselves. People have to take responsibility for their own actions. Will the present economic mess be the publics’ wakeup call?

    For additional insight see

  2. Start by rewriting the unscrupulous bankruptcy code. Once the lenders knew they wouldn’t lose, they took advantage of the borrowers.

    Nothing like bought and paid for legislation, now is there?

  3. Just out of curiosity, do you also believe that the government should not try to protect people from the dangers of crack cocaine, and that we should instead rely on individual responsibility?

    I ask because you seem to be asserting that the parallel between crack and cheap credit is that they are addictive. The normal definition of addiction includes notions such as loss of control and continuing use despite adverse consequences- a situation in which it is difficult or impossible for people to rely on individual responsibility. And so my making the parallel with crack, you seem to be making a decently strong argument for regulation, not against it.

  4. We’ve had this discussion in The Netherlands after many people were duped by investing in financial instruments they did not understand.

    What is the crucial point here whether people have the necessary information to make decisions. Only then can they be held accountable for their decisions.

    And this should be regulated – financial institutions should make available the information in a clear, understandable and concise way (not in a 700-page document with lots of obscure wording and illegible small print).

    In The Netherlands it is now mandatory to have a kind of “instructions for use” (same kind which is mandatory for prescription drugs), which amongst others, specifies the risk involved.

  5. Last time I checked, the terms and conditions for my mortgage were 100+ pages. Even the abbreviated T&Cs for a contract with the phone company aren’t decipherable without a semester or two of Biz Law.

    Given that the public isn’t adequately prepared to deal with basic contracts, some type of oversight in this area seems more than reasonable, especially since the financial services industry continues to “innovate”.

    The whole “personal responsibility” argument assumes a balance of power and knowledge between participants. This is not the case here and it never has been.

    Bob, you’re bouncing reality checks…

  6. Let’s see: we won’t enforce the current laws on the books (fraud), so let’s go out and create new ones.

    What are the chances those will be enforced?

    Maybe enforcement isn’t the goal.

  7. One thing that I hope comes out of this whole mishegas is a shift in perceptions of what financial literacy “should” be for consumers. Banks and traders themselves didn’t know what were in the credit-default swaps, mortgage-backed securities, etc. that have all blown up, so how could consumers *possibly* be expected to figure this stuff out?

    Jeff is right, there is a huge imbalance of power here, and also an imbalance of expectations. Consumers have been convinced that banks, lenders, etc. have been on their side, which was a lie – but if we could create a situation where consumers would be informed just how much these entities were their friends or enemies, I think that’d be a nice start.

  8. It seems that whenever regulatory oversight is loosened in finance, the economy goes over a cliff….

    And since the bigwigs have apparently acknowledged that self-regulation doesn’t work in banking, it seems that penalties need to be imposed on lenders who knowingly lend to people who at the point of loan origination have no chance of paying back the loan.

    It’s one thing if the status of a borrower changes after the loan is made; it’s another to knowingly lend money to people without the income to support the loan.

    The borrower who bites off more than he/she can chew loses the house, wrecks the credit rating, but the banker who handed them the money just pockets the commission. Why should people profit from making egregiously bad loans?

    Accountability has been missing in finance. Let’s try to work it into the process, perhaps.

  9. Concur. Not to mention the new provisions protecting derivative holders. The reform act has proved very dangerous to our economy and very favorable to certain creditors.

  10. Concur. Not to mention the new provisions protecting derivative holders. The reform act has proved very dangerous to our economy and very favorable to certain creditors.

  11. We need a Financial Products Safety Commission. Deregulated capitalism becomes predatory capitalism. One of the primary functions of government is to protect the people against predatory behavior. Predatory behavior is generally criminalized or regulated for the benefit of the people, the government and the economy.

    Allowing a deregulated system has caused the economic crises that we now face. A crisis that has huge economic and social costs. Costs that should not be carried on the backs of the consumer.

    The issue of regulation is much larger then merely protecting the least sophisticated among us. It also protects the sophisticated from harm.

  12. I suggest a Financial Products Safety Commission that is like a board. Make it 7 elected by the people, 2 appointed by the president, and 2 from business with majority rules.

    One question: Are two boards needed, one for laws/rules and one for enforcement?

  13. I like the idea of a Financial Products Safety Commission, but I think it can serve consumers best by not being consumer focused. I think that the goal of such a commission should be to set up accounting and regulatory standards for products before they are sold.

    Imagine there’s a world where derivatives and structured securities are actually recorded as an asset on the balance sheet of one counterparty and a countervailing liability on the balance sheet of the other. I think setting universal standards for the valuation of these products before they are traded would do wonders for cleaning up our financial system.

  14. I love the idea.

    And while you are at it, how about a motion to reinstate the Glass-Stegall Act?

  15. “There’s plenty of education and information available about financial products (or not), but somehow that doesn’t get through to people when they need it.”

