Harvard Law professor and bankruptcy guru Elizabeth Warren has a really interesting proposal out today in the journal Democracy (I first heard about yesterday in Gretchen Morgenson’s column in the NYT):
It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street–and the mortgage won’t even carry a disclosure of that fact to the homeowner. Similarly, it’s impossible to change the price on a toaster once it has been purchased. But long after the papers have been signed, it is possible to triple the price of the credit used to finance the purchase of that appliance, even if the customer meets all the credit terms, in full and on time. Why are consumers safe when they purchase tangible consumer products with cash, but when they sign up for routine financial products like mortgages and credit cards they are left at the mercy of their creditors? …
Consumers can enter the market to buy physical products confident that they won’t be tricked into buying exploding toasters and other unreasonably dangerous products. They can concentrate their shopping efforts in other directions, helping to drive a competitive market that keeps costs low and encourages innovation in convenience, durability, and style. Consumers entering the market to buy financial products should enjoy the same protection. Just as the Consumer Product Safety Commission (CPSC) protects buyers of goods and supports a competitive market, we need the same for consumers of financial products – a new regulatory regime, and even a new regulatory body, to protect consumers who use credit cards, home mortgages, car loans, and a host of other products.
This would be the Financial Product Safety Commission, which Warren says could either be part of the CPSC or an independent body. I’m intrigued by the idea. In most financial markets, wary buyers probably do more than any government regulation to keep sellers in line. But Warren is right that credit cards and mortgages are best seen as consumer products, and that the average consumer shouldn’t be expected to fully understand the risks inherent in adjustable rates.
Also, current financial regulation is organized on an industry basis, which means that any attempt by banking regulators to crack down on, say, subprime mortgage lending merely pushes business out to barely regulated entities on the financial fringe. Regulation by product would do much to end this craziness.
I’m still not clear how any of this would work in practice, though. Would the FPSC actually ban certain lending practices, or just push for better disclosure? If it did the former, it might be tough to draw sensible lines: Some people really need adjustable-rate mortgages; nobody needs exploding toasters. But if the FPSC were only about disclosure, would it really have any impact?
Also, is the CPSC really the reason why one in five toasters doesn’t burst into flames, or is there something inherent about tangible products that encourages manufacturers to do what they can to avoid embarrassing safety glitches?
I don’t know the answers. But Warren is right that the current state of affairs is leading way too many people into financial trouble.
In just the past couple of decades, financial technology has grown enormously sophisticated. The economy has been strong and interest rates have been low, so even people with poor credit have been relatively good at paying back loans. And, as Warren has often written, regulation of consumer credit has become more and more, shall we say, relaxed. What we have today is totally new world, credit-wise. Our grandparents never could have gotten a loan for 18 percentage points above the prevailing rate, unless they went to a guy named Lenny Knuckles. Today credit cards charging more than 20% are an ordinary feature of middle class life. Adjustable rate mortgages–to say nothing of option-payment ARMs, no docs, and interest only loans–were considered exotic stuff as recently as five years ago. Your mom and dad may have passed on basic habits of financial prudence, but they probably didn’t teach you how to read the loan agreement on an ARM.