Traditional Chicago Economics Under Pressure: Beyond The Thaler-Posner Debate

Richard Posner is against the proposed new Consumer Financial Protection Agency (CFPA).  This is, of course, not a surprise.  Posner has always been an articulate advocate of the view most often associated with economics at the University of Chicago: market-based outcomes are invariably better than the alternatives, and anything that interferes with consumer choice is a bad idea. 

Posner wraps this opposition to the CFPA into an odd attack (near the end of his WSJ op ed) on the personal decision-making abilities of Richard Thaler – a leading economist on consumer choice, misperceptions, and mistakes. (More on Thaler here.)

Thaler, also of the University of Chicago, hit back hard yesterday.  He is right that Posner mischaracterizes the CFPA proposal, and points out that his agenda – and that of Cass Sunstein, formerly of Chicago and now a czar in the adminstration – is simply to provide consumers with a framework for better decisions.  He implies that Posner defends defective baby cribs and their equivalent.

I would go further.

Think of it this way.  We’ve learned a great deal about how consumers make decisions, including when they get things right and wrong.  Behavioral economics, marketing, and related social science have made big strides (e.g., follow the work of Dan Ariely).

But all of this research is also available to companies.  Perhaps they knew some of this before from trial-and-error, but there is no question that many of the techniques corporate America uses – and we as consumers find ourselves “up against” – is cutting edge manipulation of our decisions.

We worry a great deal about how corporations lobby to shape their regulatory environment.  This is a struggle that is at least 150 years old in its modern form (e.g., railroad concessions), and much older if we think about powerful people bribing their way into advantageous relationships with the state. 

In addition, companies now have powerful new tools to shape how we perceive our potential choices.  Some of these tools might be good for us also – I’m open to argument on this.  But within some particular spaces, including financial products, it’s clear that many of these “innovations” are actually clever ways to extract value from consumers.

Traditional Chicago economics always had its weaknesses – particularly when you focus on the fact that the “rules of the game” are often shaped by the more powerful.  Thaler and Sunstein (and others) are trying to modernize this view more generally, while keeping the element of consumer choice as central.

But if the balance of power has shifted – due to technological innovation in social science – further towards corporations and away from consumers, then the task ahead is much harder. 

Unless companies are compelled to keep their offerings “simple enough to understand”, we will face repeated rip-offs and crises – both macroeconomic and personal – arising from our financial sector.

By Simon Johnson

77 responses to “Traditional Chicago Economics Under Pressure: Beyond The Thaler-Posner Debate

  1. This article reminded me of the saltwater vs. freshwater economics debate of the 80s. I think that the crisis shows that the salties clearly won. The Chicago school of thought is too rigid and ideological. I was convinced of this early on after reading one of Johnson’s colleagues:

    http://www.chomsky.info/talks/19960413.htm

  2. Once again I am embarrassed that The University of Chicago is my alma mater. Too bad the people teaching econ will never the people teaching ethics.

  3. Democracy should trump Capitalism, in our system.

    Or maybe we need to re-learn thousands of years of thought on how to develop a society and organize a government for the benefit of its inhabitants.

  4. Look, Posner’s a nutball (read Catastrophe: Risk and Response if you doubt this), and in the point of view of another alumnus, it’s a little silly that he’s been able to promote himself as a face of the U of C.

  5. “…there is no question that many of the techniques corporate America uses – and we as consumers find ourselves “up against” – is cutting edge manipulation of our decisions.”

    Yep. Except we like to call it “marketing science”. :) And we use lots of other codewords so we don’t have to say “manipulating consumers”.

    And this is why economists make lousy marketers; most good marketers come out of psychology. The key to selling someone something they don’t need (which includes most things) is recognizing that people are fundamentally irrational (with strong biological hardwiring and social softwiring). At best, boundedly rational (Herbert Simon, et. al.).

    Even worse, the key to making a profit in a tough world is to identify low-cost product elements that consumers _initially perceive_ to be valuable (and or to create the perception of value through marketing/media efforts).

  6. I think more needs to be said here about the alleged disadvantaged position that consumers have in general. There is a great deal of evidence that the opposite is true. Keep in mind that more simplified products are also available in most markets, and consumers are free to choose those, and thereby determine the value of simplicity. And note that the consumer protection folks hardly limit themselves to promoting simplicity – they also tend to have clear ideas on what constitutes fair pricing. The arrangements at pay day loan shops are simple enough, aren’t they? It shouldn’t really need to be said at this point in world history that governmentally determined fair pricing does not have a lot to recommend it. As far as subprime lending goes, there exists a single requirement that would have protected consumers, banks, and taxpayers alike: cash flow underwriting. Abandonment of that simple principle was the gateway to bubblehood.

  7. “Unless companies are compelled to keep their offerings “simple enough to understand””

    yep,
    because one of the most subtle and perfidious and thus successful methods of consumer manipulation comes in the guise of the person who explains it all to you in a seemingly benevolent slightly patronizing manner while ridiculing you ever so subtly for not being able to follow his/her oh so simple explanations (the McKinsey type sent to “teach” us how to become a better IP-department was pretty good at it – so I know how it feels to be at the receiving end of it)

    of course the seller cannot be blamed for forgetting himself in all innocence and throw in a “sophisticated” word and then show just a wee bit of annoyance if you dare to ask …

    teach people that its OK to ask obnoxiously – for now that is the only counter strategy I have available as I have met very very few people who are able to remain oblivious of ridicule and much to my regret no matter how hard I try I am not one of them but at least I manage to get furious.

    as for Thaler:
    I have heard him pitching his book with Cass Sunstein several times and he always opens up with the example of the fly painted in the Urinal – thus I am highly suspicious of him. I do not want my behaviour to be nudged by government by such methods to become a better person.

    I am sure Thaler/Sunstein left the subtler techniques of ridiculing somebody undecribed in their book about techniques for “nudging” us to conform with all the latest of whatever the Zeitgeist dictates.

  8. Silke: “as for Thaler:
    I have heard him pitching his book with Cass Sunstein several times and he always opens up with the example of the fly painted in the Urinal”

    Err, for target practice?

