The Problem with Disclosure

Felix Salmon has a good example of why disclosure (the preferred consumer-protection regime of free-market conservatives and bankers) doesn’t work, courtesy of Ryan Chittum. The topic is no-interest balance transfers offered by credit card companies.

As Salmon points out, most people probably realize what the game is. That is, most people know that banks aren’t in the business of lending money for free; they know that the bank is betting that it can raise the interest rate before they pay off the balance. It’s possible that you will end up getting a free loan: “If you’re smart and disciplined and lucky, you might be able to game the system and pay no interest at all on that balance. Bank of America, for its part, does its very best to make you think that you’ll be able to do just that, essentially getting one over on The Man.” But the bank knows it has the numbers on its side; and most consumers know it too, because they know that’s the only reason the bank would make the offer.

And people take the bait anyway, because they think they’re the exception. “Most people, when they sign up for one of these offers, think that they’ll successfully game the system. But of course most of them are wrong.”

The people who think that disclosure solves everything, like Peter Wallison, are remembering only half of what they learned in first-year micro. In order to get utility-maximizing outcomes, you need perfect information and rational decision-making. Disclosure gives you information about the product you are buying, but it doesn’t make you a rational actor – especially not when you have to make predictions about your own future behavior. Remember, not only are we a species in which 90% of people think they are above-average drivers, but 85% of people in hospitals who just caused auto accidents think they are above-average drivers. (Sorry, I can’t remember where I heard that – it was recently, probably on an NPR show.) (Update: engineer27 found the story – it’s from the Planet Money team.)

I suspect that the real divide in the battle over the Consumer Financial Protection Agency is between outcomes and principles. CFPA supporters believe that policies should attempt to achieve the best possible outcomes for the largest number of people; if the number of people harmed by a product exceeds the number helped, then it should be banned, or at least made harder to buy. CFPA opponents believe that policies should faithfully reflect certain principles; in this case, people should be free to make their own financial choices, even if in aggregate most people will make bad choices, and they should bear the consequences of those choices.

This is a fairly common way that policy debates break down these days. Sex education and contraception are the best example, but there’s a similar fault line when it comes to guns, drugs, and crime, among other things. It’s also an indication that the debate can never be resolved by any amount of empirical data.

By James Kwak

36 responses to “The Problem with Disclosure

  1. “CFPA supporters believe that policies should attempt to achieve the best possible outcomes for the largest number of people; if the number of people harmed by a product exceeds the number helped, then it should be banned, or at least made harder to buy.”

    Although I think you’ve clearly explained the vision that CFPA supporters actually have for the agency, this is not what they are arguing. They argue that consumers make poor decisions because they have poor information – weighted down by legalese, complex interest rate calculations, etc. But for the imperfect information provided, they would make good decisions. However, this really is about determining which products are available and how much industry players can profit from them.

    I think the reason some people object to the program is a combination of principle and practical observations. The principle side is not just a laissez-faire attitude. Some might argue that the “best possible outcome for the largest number of people” really isn’t all that clear when you get into the terms on individual products (e.g., people who use credit responsibly often free-ride off of those who make themselves into profit centers). Some might question who ultimately gets to make this decision and what might influence them. Are they making these decisions with a view to economic outcomes or for social justice purposes? If for the latter, then whose definition of justice are they using? Are the decision-makers subject to capture? Will they permit innovative products or be biased toward traditional instruments? If they allow for innovation, can they correctly predict which products will be harmful? What is a “fair” profit?

    This topic often makes me think about some of our discussions earlier this year on the various narratives people use to explain this crisis.

  2. James, here is the NPR story:
    http://www.npr.org/templates/story/story.php?storyId=106795194

    They also refer to a well-documented and “named” syndrome, the “Lake Wobegon Effect”:
    http://en.wikipedia.org/wiki/Lake_Wobegon_effect

  3. Actually, those offers always come with a 3-4% up-front fee. The banksters aren’t counting on anything: they win the second any sucker takes the 0% interest bait. The fee is the meat, the interest payments are gravy.

  4. Richard Hoogsteger’s favourable comment about the Canadian civil service has got me thinking. Here is one example of how effective a civil service can be.

    Here is a Canadian version of Elizabeth Warren and Brooksley Born. Yep! Another woman keeping the fiscal house in order.

