Who Watches Watchers?

James Surowiecki says U.S. voters should support a new Consumer Financial Protection Bureau (C.F.P.B.) because consumers make finance mistakes:

Many Americans are ill informed about financial products. … You might think that businesses offering better products would have an incentive to make sure that potential customers were able to distinguish between ripoffs and good deals, but … there’s “a limit to how much explaining a creditor can do before losing the attention of its customers.” … Warren … talked to a number of banks about introducing a credit card with a higher up-front interest rate but lower penalty fees—a cost-effective arrangement for many people. But … there was no way to convince consumers that it was a good deal. In a world where marketing is all about the lowest teaser A.P.R., … you end up with a race to the bottom. …

The C.F.P.B. hopes to change this, largely by insuring that consumers will be told the true terms of a deal, in a simple and clear fashion. … Some bankers … maintain that the C.F.P.B. will go too far and end up strangling financial innovation. But, over the past century or so, new regulatory initiatives have inevitably been greeted with predictions of doom from the very businesses they eventually helped. … History suggests that business doesn’t always know what’s good for it. (more)

Let’s see, banks offer bad products, because many consumers are too lazy to notice and choose good products. So voters should empower regulators to make rules banning bad products, or at least overly hidden products. But isn’t it also possible that regulators might offer bad regulations, because voters are too lazy to notice and choose politicians who support good regulations? Why would voters pay more attention to choosing regulators than banking customers pay in choosing banks? And if voters pay less attention, how does adding this extra layer of choice improve the overall situation?

You might argue that when choosing their votes, ignorant voters can rely on interest groups and better informed elites, who share their interests. But banking customers could also rely on interest groups and informed elites in deciding where to bank. Yes, banks often try to create and buy off apparently independent groups and elites that pretend to offer neutral informed advice, to fool uninformed customers into buying bad products. But the same thing can happen at the political level – how can voters know which organized groups and elites are actually informed and share their interests?

It would seem that any process that ignorant voters could use to decide who to trust on regulations could also be used by ignorant consumers to decide which banks to patronize. Since banking consumers have far stronger incentives to choose well on banks than voters have to choose well on politicians, how can it help to replace a possibly quite severe ignorant banking consumer problem with an even more severe ignorant voter problem?

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  • What you are missing is that good and honest banks run by good and honest people want to offer good and honest products but they can’t because of the race to the bottom by the crooks and frauds.

    It is just like the companies run by people who don’t want to pollute and who don’t want to risk their employee’s health, but they have to compete with companies that don’t care about the environment and because environmental controls cost more than just dumping pollution into the atmosphere responsible companies can’t compete in the race to the bottom unless the playing field is equalized by regulation.

  • Carl Shulman

    I have a lot of sympathy for this argument, but I think it presents too one-sided a case. The median voter interested in the issue enough to change a vote based on it may think better about it than the 5th percentile consumer. Low and differential turnout in the US means voters are smarter and better educated than consumers, on the whole.

    • This sounds like an argument for more conformity, as in “We’d be better off overall if everyone were forced more to act as the median voter thinks they should act. The harms to those with better judgement than the median voter is outweighed by gains to those with worse judgement.” And under this rationale there’d be no point in regulations that substantially constrain the median voter.

      • What serves customers best are efficient markets. What serves efficient producers best are efficient markets. Markets can only be efficient if there is transparency.

        When there are asymmetries of information, regulation can enforce transparency and can make markets more efficient.

        Efficient markets can grow faster than inefficient markets. If you want to promote growth, fostering efficiency by enforcing transparency is a low cost way to do it. Of course the inefficient producers and monopolists don’t want efficient markets. Why should those who want growth, efficient producers and non-monopolists tolerate non-efficient markets?

    • Vladimir M.

      Carl Shulman:

      Low and differential turnout in the US means voters are smarter and better educated than consumers, on the whole.

      Yes, but the problem is in the incentives. A stupid consumer still has the incentive to make the least bad choices given his limitations. A smart voter has the incentive to optimize his policy preferences for signaling and emotional satisfaction, regardless of their actual consequences.

      Not to even mention that the link between voting and policy is nowhere as direct. Voters have little to no influence on bureaucrats and courts who shape raw legislation into actual regulations and policies. And in matters of finance, this process is impenetrably obscure and complicated for anyone but a handful of expert insiders.

  • You’re missing this: the proposal is not about protecting the consumer. That is solely the excuse, the pretext. The actual intent is to get more power.

    You must read actions and consequences, disregard words.

