Opinion

Felix Salmon

Roger Lowenstein vs the CFPA

By Felix Salmon
March 9, 2010

Roger Lowenstein has a column up on Bloomberg with the headline “Smart Banks With Dumb Customers Don’t Exist” — which just goes to prove that smart writers with dumb ideas do exist. Ryan Chittum has already done a good job dismantling the piece, but I feel the add to add my own two cents with respect to his characterization of the Consumer Financial Protection Agency:

The new watchdog, wherever it goes, is the linchpin of the emerging financial-reform bill, and its premise is that greedy bankers exploiting dumb consumers essentially caused the credit crisis. Stop bankers from selling toxic mortgages and other harmful loans and we won’t have any more meltdowns.

Even though bankers were greedy, and many borrowers were naive, this is a simplistic way of viewing the financial crisis and one that misses its underlying cause. Since mortgage bankers make money from loans, it’s tempting to think of them as parasites that prey on customers. But there is no such thing as a smart bank with a dumb customer; if the loan turns sour, the banker was dumb, too.

Where did Lowenstein get the idea that the premise behind the CFPA was to prevent a systemic meltdown? Has he never heard Elizabeth Warren or anybody in the Obama administration talk about it? I’ve made the case that the CFPA might have beneficial secondary effects, from a systemic perspective, but from day one its primary role and raison d’etre has been to protect financial consumers. As you might guess, from its name.

The CFPA was first proposed in its present form by Elizabeth Warren in the summer 2007 issue of Democracy. Clearly she’d been thinking about it a lot before that article appeared, and equally clearly, if you read the article, preventing meltdowns is simply not there. Partly because the meltdown hadn’t actually happened at that point. So Lowenstein is simply wrong on his “premise” statement.

As a result, when Lowenstein starts attacking the “simplistic way of viewing the financial crisis”, he’s really attacking no one at all. But then he goes on to pooh-pooh the idea that mortgage bankers are “parasites that prey on customers”, using the argument from his headline.

The problem here is that Lowenstein’s argument is based on three very shaky foundations. The first is that if a bank preys on a customer, that makes the customer dumb. But being preyed upon is not a sign of stupidity. This is an important point, because one often hears, when it comes to things like overdraft fees, that they’re all the fault of those dumb customers, and that therefore (and this is a logical step I’ve never really understood) we don’t need to worry about them. What’s undeniable is that calling ripped-off consumers dumb serves to stigmatize them, and make them less sympathetic.

Lowenstein also seems to think that the CFPA cares mostly or entirely about mortgages, when in fact its remit is far broader and more important than that. It will regulate all manner of debt products, from credit cards to payday loans — and it will also regulate non-loan products as well, like checking accounts, pre-paid debit cards, and even (maybe, this is unclear) certain retirement and savings products.

But Lowenstein’s deepest error here is to think that if you do business with a “dumb customer” then the loan will invariably go sour and you’ll end up losing money. This is clearly not true if you’re working within the originate-to-distribute business model, where you can pass the losses on to an end investor after taking your cut up front. But it’s also not true even when you hold on to the loan yourself. The millions of Americans who were eligible for a prime mortgage but ended up being sold a subprime mortgage instead were undeniably ripped off, even when they made all their payments in full. The people who get put in the credit card “sweat box” — something designed to extract the maximum amount of money from them before they inevitably go bust — are highly profitable for lenders. And people who regularly pay multiple $34 overdraft fees on a single day are always going to be a gold mine for bankers.

Lowenstein indeed seems to be opposed to the very purpose of the CFPA:

A sound economy needs healthy financial institutions. Rather than stop lenders from hurting consumers, the first priority should be to keep the banks from harming themselves. In the short run, solvency is often at odds with what consumers want (or with what they think they want).

To which I only say that if you need to gouge consumers in order to remain solvent, you shouldn’t be banking in the first place. And no one will miss you when you go away. Yes, a sound economy means healthy financial institutions. But that never has to mean unhealthy customers.