    Shelia Fraser is the Auditor General of Canada. In 2004, she reported that up to $100 million in government funds had been awarded to certain entities for little or no work. The resulting sponsorship scandal toppled the Liberal Party of Canada under Prime Minister Jean Chretien.

  5. Unregulated disclosure is also a bit of a cop-out, even on its own terms, as the contract takes place within a larger set of rules that a truly informed buyer would need to understand as well.

    Take a mortgage example. Some states, such as California, do not permit personal recourse for primary mortgages but do permit it for secondaries/refinancings/HELOCs. Securitization challenges aside, the lender would prefer an outcome where he has both the security of the house AND the opportunity to pursue the borrower personally to an outcome where he has the house alone.

    “Full” disclosure of the mortgage would entail disclosing all fees, terms, structure, etc. But unless the borrower knows something OUTSIDE the contract – namely California property law – he doesn’t really understand the importance of the structure, regardless of how minute to disclosure may be.

    The firm that has an army of lawyers on its side and countless historical transactions of the same type is always going to have an advantage in a battle of fine print.

  6. If a person is in the 52nd percentile, they are indeed above ‘average.’ If a 52nd ‘percentiler’ imagines him/herself an 85th ‘percentiler,’ trouble will ensue.

  7. Con artists understand the uses of disclosure well.

    **************

    Baseline… Basel-ine?

    The first usage of the term “baseline scenario” was in “this newspaper article from 1981” which references an economist who moved from the USDA to the Kansas City Fed.

    “Here” is an example of the sort of work and thinking he (Hughes) was doing.

    So did the whole idea of baseline scenarios and financial / economic stress testing come from the world of agriculture?

    It’s interesting that this blog calls itself “baseline scenario,” which is a term used in connection with stress tests, yet it was founded with this name back in September of ’08. We didn’t begin to talk seriously (in the media at least?) until February of this year from what I remember. Did you guys know something ahead of time?

  8. “…first usage that I could find”

  9. Grrr.

    “…talk seriously about stress tests”

  10. “I suspect that the real divide in the battle over the Consumer Financial Protection Agency is between outcomes and principles. CFPA supporters believe that policies should attempt to achieve the best possible outcomes for the largest number of people; if the number of people harmed by a product exceeds the number helped, then it should be banned, or at least made harder to buy. CFPA opponents believe that policies should faithfully reflect certain principles; in this case, people should be free to make their own financial choices, even if in aggregate most people will make bad choices, and they should bear the consequences of those choices.”

    Well, I guess that puts me somewhere in the middle, but I think I have a lot of company. I have no trouble with no-interest balance transfers, unless they are touted as “free”, with the fee in the fine print. At the same time, I support a consumer financial protection agency, for a number of reasons. The main reason is not that people are irrational, but that they are innumerate and financially ignorant and inexperienced. That makes them easy prey.

    I do not think that principle belongs only to the opponents of the CFPA. (For one thing, caveat emptor is a warning, not a principle.) Opponents believe that the government should not protect people from themselves. I agree, with perhaps a few exceptions. But there is another principle involved. The government should protect people from others (with many exceptions).

    The evidence indicates that the recent housing bubble involved fraud on a massive scale. For that to happen, there also had to be a lot of behavior that approached fraud. This underscores the need for more active regulation. A few prosecutions in 2005 might have minimized the damage we have seen.

    You don’t have to be utilitarian to care about outcomes. It is, after all, bad outcomes that alert us to problems. That fact does not force us to seek the best outcomes for the most people. In a secular society, the purpose of regulation is not necessarily moral. It is mainly concerned with outcomes, and we always make tradeoffs. If we lowered the highway speed limit to 20 mph we would save lives, increase gas mileage, and reduce carbon emissions. But we would spend more time on the road and pay more for items that are transported by highway. As a society we weigh the outcomes and make tradeoffs.

    There is a social reality in regard to consumer protection that is not involved in any question of outcomes vs. principles. Consider the sociopath. He — most are men — has no conscience and is a master manipulator. Being selfish, he does not particularly try to hurt other people, but he often does. In principle, with enough savvy and character one may protect oneself from the manipulation of the sociopath. However, sociopaths are very good at manipulation. They practice it all the time. And everybody has character flaws and weaknesses, and so we all are vulnerable to manipulation. It is our fault if we allow ourselves to be manipulated. At the same time, is the sociopath blameless?