    One problem is the innumeracy of the U. S. culture. That is a problem that has no quick and easy solution. Middle school could help, but the teachers are, by and large, not very numerate. News reporters are, in the main, highly literate, but as a group they are innumerate, as well. This hinders a lot of reporting, but the editors are innumerate, too. As are their readers and listeners.

    Financial professionals, OTOH, are highly numerate. That makes it easy for them to take advantage of their innumerate customers. Making information available to consumers does about as much good as handing them a copy of the “Analects of Confucius” in the original Chinese. They are simply not, as a group, equipped to understand it.

    “Don’t sign anything you do not understand.” may be a good rule for the individual, but if everybody applied it, our economy might come to a screeching halt. Most people are fatalistic. Everybody knows what the fine print means. If anything out of the ordinary happens, you’re screwed. But as an ordinary consumer, who can you do business with who will not screw you?

    I have no idea if a Financial Products Safety Commission is a good idea. Forgive me for being cynical, but it sounds like a for show agency. Look what we are doing to protect you. (OC, they can still legally screw you.)

    What we need is easy to understand consumer financial legislation, so simple that even a Congressman can know what he is voting on. ;) For instance, how about a Federal usury statute that caps consumer loans at 20% per year? Simple, easy to understand. Everybody knows the story.

  16. Capture of Law Making on the way up,
    and to the degree that doesn’t work,
    capture of the regulatory bodies.

    On the way down, too big to fail tramples any mental illusion that the rule of law will prevail, so any laws that managed to remain upright into the crisis, are subverted for the sake of a crisis.

    Regulation discussions are deck chair rearrangement on the Hindenberg…although I’m sure the newly appointed commision will provide yet another cushy pay check until
    the next disaster sneaks by everyone, including the new
    commission, which will be captured in short order.

    If it isn’t obvious, we were always on our own, and will be in the future.

  17. In a response recently, I gave a little personal history regarding the time that I was doing real estate closings and spending quite a bit of time trying to help my clients understand the deals that they were getting into. There were lots of very ordinary deals (FNMA forms) which were easy to parse out so that they could grasp what their borrowing meant in real terms. However, there were lots of adjustable rate mortgages where the Truth in Lending Statments would be very abstruse and bear little relationship to the actual deal unless you understood what they meant and how they were derived (similar, but different concepts). One nearly has to be a professional actuary or mathemetician to understand these things. And then there were the lengthy promissory notes, etc. Nowhere is there a requirement to simply give a plain English explanation of how these loans work.

    The old emptor caveat phrase: “read the fine print” needs to be amended to read: “read the find print, and remember, it’s all fine print.” I won’t say that enyone ever walked away from a deal, but occasionally someone would call their loan officer from the closing table to get a couple of changes made regarding things they would not go along with.

    The bottom line is that when loans are presented, prior to closing, there should be a requirment that the borrower receive a clear and concise description of the loan and its ramifications. The average borrower has no clue.

    HUD has established some fairly strong guidelines as a part of RESPA (the Real Estate Settlement Procedures Act) that covers much of this activity. It could be strenthened. But, nothing will ever make up for disingenuous lending practices and their effect on consumers who are naive.

  18. Bobby;

    We have regulations to improve our consumer products from medicine to chemicals to autos to airplanes.

    Why should the financial industry be exempt?

    Would you like some DDT with your breakfast?
    How about we make cars cheaper. Lets not use safety glass and seat belts. That way a 20mph collision can result in decapitation. Wouldn’t that be progress?

    Thats some nice dogma you have got. Hopefully the American people( and politicians) are beginning to see through it.

  19. And, the government has no business protecting us against murder or rape either? These laws interfere with the “Market’s” natural ability to protect us? “The” Market just can’t take any interference?

    Poor little weak Market. It needs so much protection against government regulation or it will just die out? Or, is “The Market” actually the independent actions of billions of people and businesses who are easily able to adjust to demands of people’s necessary protections enjoyed only through united government effort? And, is this adjustment of people generally what we call the exercise of conscience?

    The “ungoverned Market” is in fact so powerful that only the government its people united by their consideration for the general welfare are at risk of being overcome by small groups monopolizing it (an oligarchy of bankers, perhaps?).

    The first justification given for the very first republic was to protect the people against a “Market” controlled by exclusive political or monied power in favor of a new idea of a “Market” controlled of,by and for the general good.

  20. I said: “I have no idea if a Financial Products Safety Commission is a good idea. Forgive me for being cynical, but it sounds like a for show agency. Look what we are doing to protect you. (OC, they can still legally screw you.)”

    I have found out that I misunderstood about the commission. I thought it was aimed at consumers. Instead it has very broad scope, covering people who employ lawyers and financial professionals. That does not sound like a for show agency. :) I withdraw my comment about that.

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