    ;)

  9. Lawrence Baxter

    “there is no question that many of the techniques corporate America uses – and we as consumers find ourselves “up against” – is cutting edge manipulation of our decisions”

    Simon, you are touching on a point that has not received attention during the debate over the proposed Consumer Financial Protection Agency, namely that the creation of this agency constitutes a use of the very technique companies use all the time. While in the corporate world I was engaged all the time in reorganizations. Sometimes these reorganizations were silly, but very often reorganization was necessary to provide particular focus on a strategic issue that had become important. Reorganization for such reasons is merely a formalized version the familiar technique of creating a SWAT team to get results in addressing a new or growing challenge.

    So, too, with financial services reform. There are many laws to protect financial customers that have been neglected, poorly implemented and/or observed. The regulatory web of consumer protection has become a mess and is ineffective because it enjoys no managerial focus. Some self-interested companies, far more powerful than consumers and even regulators, have been able to avoid the impact of these laws through regulatory and statutory arbitrage. The proposed CPSC would simply restore or intensify focus on consumer protection in the face of a much more complex industry and web of financial products.

    What puzzles me is the amazing naiveté of seemingly hard nosed economists of the Posner ilk. The “marketplace” they assume to exist is nothing like the reality and it sometimes seems that these “free market” economists have never set foot inside a real corporation. Companies use the techniques they despise all the time. I have yet to read a satisfactory explanation of why techniques used by private enterprise should not also be used by government–unless one does not believe in a role for government at all.

    Indeed, we see the same contradiction playing out in the health care reform process: private insurance companies are screaming blue murder about government being able to use its sourcing power to drive down the price of drugs and services (oops, I meant to say “engage in unfair competition”). I am not sure how this reconciles with the view that public enterprise and/or regulation is inherently less efficient than private, or why, if the latter view is correct, the specter of government competition is anything to fear. And I don’t understand why driving down prices, if government is reasonably efficient, is unfair–unless one believes that private enterprise has a right to earn rent from the human condition.

  10. Posner does distract a bit, when he tires to argue that notion that has not worked out (screwy equity premium means “buy stocks”) necessarily makes another notion from the same source more suspicious. If, as Posner suggests, we are all very good at figuring out which arguments are right and which contracts are fair, then we should be able to assess Thaler’s and Shiller’s thinking, without knowing whether they have made unfortunate statements in the past.

    If Posner’s revelation of Thaler’s “equity premium” view matters, if it is worth the space it takes up, then we have to ask why Posner maintains his other views. If we rely on authority, rather than evidence, then knowing that Thaler is fallible is important. If we rely on evidence, as Posner wants us to think we do, then Thaler’s views on the equity premium are irrelevant.

    Posner ends by posing what he seems to have meant as a rhetorical question – do we want people who are prone to irrational thinking to write regulations aimed at protecting us from irrational thinking? I am not sure that we should accept the question as rhetorical. I think we should actually try to work out an answer. Is there reason to think that we, given the isolation from the temptations of marketing, with research available to inform us, cannot craft rules that defend predations on our irrational tendencies? I’m not sure we should accept that sort of fatalism.

  11. Min
    “Err, for target practice?”

    seriously no matter how much it makes me object because it reminds me of adolescent competitions of target hitting it is also kind of smart because all the women who ever had to clean up toilets having been used by men will be on his side and all the men will side with him also because: “see, it is not my mistake” – but it is exactly the kind of smartness I do not want

    if you want to see the ultimate urinal look at this picture of special urinals designed to incentivise bankers – seriously the idea was to give them a top of the world feeling

  12. Harvard’s Professor Hanson has thoroughly reviewed Posner’s influence on the law – and responded with a critique incorporating the scholarship of Thaler, Tversky, Kahneman et al.

    A representative sample of Hanson’s work is available here: http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=267612

    The “Taking Behavioralism Seriously” trilogy, as well as “The Illusion of Law” are particularly relevant to this post.

  13. love that picture, there is a great 90 minute movie script out there somewhere you could launch with that picture in the opening credits. It says it all. Even better would be to show the women execs using it too.

  14. Silke: “if you want to see the ultimate urinal look at this picture of special urinals designed to incentivise bankers – seriously the idea was to give them a top of the world feeling”

    Incentivize bankers to what? Go to the bathroom? Piss on everybody? (Figuratively speaking, of course.)

    Seriously, as I hinted in my earlier post, when you talk about the urinal example I have no idea what you are talking about.

  15. I think the reason Posner’s arguments seem odd (for him) is that he is making the arguments by borrowing CFPA proponents’ premises. Here is what I think he is saying:

    1) The idea behind the CFPA is to cure the information asymmetry that exists between consumers and financial service providers. Proponents argue that consumers do not have access to complete information because disclosure documents are not written in a language they are fluent in and their financial counterparties have no economic incentive to decipher anything.

    2) A defense of the CFPA framed by behavioral economics would suggest that the problem is not information asymmetry per se, but metacognitive asymmetry.

    3) The CFPA advocates essentially want to have their cake and eat it too. Substituting an information asymmetry for metacognitive asymmetry on the consumer side of things pragmatically distracts from any normative judgments that might be made about consumers’ behavior (did they understand what the outcomes of their decisions would be versus did they think they were unlikely – there is no “bad” decision that can be made from their standpoint). But they also want to portray bankers as evil, so bankers are presented as having both informational and metacognitive advantages over consumers.

    4) If one believes that there is a metacognitive disparity among market participants, the CFPA as presented will not close the gap for two reasons. First, it is geared toward information rather than decision-making in the truest sense. Second, it is not an us-against-them situation, as evidenced by the fact that experts misjudge the “safety” of investments themselves. He could have made this point better by mentioning as many others have that the Federal Reserve saw no problem with these products not too long ago.