  • wophugus

    You are focusing entirely on the incentives for the consumer and completely ignoring the fact that for-profit banks and a non-profit consumer protection agency designed to regulate banks might have different incentives. If I have a choice (to be hyperbolic) of making someone who wants to destroy me the CEO of my company or someone who loves me the relevant question isn’t whether I’ll do better working to keep one of them honest, it’s whether I have to work as hard to keep one of them honest. I don’t, the guy who loves me won’t try so hard to destroy me.

    I’m not saying it’s super obvious that consumer protection agencies have more incentives to protect consumers than banks, I’m just saying it’s a question you have to grapple with if you want to address this issue. It’s super possible that consumers could be equally apathetic to both but one could do a better job of protecting consumer’s interests than the other.

    • I was going to say that. We can’t be sure of what the regulator’s incentives. We have a pretty good idea of what the company’s incentive will be.

      Partially because company’s have an incentive to improve their own bottom line, a lot of their signalling is unreliable, so it makes sense for a consumer to not try and glean much information from ads. But if there were a third party watchdog like Consumer Reports, people could read if certain offers were good for them. This pushes back the incentive problem to the watchdog, which is theoretically supposed to be based on reputation. That didn’t work for the rating agencies, which were a legally certified cartel and, according to Charles Calomiris, giving buyers the bogus rating they wanted in order to engage in regulatory arbitrage.

    • I though that was the point of Robin’s second-to-last paragraph:

      You might argue that when choosing their votes, ignorant voters can rely on interest groups and better informed elites, who share their interests. But banking customers could also rely on interest groups and informed elites in deciding where to bank.

      Robin’s question isn’t “why should consumers trust regulators over banks?”, it’s “why should consumers trust regulators over other elite without a direct economic interest?”. In other words, why do we enact the recommendations of the elite into law rather than just having consumers choose based off the elite’s recommendations?

    • If all that was needed was a third party advisor with ambiguous or “non-profit” incentives, then it would be enough to have independent orgs who offer advice to people about banking products. You need regulators to force people to follow such advice.

    • Lord

      Totally agree. Voters are irrelevant. It is the incentives of regulators and those that appoint them that are critical. Consumers don’t have to trust regulators and would do better not to, but we are not talking about trusting them for there is no trust involved when no choice is involved. Unless one conjures up a regulator so perverse their objective is to prevent the offering of good products, a regulator would at worst be an industry captive which is to say the same as if they didn’t exist.

      • A regulator who is an industry captive is far worse than no regulator at all. “Preventing the offering of good products” is a substantial part of what all regulators do and captured regulators do this more than most.

        Consider that taxi regulations invariably are designed to limit the number of cabs on the street. Suppose the regulators are unusually well-meaning and clever and manage to successfully eliminate only the *bottom* 50% of cab-drivers. Now all the cabs that remain are better cars, better drivers, less dirty, less polluting than before, so the regulators have increased the average *quality* of a cab ride…but there are half as many cabs so it’s harder to find one! By “improving” one set of metrics to the benefit of existing suppliers and those with political pull, they’ve made every customer worse off.

        The FDA does the same for drugs – drugs and devices may be better tested but are fewer and more expensive and slower to get approved, which is worse overall for the consumer. These new banking regulations will do much the same – eliminating even “the worst” financial products makes everyone worse off by reducing innovation and competition.

        Captured regulators don’t fail to regulate an industry, they regulate it *more*. They do so to the benefit of existing suppliers and the detriment of upstart challengers who aren’t grandfathered in and can’t jump through the new regulatory hoops. This harms us all.

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  • josh

    Where do people get the idea that voters choose regulators? That’s ridiculous.

  • Matt Knowles

    The problem is that people are continually trained NOT to concern themselves with which bank to use, or which politician to vote for. Instead of trying to reduce the impact of bad choices, we should force people to suffer the consequences of bad choices so that they are trained to make better choices.

    • Bingo.

    • AlephNeil

      And if you really love your cat you’ll train it not to drink antifreeze by making it suffer the consequences (as opposed to not having open bottles of antifreeze lying around).

  • You might usefully take a look at Jane Jacob’s Systems of Survival, which describes the differences in ethical principles between government and commerce. These principles are, of course, not always adhered to, but that doesn’t mean they aren’t real.

  • I find this argument persuasive in the abstract, and I certainly agree that we are over-regulated compared to the optimal point. But I have trouble believing that we would be better off with the near-zero amount of regulation suggest by this argument.