    Proponents of the principle of caveat emptor are in the curious position of holding consumers to high standards while holding businessmen and financiers to a low standard. They are assumed to be greedy, to attempt to maximize their own profit, even at cost to others, as long as they do not break the law, and to capture regulators and legislators so that regulation and law are tilted in their favor. What principles support that?

    Now, offering 0% balance transfers may be mildly manipulative. I am not calling credit card executives sociopaths. However, there are more predatory practices out there, and when consumers get hurt, the fault does not belong only to them. It does us no good to pretend otherwise.

  11. CFPA opponents believe that policies should faithfully reflect certain principles; in this case, people should be free to make their own financial choices, even if in aggregate most people will make bad choices, and they should bear the consequences of those choices.

    This is a fairly common way that policy debates break down these days. Sex education and contraception are the best example, but there’s a similar fault line when it comes to guns, drugs, and crime, among other things. It’s also an indication that the debate can never be resolved by any amount of empirical data.

    Yes, I imagine market fundamentalists would like to propagate the notion that this is just like a “victimless crime” or an endemic social problem.

    Of course it’s no such thing, but rather common gutter fraud, qualitatively no different from some alley trickster running a game of three-card monte.

    The only difference is the magnitude, and it’s only this magnitude which has allowed the pickpockets to buy social respectability and political power.

    I suppose the comparison with sex ed is apt in one way – the FIRE sector is a kind of social disease.

    But the correct response when you have such an affliction is not to treat it as a chronic condition you just have to suffer and live with, but to get rid of it.

  12. actually the Greek fishermen on “my” island deposited their money with their wives/mothers who had different purses for them in a drawer – if they needed money for an evening in the tavern they had to get it through Mama/Spouse before the women had vanished for their own get-togethers.

    I do not know whether the women had the power to impose that system or whether the men were wise enough to want it themselves

    incidentally those were the same men whose self-image demanded? that during morning negotiations in the cafés or visiting on another island they paid from inches thick bundles of bank notes.
    where those bundles were stored when night-out was up I have not found out

  13. Opponents believe that the government should not protect people from themselves. I agree, with perhaps a few exceptions.

    but shouldn’t government try to prevent the sale of the equivalent of snake oil within the territory of the people who elected it – and what a person with the ability to add, subtract, multiply and divide can’t figure out for himself is snake oil

    here’s Quentin Skinner on Hobbes, wasn’t there something that allegiance depends on safety provided?
    – just because they do the robbing now digitally doesn’t make them any less dangerous than those guys in the castles on the mountain tops (Raubritter=robber knights – notice the “knight”) who would provide for themselves by raiding the traders who passed below – some even being civilised enough to do it without any throat cutting

    http://deimos3.apple.com/WebObjects/Core.woa/Browse/itunes.open.ac.uk.2230343877.02230523561.2230425708?i=2065723091

  14. Consider the sociopath. He — most are men — has no conscience and is a master manipulator.

    go work in an office where the cubicle level is exclusively women. Just because the news worthy perpetrators tend to be men doesn’t mean that women do not excel at it.

  15. this credit card story reads like a sober description of the odds at roulette, i.e. pointing out why there’s a zero. Nevertheless people flock into the casinos and when I watched faces around the tables I was amazed how many look as if they were in real pain when they have lost once again.
    Could it be that the lure of the glitz such a Spielbank full of velvet and silk offers, is so strong that it overwhelms all reason? If that is a point than the question would be how to make sober reasonable action seem alluring, daring, glitzy

  16. After reading Min’s thoughtful comment, I thought it might be useful to repeat in a different form the point of the original post. If the CFPA simply regulates how products are marketed in the interest of clarity/transparency and provides cautionary information about outcomes and consequences, it falls into the choice category. If the CFPA bans or restricts products, it falls into the utilitarian category, regardless of whether the good is directed at society as a whole or specifically its more vulnerable members. You can split the difference in a variety of ways and you can have the two factors relate – and not necessary in a benign way (e.g., consider how a Social Darwinist might consider a differential outcome based on innumeracy or ignorance to be a utilitarian feature rather than a bug). I agree with Min that anything specifying a moral good is principle-based.

  17. specifying a moral good is principle-based

    If “Do unto others as you would have others do unto you” is a moral good that is also principal based then “principal based” is a meaningless category.