    The idea that a metacognitive gap might be the problem lends itself to questioning whether such an agency would ensure disclosure or behave as a surrogate parent for consumers. As far as Posner mischaracterizing the CFPA, I think he does, but this is kind of like saying that critics mischaracterized the TARP when it was first presented. The CFPA is, as Thaler observes, really lacking in specifics. Can you blame anyone for wondering to what ends it will ultimately be taken? Even my worst fears about the TARP did not accurately capture how slippery a slope government intervention was.

  16. Lawrence Baxter: “What puzzles me is the amazing naiveté of seemingly hard nosed economists of the Posner ilk. The “marketplace” they assume to exist is nothing like the reality and it sometimes seems that these “free market” economists have never set foot inside a real corporation.”

    I do not think that they are naive, but biased. I do not know about Posner, but Hurricane Katrina was like a national Rorschach test that revealed a lot about politicians and pundits. I reluctantly came to agree with my girlfriend. A lot of these people are just mean. (As I said, I do not know about Posner.)

  17. kharris: “Posner ends by posing what he seems to have meant as a rhetorical question – do we want people who are prone to irrational thinking to write regulations aimed at protecting us from irrational thinking?”

    OTOH, do we want people who are prone to irrational thinking to decide not to write regulations?

    More pertinently, do we want people who think that they are rational to make the decisions, or do we want people who know that they are irrational? ;)

  18. Bond Girl: “A defense of the CFPA framed by behavioral economics would suggest that the problem is not information asymmetry per se, but metacognitive asymmetry.”

    A weakness of behavioral economics seems to be that it accepts the mainstream economics dogma about rationality, so that its arguments are premised on the irrationality of economic actors. That is one reason that I dispute that view of rationality. For the most part I have Kant on my side, and he was no dummy.

    Moi, I think that defending the CFPA because of the irrationality of the consumer simply plays into the Nanny State rhetoric about saving people from themselves.

  19. Grey Economics

    Dr. Johnson,

    You wrote:

    “But within some particular spaces, including financial products, it’s clear that many of these “innovations” are actually clever ways to extract value from consumers.”

    and

    “Unless companies are compelled to keep their offerings “simple enough to understand”, we will face repeated rip-offs and crises – both macroeconomic and personal – arising from our financial sector.”

    From the second quote, I’m assuming you think the US government should compel these companies- but I don’t know how to hold any faith in the govt’s ability to “compel” these businesses, given the govt’s track record, especially in regards to reigning in the businesses engaged in creating “innovative” financial products (the first quote).

    None of my comments come from a high view of the “free market” (never seen one before) or a high view of modern corporations – quite the opposite, in fact. I have no truck with the Chicago School, as I am not versed enough in economics to lump myself with any school of economic thought. I just don’t think the US Govt. is capable of the task you are talking about.

    And I see your point- you probably know far better what large corporations are capable of, and the tools they have available; my stance begs the questions “who else is big enough to take these guys on?”.

    If I say that the citizens of America (taken as a whole) are big enough to deal with this, the obvious point is that they aren’t capable- given everything we’ve seen in the financial markets and the outrages perpetuated against them by huge players in the business world.

    But, if civic governance is the only defense that a people has, then a people hasn’t a prayer when a government fails to protect them from large corporations- like, say, the East India Company.

    Maybe it’s because I’m an American, but I just don’t think the power of a nation belongs to (or is held by) the government or the business of a nation, as much as they try to grasp it.

  20. Min
    Piss on everybody?

    yes and in this special case it was Commerzbank bankers to enjoy the fantasy of pissing on the other bankers most specifically the competitors from the Deutsche Bank – was supposed to get them fired up for the next round of trading

    as to Thaler’s urinal example I just find it juvenile and childish or boyish – Latrinenhumor is a standard German expression for it referring to the jokes soldiers supposedly told to eachother while sitting in a row on their “thunder beams” in the good ol’ times

  21. “Posner has always been an articulate advocate of the view most often associated with economics at the University of Chicago: market-based outcomes are invariably better than the alternatives, and anything that interferes with consumer choice is a bad idea.”

    But how does being stuck with a virtual monopoly of health care insurers in any given state or region, and being stuck paying their inflated premiums for very little in return, have anything to do with “consumer choice”? I don’t have a choice. I have basically 2 big insurers to choose from, and 3 plans: HMO, PPO, and go-fuck-yourself, also known as the health savings plan. No matter how little I use my insurance (which is VERY little), I get the invariable cattle grid to traverse, in the form of a questioning/warning letter, each time my doctor puts in a claim. Once they accused me of not using a participating lab for the blood tests he ordered. My claim for emergency treatment was rejected when I went to a clinic for strep throat while working for the Red Cross in NOLA immediately after Katrina; they said I didn’t go to an emergency room. Problem was, there was no ER in NOLA at that time…the hospitals were all closed or in ruins.

    So tell me again how not having a public option will keep the bureaucrats from getting between me and my doctor???

  22. not sure that claiming that pay day lending arrangements are simple works. consider the market for them. the least knowledgeable, and the easiest to manipulate consumer. and wasn’t the real problem. it was the lack lending standards set up by lenders based on the assumption that houses always go up, and that those who wrote the contracts could sell ASAP so they wouldn’t have them when they went bad, and the rating agencies rating junk securities as AAA, which meant that banks could (and would) buy them. course it didn’t help that the mortgage salesman only got paid for mortgages sold, and didn’t care if they got paid back, and that the investment bankers could leverage up 40 to 1, to be able to create this debacle

  23. Praedor Atrebates

    The only thing one needs to know is these simple mathematical equalities:

    The Chicago School = Augusto Pinochet

    The Chicago School = Milton Friedman

    Milton Friedman = Augusto Pinochet

  24. If I recall correctly this is the kind of economics which Keynes referred to as the “special case” of economics which describe a world which does not exist.

  25. True competition is the critical factor in assuring consumer choice. Lack of competiveness results in offering consumers a limited range of choices, like the panoply of time bomb mortgage products foisted on unsuspecting borrowers, all of which placed huge risks on the borrower, investor and taxpayer while inordinately enriching those who packaged and sold them.

  26. True, although it’s even simpler than that.

    Friedman went to Chile to give Pinochet a direct pep talk about how he wasn’t being predatory enough.