    Maybe regulators have higher status than other consumer watch groups, which would attract smarter/better elite to be regulators. I suppose regulators have higher status for the simple reason that their decisions have the force of law, rather than just functioning as recommenders. Yes, we think that regulators are often bad and stupid, but do we really think the consumer watch dogs are better on average?

  • Eric

    Meh. This looks more like an information problem, coupled with cognitive biases that work against consumers.

    Let’s put it this way.

    (1) Banks have highly trained analysts and access to lots and lots of data and experience about consumer behavior. They can create complex products difficult for consumers to understand.

    (2) Individual consumers (rationally and not) can’t expend the effort to understand complex financial products because they have better things to do (like work).

    (3) Consumers also have cognitive biases and limitations that hamper their ability to evaluate the financial products of banks. Nor do they have ready access to data about how such products actually perform.

    So, there is a big power, information, and cognitive imbalance here that makes it hard for consumers to be “rational maximizers”.

    Perhaps one regulatory solution would be to require some sort of 3rd party simulation of actual financial returns for any financial product. Perhaps then consumers have better than a snow-ball’s chance in Hell to understand and evaluate financial products? Or perhaps we should just grant power of attorney to some company with equal access to highly rational expertise and great piles of data for analytics. That company could be contracted to be our agents on hard issues (life insurance, medical insurance, degree programs, banking services, etc.) since we really can’t trust ourselves to make rational decisions. Sorta “opt-in” totalitarianism, or “totalitarianism as a service”.

    Just thinking out loud….

  • Eric Falkenstein

    Consider that government is highly involved in education. There’s a lot of waste in education but it’s not considered morally bad because it is all legal, if not encouraged. It’s easy to pursue a perverse higher agenda when you don’t require the tactics to be cash-flow positive because it’s all justified via nonquantifiable spill-over effects and moral righteousness.

    I predict all government will do more like what it did with mortgages: encourage particular types of transactions that will have with lots of short-term profitability. Then, when it blows up, they will blame the banks.

    If they really wanted to help poor people financially they would raise their costs for certain behaviors: get rid of state lotteries, have a minimum bank balance to get a credit card, etc. Instead, they want to encourage the activities that most hurt them. Subsidizing foolish financial behavior, from overdrafts, to excessive debt, is like giving poor people drugs to make them happy.

  • Matthew

    Should the violins on the Titanic play a waltz or a classical piece?

    Meanwhile the entire dollar / fiat / debt Ponzi is listing heavily to starboard and some very disturbing groaning and popping noises are coming from the bulkheads. Get in your gold and silver-colored lifeboats while you still can.

  • Don

    Your premise is that deceptive business practices only work on lazy consumers. If that is so, and if we don’t trust a government voted into office by the same lazy people, then why not get rid of all government regulations? Why not get rid of laws prohibiting deliberate false labeling of goods, for example?

    It makes no sense to talk about consumer choice in a “market” where businesses are free to lie to consumers, and to profit from the lies. Consumers can’t exercise informed choice without information. Businesses have an incentive to withhold information consumers need to make that informed choice—i.e., an incentive to lie. Consumers don’t have the resources to expose all the lies, not least because they can’t subpoena proprietary business records. So there has to be a disincentive for businesses to lie, in the form of government enforcement.

  • PaulNoonan

    Surowiecki even makes this point in The Wisdom of Crowds when he discusses people’s ability to follow the correct expert.

  • Jason

    Let’s assume no one really knows what they are doing, so carefully crafted policy runs the gamut from good to bad.

    When enacted, it is plausible that banks will first comply and then try to evade regulations. Compliance is expensive, but inventing a workaround is expensive and hard.

    Under this model, regulatory workarounds that are worth more money to the bank, and thus to the consumer who chooses their services in the market, will eventually be used to evade regulations. Regulations that “work” will benefit everyone. You start with a spectrum of regulations from good to barely good to neutral to barely bad to bad. Bad regulations are evaded. Barely bad ones are not, but represent the cost of doing business for ignorant voters/consumers who would rather spend more time doing fun stuff than paying attention to bank loans or regulatory policy. The end product is mostly positive and the negative can be considered the cost of not having to engineer policy as well.

    Also, from this model, it seems any process of deregulation would be bad. Like the regulators proposing a span of regulations from good to bad, deregulators would try to remove regulations that run the gamut from good to bad. Since bad regulations are evaded, their removal does nothing. However, good regulations are likely to be removed.