  18. If “Do unto others as you would have others do unto you” is a moral good that is also principal based then “principal based” is a meaningless category.

    Not a meaningless category, because it highlights where the recommendation is grounded. Another way to put it is the distinction between instrumental and principle-based reasoning. Here’s an example: if someone favors faith-healing as their healthcare option because they believe it’s wrong to try to interfere “artificially” with God’s Will, that’s a principled decision. If they favor it because they believe it provides a superior outcome in terms of physical health, that’s an instrumental decision that may be resolved. If they favor it because it assures eternal life-after-death, that’s an instrumental decision, but unverifiable. In terms of the topic under debate, if “choice” is a basic moral preference, there’s an impasse, although there’s all sorts of rhetorical ways you might use to change thay preference. If it’s an instrumental decision because choice leads to a superior utilitarian outcome over some defined course of time, then let the measurement begin. Choice architecture suggests that many people consider choice to be a bedrock value, to be reconciled with utilitarian outcomes.

  19. Min, while you may not be willinng to call bank executives sociopaths, others are – there was recently an item in the news about a study done that showed that a disproportionate number of corporate executives demonstrated near-sociopathic tendenceies.

    Unfortunately, like James, I can’t recall where it was…but from my personal experience in the banking industry, I am not at all surprised, and more than a bit worried, by the study’s conclusions…as a result, I’m no longer working for financial institutions.

  20. James, excellent post as always. It’s becoming increasingly clear that there are no “rational” solutions to the divide between the two camps here. What’s fascinating is that the same seems to be true of the health care debate.

    I wonder if the population divides the same way on the two questions, or if there are important differences (for example, is there a deeply-rooted distrust of corporate decisionmaking regardless of industry, or is the divide more along D/R party lines?).

    From my reading of history, it does seem as if there’s a tendency for societies to experience a deep and potentially final political split when those who are more rational and/or educated become unwilling to accede to the emotional demands of the less-educated. Unfortunately, as the example of the Pythagoreans demonstrates, there are usually a lot more of the less-educated who succumb to emotional appeals…

  21. David Nowakowski

    There is a lot of condescension in the comment about drivers, though it is a valoid point, and other stats also point out that people have poor (irrational) self-control and unjustifiably high expectations when it comes to themselves vs. The “average”. This is certainly partly a result of the focus on self-esteem that educators have had the past few decades.

    That said, my math instincts immediately kick in when I see a stat like that. The obvious model is a two-state driving system, where drivers are either ‘horrible’ and score zero (and drive NY cabs), or adequate, and get a 10. Suppose 10% are bad. Then the average driving score is a 9, but 90% of drivers are indeed above average.

    They need to do the survey and ask the proper question: are you an above-the-MEDIAN driver.

  22. The essay on sociopathic behavior was in the New Yorker, November 10, 2008, entitled Suffering Souls by John Seabrook — available online.

  23. Does anyone really believe real people read those things? 20 years ago the documentation at a real estate closing was about an inch high. Today, it is at least 9-12 inches high, most of which is statutorily required disclosure. I can promise you that the buyers haven’t plowed through, much less understood, all that jargon. All this ‘disclosure’ stuff is just a fiction to avoid protecting the public. The problem is that poor choices in some areas don’t just harm the chooser but can ruin all of us. We did not participate in the real estate bubble have no debt are not big consumers and invest conservatively. The poor choices others make mean we are being ruined, people will not be able to educate their children or retire through no fault of their own. The consequence of irresponsible supposedly ‘free’ choices in unregulated markets are too catastrophic to be allowed. QED.

  24. I was wondering if I might have a chance at working at a bank if I listed “sociopath” as one of my skills on my resume.

  25. The author might have been William K. Black.

  26. there’s a tendency for societies to experience a deep and potentially final political split when those who are more rational and/or educated become unwilling to accede to the emotional demands of the less-educated.

    that’s what they keep telling us about the Nazis, it was all the fault of the uneducated emotionalised masses
    I think myths like that are so persistent because they allow the educated to keep adoring Heidegger and his ilk for their deepness or whatever and to never ever mention their support for the MasterRace or whatever else they found to admire in those riding boot wearing black clad clean coiffed young man

  27. I agree, the not just bad but fraudulent debt of the real estate bubble created winners of banks, developers, and the least qualified buyers – if you’re going to go bankrupt or be foreclosed anyway, better a lot of debt than a little – and left the honest buyers as the bagholders.