  27. The financial industry has spent millions lobbying Congress to make enrolling in 401(k)’s the default position for employees, rather than an opt-in choice that must be freely elected.

    It produced reams of research (I have some in my files) showing that employees make irrational decisions, failing to save, and failing to choose investments appropriate for their time horizon and risk tolerance.

    It clamored for regulation forcing plan participants to do the “right” thing, because they wouldn’t do it on their own.

    Curious, isn’t it?

  28. I think Herman/Chomsky cover this in Manufacturing Consent.

  29. “Unless companies are compelled to keep their offerings ‘simple enough to understand’, we will face repeated rip-offs and crises – both macroeconomic and personal – arising from our financial sector.”

    Milton Friedman pointed out in another context that eventually the public does recognize and react to the new status quo. I would expect that, without new regulation, most consumers are going to go back to keeping money in the safest, simplest financial instruments–banks, if there are still insured banks, simple cash, if not. This is probably not an outcome the Chicago school and its business supporters desire.

  30. I’ve just finished reading Chomski’s piece linked by John. What a great text! It’s a talk from 1996 but it could have been written yesterday.

    One excerpt concerning finance:

    “Around- from about maybe — the time when you have data, like, late 19th Century, up until about 1970, rough estimate was that about ninety percent of capital transfers had to do with the real economy, you know, with investment and trade, ten percent speculation. By 1990, the figures had reversed. By 1995, the latest UNCTAD — you know, U.N. Economic Commission estimate was about five percent real economy, ninety five percent speculation — short term speculation, like, against currencies, which is, essentially, aimed at driving down growth and increasing profits and lowering wages.”

    Chomski is a national treasure. If mainstream journalists only had half his intelligence, integrity and courage we would have real democracy.

  31. Patrice Ayme

    The economy is too serious a subject to be left to consumers alone. Seriously.

    http://patriceayme.wordpress.com/

  32. Patrice Ayme

    The Nazis went even further than Friedman in treating the consumers as kings, lords, gods, and makers of fate, independently of any moral code. They consumed everything, literally speaking. And not just other people’s teeth, hair and properties. For the Nazis, profits were all, and people just a way to get there.

    Interestingly, they were defeated by command and control economies in Britain, the USSR, and the USA, demonstrating, at least in the ultimate survival test, that intelligence defeats the profit obsessed beast.

    I wonder if Milton Friedman could have seen the connection… And realize that his main conceptual drive was going up in smoke…

    http://patriceayme.wordpress.com/

  33. You may be correct about the cash flow underwriting – I’m no mortgage loan specialist. But by bringin gup that proposal, you illustrate what happens when regulations are abandoned – thus illustrating why more rigorous and more sustainable consumer protection from government is a necessity in the modern financial world.

    Clearly, mortgage lenders, and those who speculated on mortgage backed securities, woul dot have done so if they had been required to hold, say, a sum equal to 50% of their investment portfolios in some kind of reserve to cove rtheir bets. Many of them held less then 10% if currnet news reporting is to be believed. That approach was not economically sustainable – but wss entirely appropriate in a lax regulatory environment where consumer protection takes a back seat to profits.

  34. “Behavioral economists are right to point to the limitations of human cognition. But if they have the same cognitive limitations as consumers, should they be designing systems of consumer protection?”

    From Posner’s piece. This is somewhat disingenuous. There is no reason why institutions, indeed individuals cannot better themselves. Here, I refer to the distinction neuropysiologists draw between System I and System II decision-making.

    System I decision-making provides fast, approximate but not very accurate responses; system II is more deliberative, much slower and correspondingly more accurate. Research suggests that while humans can do both types of reasoning (unlike other species), they are inclined to System I. However, education -or improved cognitive ability- can offset these tendencies – see Oechssler, Roider and Schmitz (2008) “Cognitive Abilities and Behaviorial Biases” and Frederick (2005) “Cognitive Reflection and Decision Making”. Similarly, institutions- processes of deliberation and checks and balances as well as personal commitment devces can be understood as a way of encouraging System II decision-making- by cooling passions and subjecting them to more conscious evaluation. Indeed, some of these mechanisms arguably entail a less invasive form of liberal paternalism than even Sunstein and Thaler suggest.

  35. Problem now is where are you going to find the democracy. This is just more looking out for the wealthy on the backs of the lower & middle class. CFPA is needed and with big teeth and a bad attitude!

  36. Re: Nanny State

    It is not just that. As a practical matter, I find the “product” analogy very problematic in this context. I am not sure the government can standardize financial experiences by standardizing financial products in the same way that it can ensure that consumers have basically the same experience consuming ground pepper by limiting the amount of bug parts it may contain. Concepts like affordability are pretty dynamic and complicated and go well beyond what is and is not “standard” contract language.

  37. There is need to be embarrassed to have studied at the Uni of Chicago it is a fine institution. Economist’s such as Eugene Fama and Merton Miller, of Chicago, made some important contributions to the field. Even though some of their work (clearly not all) has turned out to be severely flawed.

    The school of thought is something that should be criticized. Market fundamentalism (or if you like the Chicago School of thought, Neoliberalization, the Washington consensus, etc…) is fundamentally wrong no matter how profitable it has been to some over the past 30 years.

    It is just my understanding that since economics is a social science it is more of an art and a balancing act then a series of rules and charts. Socializing one industry/company or privatizing another could be either beneficial or detrimental depending on the country, details, and facts.

  38. Sorry, should read: *”There is NO need to be embarrassed”*

  39. Disclosure might be enough, although it would certainly be helpful to limit the frequency and/or severity of modifications to the contracts, changes to fees, elmination of grace periods… And require that such changes be sent in clearly worded documents (without having to read 6 pages of dense fine type).

    But Congress is no saint.

    If Congress really wanted to show support for consumers, however, it might consider rescinding the legislation that severely weakened traditional bankruptcy protection laws a few years ago…

    Libertarians (such as Ron Paul) seem to think that rapid liquidation of debt is important to recovery. They should, then, strongly support restoring the traditional bankruptcy measures…

    Indeed, Ron Paul argues strongly for Bankruptcy for companies:

    http://www.321gold.com/editorials/paul/paul032709.html

    I wonder how he voted on the law which made bankruptcy so much more difficult for consumers?