    Again, since no one really knows what they are doing, business will go right ahead and try new things in the areas where the good regulations were removed.

    And since no one really knows what they are doing, we never actually know which regulation in place is good or which deregulatory action led to a financial crisis.

  • Bankster

    As long as the tax slaves are made to pay for the mistakes and banks are allowed to keep the profits, I have not problem with it.

    Public risk. Private profit. It’s the Amerikan way!

  • DrModern

    What you are missing is an understanding of the administrative structure of such an agency. While certainly real, the problem you cite – wherein uninformed voters select suboptimal politicians – is simply irrelevant, since voter choices do not directly influence the content of regulations. Rather, voters elect representatives to Congress, which then delegates its law-making authority to an administrative agency, whose executes may only be selected in accordance with constitutionally specified norms. Although these appointments are certainly political in nature, there are significant cultural and reputational pressures on the appointment process to ensure the hallmarks of legitimacy – specifically, politicians must be sensitive to institutional pedigree, demonstrated competency, education level, bipartisanship, etc. People with graduate level training in public policy, economics, or substantial experience in banking would be good candidates. These pressures help ensure that the people who are selected to write regulations both have a significant degree of understanding of the market practices they are regulating, as well as a significant degree of knowledge about successful regulatory practices elsewhere in government. This historical knowledge is especially salient where, as here, there are obvious analogues to existing regulatory agencies – namely the SEC. Moreover, it’s not especially difficult to imagine the design of such mandated information-sharing, though there are always unanticipated complexities as markets react to regulation and loopholes are exposed.

    In other words, you’re comparing the wrong processes. It’s incorrect in attacking a proposed CFPB to draw an analogy between consumer choices about banking products (especially products that were specifically designed to be deceptive) and “consumer” choices about politicians generically. There are mediating and supervening processes that control the appointment of people to administrative agencies that ensure that those writing regulations are competent to do their jobs. The correct comparison is between consumer choice over banking products and the congressional appointment process, and surely the differences between these are obvious. If what you’re really arguing is that you do not trust the members of Congress to arrive at unbiased decisions regarding the optimal appointees, I’d say keep dreaming. It’s still relatively clear that markets beset by information asymmetry can benefit from the introduction of regulations that require information-sharing, and that the creation of an administrative body with authority over those regulations is a relatively effective means of promoting that information-sharing. If what you’re really arguing is that you do not understand why it is better to entrust these processes to government rather than to market actors, then I’d say that you’re just purveying stock libertarian ideology, which is rather ironic for a site called “overcoming bias.”

    • Amen. As to “purveying stock libertarian ideology”, Hanson is funded in part by the Koch brothers, the same people who fund the rest of the libertarian propaganda machine (Reason, Cato, George Mason, and a very long list of others). I’ve periodically asked on this blog for an explanation of whether this funding source induces bias, and if not, why not. It is a key element of Hanson’s ideas that money and cognition are or should be deeply linked (eg, in prediction markets); so I’d like to know how it is possible to take money from a major political player without being influenced by it.

      • That is a question that Robin can’t answer, because when you are trying to game the system, the first rule is never talk about trying to game the system.

        That was a great link about Jane Jacob.

    • Drewfus

      “Although these appointments are certainly political in nature, there are significant cultural and reputational pressures on the appointment process to ensure the hallmarks of legitimacy – specifically, politicians must be sensitive to institutional pedigree, demonstrated competency, education level, bipartisanship, etc. People with graduate level training in public policy, economics, or substantial experience in banking would be good candidates.”
      “Hallmarks of legitimacy” are not enough. Life is not that simple. Suppose there is disagreement on regulatory theory, policy, scope, political viability, historical records and interpretations of success/failure, economic theory, conflicts of interest, privacy and security issues, monitoring, priorities, resource allocation, independance from industry, etc? Will everything still be hunky dory?
      “Cultural and reputational pressures” would have to include all pressures, good and bad, such as “stock libertarian ideology” (ex: Ron Paul and the Fed). These pressures also exist for private firms, and perhaps more so if they are not simply assumed to be as competent and trustworthy as regulators apparently are. Indeed, why not just say the social pressures are redundant, if all these highly educated regulators are so competent and knowledgeable? Can’t we just trust them to do the right thing, sans a profit motive?

      Last problem here is that regulators are not acting in a static, textbook modelled environment. They are competing with the movers and shakers of the financial industry. The regulatory framework exists within a game – it does not simply define the world from the outside.
      DrModern’s views sound a lot like Plato’s ‘Republic’. 

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