  28. Whether or not you read it, you can’t negotiate it. It’s offered on a take it or leave it basis.

    Furthermore, one side gets to revise the language at any time and send out new terms in fine print whenever it wants. Also, non-negotiable.

    Any dispute is resolved by partial and corrupted arbitrators, as per the boilerplate.

    And everyone still pretends there has been a meeting of the minds.

    What a great system!

  29. CFPA opponents believe that policies should faithfully reflect certain principles; in this case, people should be free to make their own financial choices, even if in aggregate most people will make bad choices, and they should bear the consequences of those choices.

    And then there are the radical opponents who feel that the principle reflected should be to cause the greatest benefit to the credit card companies, disregarding any rights of the consumer. They draw strength from the observation that things seem to work this way.

  30. Seems to me that opponents of the CFPA would like this argument to be cast in the form suggest by this posting. That is, there are two opposing view points.

    I posit that a functioning regulatory scheme in this space would be quite simple in principle. It would exist to foster competition at a level that matters to customers.

    For example in the credit card arena, perhaps you could force disclosure of a very simple statistic – what was the median amount of non-principal charges paid, over the past year, by customers who owned +/- $100 around the balance you’re currently carrying, with the rules that would apply to you if you switched. Now make sure those rules apply for at least a year. No changing them without notice.

    We do this sort of thing for gas mileage. Why couldn’t we do it for credit cards?

  31. perhaps you could force disclosure of a very simple statistic – what was the median amount of non-principal charges paid, over the past year, by customers who owned +/- $100 around the balance you’re currently carrying, with the rules that would apply to you if you switched

    That’s a statistic that can be understood by everyone. Thanks!

  32. I know that this is somewhere in some lenders underwriting manuals: Each loan or credit facility must be approved based upon the borrowers ability to repay, determined by history (credit score) and income/assets (availability of repayment assets) and will be limited based upon a formula.

    It seems to me that the most certain way to control consumer borrowing is to establish statutory guidelines for every form of loan or credit facility, such that no borrower will have to make any decision except whether or not to apply. If the guidelines were mathematically formulated, and there were no loans permitted without full documentation, then the number of defaults would be drastically reduced.

    I also believe that we need to reestablish the statutory usury limits, and apply those to the APR, not the simple interest rate.

    These requirements would make it very difficult for banks to develop financial products that were not balanced and reasonable to have in the market place. They would be the most proactive form of consumer protection.

  33. Something similar was quite common amongst working class working families in England decades ago when the man would go out and do the work and come home and had his unopened pay packet to his wife. She would ensure all that was needed for the family was kept by her (rent, food, bills etc) and he would be given back a some to go to the pub, the dogs etc.

  34. I think something similar is/was practiced in parts of Latin America, except that a male worker’s pay was physically handed over to the wife without it ever touching her husband’s hands in the meantime.

    The understanding was that if the husband ever got his hands on his pay packet even for a minute, he would spend it all on alcohol and prostitutes before he ever made it home.

  35. the difference in both your examples is that “your” guys were employed i.e. their wages at least approximately known or even communicated
    “my” Greeks were self-employed fishermen living in tight interdepence with their women folk (who could see to the sale of the fish when the man had to roam the coast for a catch and who probably were tougher at negotiating the price)

    I somehow continue to believe that a self-employed man (especially one fishing/hunting for a living) can afford to be a prouder human being than one depending on wages, more in command of designing his own life-style (the similarity to the difference between a lawyer with a private practice and a high ranking manager in a corporation is striking though)
    – that’s why it amazed me that it was OK for them to grant so much power and independence to their women (however, the island of Patmos is a bit untypical insofar as the family lives in a house which is the undisputed property of Mama who will only pass it on to a daughter not to a son and who has acquired it either as dowry or found some way of working herself to the ground to acquire one by for example taking care of an old woman without family for 12 years for the inheritance. No boy is allowed to marry before his sister has a house of her own. Do not know how they do it now, 30 years later, when the seamen jobs by which they financed it presumably are all taken by the guys from Asia.) Maybe tourism helped but what is going to happen if that dwindles – will they go back to being dirt-poor again – all in one life-time?