    Oh, ya, he voted to gut bankruptcy protection for consumers.

    http://themiddleclass.org/legislator/ronald-paul-281

    But, on the positive side, this shining beacon of libertarian thought cast the only vote against banning lead in children’s toys.

  40. > Unless companies are compelled to keep their
    > offerings “simple enough to understand”, we
    > will face repeated rip-offs

    What about the Feds passing this law: “Federal Law prohibits anyone from signing anything that they don’t understand.”

    Wouldn’t it be better to fine a few thousand people who failed to heed Federal directions than fund a new agency with tens of thousands of people who will be doing “who knows what”?

    If the FDA can’t stop E Coli poisoning, and the EPA can’t stop pollution, how is a CPA (Consumer Protection Agency) going to stop “rip-offs”?

  41. Regulation capture is part of this.

    Like safety regs. that require giant car seats for kids — only comfortably fitting in cars that it was profitable for Detroit to make and sell.

  42. Even if I agreed with this philosophically, I guess I am completely cynical about the potential for any policy response at all. And I’m somewhat disappointed that for as much as we’ve discussed regulatory capture, the best we can come up with is more regulation.

    It would be difficult enough just to draft regulations trying to standardize these products, let alone enforce them with the political deck stacked against you. (Perhaps they will put St. Warren in charge at first, but politics being politics, she will eventually be replaced by a Goldman alum.)

    You will have to pardon my frustration on the issue of consumers not being self-critical about their financial decisions. It actually kind of sickens me how much of their earnings people lose to delegating these decisions. I do tend to agree with the position that this is at least not entirely an information issue.

  43. “Concepts like affordability are pretty dynamic and complicated and go well beyond what is and is not “standard” contract language.”

    Elsewhere you also say how frustrated you get at the losses people suffer because they delegate financial decisions.

    This is the heart of the problem: consumer financial products are, or can be, exceptionally complicated and they do change rapidly. I assume from your handle that you are in the industry, so dealing with these innovations and their complexity might seem easy to you. But you represent a thin slice of society. Just as we would not expect you to be a software expert and require you to fix bad code on your new computer, neither should you expect so much of individuals who have many other things on their minds, jobs to manage, and who often quite reasonably lack the complex financial education necessary to “evaluate” what they are being offered by well funded, very highly resourced experts. A balance has to be struck.

    To gain a realistic sense of the general level of financial sophistication, ask if you can sit in the phone service area of your or another financial company for an hour. This is not a slam on the average member of the public; it is simply a reality in a complex world in which very few happen to have sufficient expertise to deal with ten page, small print, financial contracts that took teams of lawyers to draft–all being paid by the bargainer on the other side of the table.

  44. When I shop for food, I could read the contents on the labels, but I would have no idea what they mean, for the most part. I’m educated and experienced, but not a food chemist. I go to restaurants, but I don’t ask where the beef comes from, largely because I know they don’t know, but, I wouldn’t know what to do with the information, anyway. In both cases, I buy.

    I don’t have time, attention or inclination to become a food chemist and inspect every article of food I buy. I don’t want to nor do I believe that I should carry a test kit with me to the supermarket or to restaurants to test for e coli bacteria or botulism or whatever. Yet, the labels are there, so disclosure requirements are met. So what? If I don’t understand what is disclosed to me, I can’t evaluate it and make a fact-based decision (I don’t’ understand the facts!).

    When the regulatory agencies have been funded properly, as during the pre-Reagan years, they have performed credibly, even admirably in some cases (FDA, FDIC, OCC, for example). E coli wasn’t a problem until recently (note that funding cuts have reduced the number of inspectors by something like 75%, substituting voluntary compliance – pretty funny for the irony, if it wasn’t so tragic and naive); neither was lead content in toys. Actually, the EPA has reduced water pollution, chemical dumping and automobile pollution a great deal and your kids aren’t suffering brain damage from eating the lead paint on your walls and woodwork. Suggesting that we eliminate regulators because they’re imperfect or can be “captured” (nice for “bribed”) is akin to suggesting that we eliminate police because they don’t prevent all crime and can be bribed.

    Wholesale capture of regulators didn’t occur, except in the investment segment of the financial services (nobody ever went to jail for churning, for example, or had to repay the victims). Capture will always be a problem and diligence is required to prevent it or discover and punish the offenders, but, properly funded agencies have performed well especially when the political appointees who head them actually heed the work of their professional staffs. One key to regulatory success is compensation and status. Compensate them competitively and recognize them for their successes and general good work. Weed out the lazy or incompetent. Sound familiar?

    Failure to address and solve the “metaproblem” of who watches the watchers has dire consequences. The metawatchers are the Members of Congress; we, the electorate are the ultimate watchers. It is incumbent on us to hold our representatives to task and eject them from office when they stray.

    The simple naivete of the “caveat emptor” crowd actually makes me laugh. If they want to spend the bulk of their time, energy and intelligence being wary of sellers of goods, services and advice while they wait for “the market” to force competitors to clean up their acts, let ’em. I have more productive and more pleasant things to do. This freedom of choice, not to have to learn chemistry to live past 40, is an important part of what defines a civil society. It’s my choice as a consumer to trust others in my society to make some choices for me. We all do this as a matter of course every day in all aspects of our lives.

  45. <>

    Gosh, that’s a polite way to put it. Extracting hard-earned money from their (your, my) wallet is more like it.

  46. I was trying to quote this passage from Simon’s missive: But within some particular spaces, including financial products, it’s clear that many of these “innovations” are actually clever ways to extract value from consumers.

    Somehow the feed did not like my double > and <

  47. I realized almost immediately my language might be confusing there and I apologize for that. I was speaking in a regulatory context, and by “complicated” and I meant difficult to standardize.

    I’m not sure that proponents of the CFPA know what they mean when they say that a standard product has to be offered. They want to say a standard contract, but what they are really getting at is affordability. Affordability is a difficult concept to pin down – if you do not believe me, look at the eligibility requirements for Section 8 housing. There are such things as standard underwriting criteria for a mortgage, but that means one thing with respect to a specific product and another thing wih respect to a person’s finances generally because people value things differently and have altogether different circumstances. But just because these issues are difficult to standardize does not mean that people cannot and should not reason through them.

    Almost every person I meet unloads their financial life on me. Rest assured that I have a sense of perspective. If that matters to your argument.

  48. Did Professor Warren ever come back to explain what she meant by innovation?

    The fact that this blog has treated “regulatory capture” seriously, however briefly, is encouraging. That it’s discussed the tools of modern mass manipulation is also a breath of fresh air. Some economists are beginning to wake up to the fact that their masters might not be the angels they thought they were. Let’s hope many, many more begin to wake up.

    It still seems as though most people are buying the polarized right-wing, left-wing, blue and red baloney though. It is the same corporate interests behind the vast majority of our “representatives.” It does not matter for whom you vote… they get what they want. Stop deluding yourself. Universal healthcare is wonderful. Universal healthcare that is used by sociopaths to streamline their unlimited appetites for cash is not. Consumer protection? Fantastic, but not another agency meant to drug us into complacency. Stop being herded.

    Very powerful interests gave us enough rope to hang ourselves, Phase I. Phase II is happening right now.

    If our meltdown was not orchestrated, we have some extremely deep issues to deal with, and they won’t be solved by the economists.

    If it *was* orchestrated, are the maestros ultimately benevolent or or malevolent (from the perspective of the bottom 99%)? One would hope that good people are using “bad” people to achieve their utopian goal. It might very well be though that the “bad” people have corrupted them all. 20 years from now are we going to have the same society, just more globalized and serf-like? Will we have the start of a glorious new Holy Roman Empire? Exactly what “foundation” is being laid?

    Plenty more tinfoil where that came from.

  49. Over at Paul Krugman’s column in the NYtimes we find this jewel:

    “At a recent town-hall meeting in suburban Simpsonville, a man stood up and told Rep. Robert Inglis (R-S.C.) to “keep your government hands off my Medicare.”

    “I had to politely explain that, ‘Actually, sir, your health care is being provided by the government,’ ” Inglis recalled. “But he wasn’t having any of it.”

    (While the Krugman column is actually on health reform) this example illustrates just how irrational the real world can be. The cherished value of “freedom to chose” being entirely muddled here.

  50. “Holy Roman Empire?”

    the Roman Empire only became Christian in the 4th century AD with Constantine and he moved its capital to Constantinople. They continued to call themselves Roman all till the end even though they switched to Greek language but we remember their way of doing things as Byzantine!

    and as to the so called HOLY Roman Empire – it had Germans as Kaisers and one of them had to go to Canossa to appease the Pope and its history is just a mix of mind-boggling ups and downs

    So if you are looking for something glorious maybe the not holy Roman Empire during the time of the Pax Romana would be a better choice. ;-)

  51. Management sciences have been studying and using “irrationality” before economics. For example, Skinner’s works about how to “program” people have been used to conceive techniques to motivate sales forces.
    Management sciences are all about having people do what you want them to do. They have two targets: 1) your market (marketing) 2) your organisation (“organisational behaviour”). A large part of an MBA course is about how to influence people (the remaining being about finance and the rationality of markets).
    A few examples:
    -Professor Cialdini (cf. his bestseller: “Influence: science and practice”) teaches you how to use universal rules mankind follows unconsciously to get what you want from people. For example reciprocity (“people repay in kind”), social proof (”people follow the lead of similar others”), consistency (cf. London stock exchange’s “My word is my bond”), etc.
    -Professor Chatman studies corporate culture (i.e. the mostly unconscious rules guiding the behaviour of members of a company) and explains how a manager can use it to get more from employees, and have them do what he wants them to do (change management).
    -Among other interesting studies there is quite a lot about how to use “framing” in negotiation.
    These sciences have two unexpected characteristics: 1) parasitism: they tell you how to exploit society in your own interest; 2) totalitarianism: they tell you how to use people as “machines”. (This has been known for quite some time: March and Simon (“Organizations”) have shown that traditional organisation sciences make the assumption of the “machine” model of human behaviour.)

  52. Gaute Solheim

    If Posner is right in believing that the consumer is perfectly capable to make the best choice, then his only argument left is the cost of the regulation. The “plain vvanilla” loan would, if I understand him correctly, not influence or confuse the rational consumer. The rational consumer would of course take a quick look at the PV option, and then switch his focus to the more rational choices presented by the bank. So why is he spending all this energy fighting something that will not influence the outcome? Or am I missing something in his article?

  53. Christopher Faurie:

    “totalitarianism”

    you bet!!!
    and the next mankind saving manipulation technique by the name of “Nudge” will of course be totally different, totally benevolent and only interested in the welfare of “us” albeit as defined by Thaler/Sunstein or the government or science or any other Zeitgeist-compatible guru.

    for all my professional life I have read any popular management book to be forewarned for all the latest the guys brought back from their training courses i.e. The How-To of motivating the subordinates via praise without pay raise and what is the most efficient praise and create teams that resemble the hunter groups of old etc. etc.

    All this stuff was taken seriously at one time or another and employers (and mine was a global player and until mergeritis overtook him a very decent one) paid lots of money to have them taught to their young academics and future department heads/directors/CEOs –
    and now these’ll probably get taught how to “nudge” by keeping in mind the picture of themselves trying to hit a fly while pissing… sorry, it must be class thing but this image makes me furious without end

    (during the merger craze the must have fad were gatherings of departments to be merged in nice hotels while making them play silly games like lifting/pushing eachother through nets with big holes hung high over the ground and other such pseudo-psycho-stuff supposed to create bonds and trust – if somebody has pushed your ass of the ground you will trust for ever and ever

    one must just never forget that no matter how nice these manipulator-people claim to be if one listens carefully one will always be able to hear the threats with the horrors one will suffer if one does not follow their superior guidance
    – maybe the old ones who painted the horrors of hell on the ceiling of the Baptisterium in Florence to impress the pious had one advantage over us: they were straight and honest-

  54. Given all of this economic uncertainty I’m surprised the gold price has not performed better, as explained here http://www.bloomberg.com/apps/news?pid=20601082&sid=aByQVbB2gUpc

  55. The CFPA would short circuit the unending varieties of corporate mis and dis information in ways that would still enable consumers to make choices between tranparent product offerings, but not disallow corporations from developing products to attract consumers to better alternatives as they are developed. Too frequently we focus on extremes in “potential” negative outcomes of rules, as if they should control. Such a shame. Time to stop.

  56. Bond Girl: “I’m not sure that proponents of the CFPA know what they mean when they say that a standard product has to be offered. They want to say a standard contract, but what they are really getting at is affordability.”

    I am not sure that affordability is what they are “really” getting at. My first job was as a door to door salesman. I can tell you that very few of my customers who bought on time understood what they were doing. Standard contracts are not a cure for financial ignorance, but they do something to help people understand what they are signing, and do not scatter surprises around in the fine print. They also allow comparison shopping. A customer can see how others are filling in the blanks. Also, if a lender tries to sell the borrower on a more complicated contract, the borrower can always ask him or herself, why are they telling me that something I do not understand is better for me than something I do? Maybe they are trying to fool me.

  57. I am curious about an Information View of free markets. To what extent is capitalism contingent on a lack of information? If the sole benefit of markets is efficient resource allocation through price discovery, then irrational bids will distort the process – and judging from the health care debate (“I do not want government health care! Stay away from my Medicare”) our markets are shaped by comprehensive ignorance and irrationality.

    If we had perfect information about objective reality and our needs, then we could plan. But we don’t have the former, and the latter – our needs – are to a large extent sujective.

    So the dearth of reliable information is at the root of the need for markets – not just scarcity of resources per, but scarcity of knowledge.

    But corporate success is often dominated by further obfuscation – not only is information not available to the customer, it is intentionally withheld, and access to other sources of relevant information is impeded and polluted by means of disinformation, abusive infringement claims, needlessly complex “products” etc. The last thing the corporate worlds wants is an “informed decision”.

    Is the corporate approach to the markets fundamentally incompatible with an Information Society? Do we require legal solutions to define a difference between “Free Speech” and the “Right To Lie”? Between personal and corporate speech? A corporate version of Brin’s “Transparent Society” – commercial activity (sales, not R&D) are subject to mandatory “open books” requirements?

    Lack of disclosure and misrepresentation are a mortal danger to any open society, a lethal impediment to a functional democracy. If these are two pillars on which rests the corporatist approach to markets – as a means to find and leverage information for the benefit of society – then we will need a reform more fundamental than anything since the FOIA to make the professed US system of governance sustainable.

  58. Well Charlemagne looked back wistfully at the Empire of the Pax Romana days, but this period lacked the religious element which seems to be growing stronger again these days, and the feudal elements…

  59. Uncle Billy vs. Mont Pelerin
    if you are keen on religious element and the feudals I recommend
    John Julius Norwich Byzantium (3 books) about how you can create bloody religious strife again and again and again out of the same argument (Christ’s nature)
    these books which have been written way before the Twin Towers and the new oligarchs and that makes them all the more creepy in that plus ca change sense

    and if you want to learn the how of starting as a rogue end as a king (oligarch) Norwich’s “Normans in the South” reads really creepy
    – it is out of print but if you check regularly at abebooks.com you might be as lucky as I was and find one for an almost normal price.
    Next I will have a go at Norwich’s history of Venice because before the crash you could get the impression from reading the London Times that Londoners would have much preferred London to be a state of its own and not saddled with all that land the revenue of which would just not come up to modern standards ;-)

  60. Cheers, Silke. Will look into these.

  61. Hey Silke, now that’s funny.

  62. I mean of course the photo of the urinals at Commerzbank.

  63. (LOL) My goodness Silke, please explain further relating to your comment …

    “keeping in mind the picture of themselves trying to hit a fly while pissing… sorry, it must be class thing but this image makes me furious without end

  64. Tippy
    thanks for the compliment I feel honestly flattered but
    how to explain further I do not really know – even Michael Lewis has according to some reactions on this blog not been able to bring the events at AIGFP to life for people who have not lived through similar stuff or who are lucky enough not to be able to look at the world in a cynical way. But since stories from the cubicle world seem to amuse you here are some more.

    – Employers of all sizes are forever dreaming of the super workforce, programmable like roboters but smart as the hottest savants. Or as one of our popular mantra stipulated “25 year olds with 50 years of experience” – the crazes they came up with to achieve there ideals are really without end and most of them are teaching quite a patronizing (I am better and wiser than you) attitude while claiming it is all about understanding and compassion and I am your equal. In small outfits if you are unlucky your boss will just try the latest it-book of the tennis- or golf club on you.

    Fortunately the world is full of sane people who manage to return to their original decency once the enthusiasm for all the new stuff they have been told wears off.

    The big guru of the management by motivation guy seems to be a Peter Drucker who seems to be quite a sound person albeit from the Freudian tradition. But as always even if the originator is to be taken serious there are lots of followers who also want to make a buck in the training business. Also I found Dale Carnegie’s book “how to make friends and influence people” full of sound advice when having to get excitable staff submit to bureaucratic necessities and stay friends with them and trustworthy at the same time.

    I get excited about Thaler/Sunstein because it looks like they have come up with something genuinely new and different from the two I mentioned above (if no miracle ihappens it is going to be management by stealth). But pitching it via the urinal-example just awakes the old cynic in me imagining all those management trainees coming back dreaming about how to implement flies in urinals.

    Oh, and one more thing the probably rightfully esteemed management consultant Drucker was according to his wife completely incapable of running even the smallest outfit himself – she started one herself rather late in life and was as to practicalities all by herself. Therefore I presume to doubt that Mr. Thaler has even the vaguest idea of how young managers talk to their subordinates and how they react if their bright new strategy does not bring the instant wonderful result the workshop promised them they would achieve.

    One more extreme but no way rare example for you:
    in the 70s the biggest Dutch insurer (life and health) kind of forced his salaried salesmen (the “better ones” those who kept corporate clients happy) to participate voluntarily (note: forced voluntarily) in Psycho-weekends were they were supposed to open up (opening up was the fad of the 70s anybody who insisted on keeping private things private did this only because he/she was neurotic and therefore in urgent need of undergoing disinhibition treatment) – if they got somebody to writhe on the floor while shedding tears they felt they had done a good job (the salesman taking care of me at my company was quite devastated after the event and worried what his refusal to writhe and cry would do to his career). If you refused to sign up for one of these voluntary opening-up exercizes you could more or less let forget about promotion. Having experienced eachother “opening up” showing their most inner sorrows etc etc. was then supposed to create unique human bonds between the middle range managers (at the beginning of this century it was ass pushing.)

    Just one more example of the more serious kind:
    when McKinsey hit the department I was working in in the 90s they pitched the idea that avoiding the last 10 percent of mistakes it cost 80 or so percent of the total so it was cheaper to incur the cost for correcting these mistakes (always when they talk about the last 6 months of life health costs did they tweak the figures after they had heard of MIcKinsey’s idea or did they come up with it independently?). As I was working as a paralegal in Intellectual Property we had a real hard time identifying those 10 percent that did not irrevocably make us lose our patent rights. It took us months and months and proved on the whole not to be a bad idea at all. Just as we were through the next schooling day had to be attended to hopefully invented by another consulting company. It was called TQM-Total Quality Management and promoted zero toleration for any kind of mistake.

    The last department boss I had showed us some of the power points he had brought back from his last schooling – something to do with happiness or being content and intereconnectedness less thinking in up and down more flat – it was a circle with segments The thing that struck me was that even though time figured prominently on the thing, location did not. Obviously it stipulated that you had to manage to be happy no matter where you found yourself, claiming that a nomadic life had to be wonderful for everybody and having roots in one place something not to be desired.

    To summarize whatever theory is developed by the theoreticians the schooling industry will turn it into workshops and educate the world.

  65. Well Silke, I can’t say I fully understand your point here, but maybe that was not your intention, other than to debrief about your personal experience with corporate lunacy. A case of more is better meaning too much of a good thing can only lead to more of the same thing (being more good things) or some such formulation.

    Although, I do recall a certain Fable by a pair of your countrymen, folklorists of sorts, the German version based on an older version by Aesop about a
    Goose that Laid Golden Eggs.
    The German fable being more charming of the two Wiki entries.

  66. Tippy,
    no it is not the golden goose I was aiming at but at how will it feel to be at the receiving end of a manager’s motivating/disciplining efforts, if in the back of his mind while he sees the image of himself trying to hit the fly in the urinal

  67. Silke, I thought perhaps these companies were making so much profit they were spending money on innovative management techniques (the Psycho weekends LOL) which is why I thought of the golden goose.

    Silke you are very cool in my books.

  68. Well I will take back the LOL. Being on the receiving end of such techniques might not be funny at all.

  69. sorry Tippy I overreact as usual
    but being German and having grown up with the elders nature and destiny gave me I am maybe a bit hypersensitive and alarmist to or about everything that has even a whiff of manipulation and brain washing especially when it is from the mighty to the dependent

  70. I heard about something similar in Vancouver. An office was in the middle of a large project and working on deadline. The staff were then told the senior management team had died in a plane crash. The staff response to this false emergency in getting the project completed was video taped (for a project post mortem?) Some found it offensive that that the owners of the this company sanctioned (organized?) this kind of deception on their staff.

  71. Tippy
    without knowing some details it is hard to guess whether it is true or not or how much of it – on the face of it it sounds plain outrageous. So when I get told stories like that I wait for some scene that reminds me of something and start from there – that maybe something totally minor and unimportant but when it comes to life for me and I “see” it as an image or hear the tone of voice that might have been used I get interested. Of course there are schemes about on how to get groups to outperform themselves (über sich hinauswachsen – to grow over and above of themselves) the way soldiers are said to do sometimes while in battle. it is the death part that makes me hesitate to believe. People tend to be superstitious to be proclaimed dead or to proclaim dead. It makes even the callous uneasy.
    But even if part of it should be urban myth there probably remains quite a story.

    I read again and again people trying to refute Milgram or the Stanford experiment – I believe the results of both wholeheartedly because I have seen situations like that in miniature form in office life – I call it judging Miss Marple Style: that reminds of the … we had in St. Mary Mead …

  72. Silke, your insight will be much welcome at the weekend comment competition. Suggest we reconnect there.

    Your high regard for George Orwell has got me thinking about our previous comment competition: “So who is our Upton Sinclair and when will they write the definitive piece that captures imaginations and changes the terms of the debate? Is it about how consumers were mistreated, politicians captured, or the public treasury ransacked?

    There is so much brainwashing underway I am wondering if an author more akin to George Orwell would be the right person to write the book or movie proposed by JS

  73. Consider this bit of “brainwashing”.

    More birther stuff: a recent poll concluded that “as many as three-quarters of Southern whites either asserted that Obama wasn’t born in the United States, or at least had doubts.

    And we wonder about innumeracy and financial literacy and whether there should be a CFPA. There must be method to this madness.

  74. Tippy
    am looking forward to the weekend question but one last as to the Upton Sinclair’ Jungle – Orwell didn’t really write one like that – at least I have read nothing that his road to Wigan Pier which is about life on the dole is anywhere close to Sinclair-Fame – the only other one I can think of in the Sinclair category was Uncle Tom’s Cabin and neither Beecher Stowe nor Sinclair were as writers nowhere near top of the heap – so my bet for a possible Sinclair-Updater is still looking more at the Grishams and Crichtons of today. But the fact that novels that change so much INSTANTLY seem to be so rare should tell us that we are probably in for a long wait there – wonder what the blog will come up with for Sunday

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