Comments
12 comments so far | RSS Comments RSS

In fairness to Lowenstein, it is sometimes tough to disentangle Elizabeth Warren the Chair of the Congressional Oversight Panel on TARP and Elizabeth Warren proponent of the Consumer Financial Protection Agency. There are moments when listening to Warren, particularly on programs like the Daily Show, where it’s unclear if she views promotion of the CFPA as a natural extension (or even part of) her duties as Chair of the TARP panel and part of efforts to prevent future TARPs.

One of the challenges of the current approach to financial regulatory reform is that CFPA and efforts to reduce systemic risk seem jumbled up. It’s not all, or even mostly, Elizabeth Warren’s fault – just saying Lowenstein’s intuition isn’t entirely off base.

Posted by adamjkatz | Report as abusive
 

Felix, in this string of post you’re operating on the assumption that government ought to make laws which prohibit stupid people from injuring themselves by doing stupid things. Not incentivize them, not educate them, not regulate how salesmen can sell to them – prohibit. If you have a problem with how overdraft fees are currently charged, you have a problem with giving people the freedom to make terrible decisions, because overdraft fees are charged according to precise rules which are disclosed and widely-known.

You might say that the common welfare will be improved if banks make less money, ordinary people pay higher account fees, and total idiots aren’t constantly battered by overdraft fees. If so, perhaps the government should start prohibiting free formation of contracts. But you could make this argument about any number of situations, and standing alone it is a ridiculous one. SUVs are wasteful, ugly and stupid, so we should ban them. Most of what’s on TV is crap that makes people dumber, so we should take it all of and replace it with education. Etc. I don’t think my personal preferences ought to be the law of the land. By the way, I’m not making a slippery slope argument – I’m saying that you have not articulated any principle other than “Government should prohibit dumb people from doing things, for their own good”. If you don’t bother to point to real evidence of informational asymmetries, predatory fraud, market failures, or non-priced externalities, this is an argument for totalitarianism. Even if you do have an unstated economic argument, you have to consider whether the government is going to be capable of effectively executing this rationale.

As to the specific critique of Lowenstein, you repeatedly indulge in the reverse fallacy. Bankers are greedy, but consumers are saints. Someone doesn’t just fall into the subprime mortgage they can’t afford or huge credit card debt. They get it because they are greedy, because they want more, and because they are unwilling or unable to work and save for what they desire. Again, you can argue that the government should help them to be less dumb, but you need to articulate some sort of principle for where we stop short of totalitarianism.

Posted by najdorf | Report as abusive
 

I believe the proper response to the last paragraph is that if the problem is dumb banks hurting themselves then we don’t need to worry about them.

Actually, though, I rather thought it was more often proponents of the CFPA who characterize people who get themselves into trouble with exotic products as dumb, with opponents more concerned that people who would benefit from them would be shut off from them. This kind of requires that somebody who is getting a mortgage with negative amortization actually understands it well enough to be able to reasonably assess that it’s in their interest.

Finally, I’ll echo Adamjkatz’s point (I think) that the first person to propose an idea doesn’t get a monopoly on the arguments in favor of that idea, and it does seem likely that the CFPA is getting a lot of its support from people who view it as a response to systemic risk. Lowenstein may not be responding to Warren’s primary (or original) concern, but I do believe that what he is responding to is a viewpoint that actually exists in a nonnegligible way.

Posted by dWj | Report as abusive
 

It is a fallacy to believe that only the foolish or uneducated are preyed on by financial markets; sometimes dumber investors outperform smart ones simply because they aren’t smart enough to be fooled: http://www.som.yale.edu/faculty/jjc83/fe es.pdf. Retail financial markets are one of the few examples in which more competitors results in higher prices: http://papers.ssrn.com/sol3/papers.cfm?a bstract_id=949349.

This is only possible because increasing the number of providers actually increases the complexity of the products, thus preserving pricing power. What exactly is the argument for blocking regulation to present these products on a like-for-like, comparable basis? Just how would that put us all under the yoke of a totalitarian regime?

Posted by Greycap | Report as abusive
 

To Felix’ point, the reason why people leap to systemic risk reasons for CFPA is because they cannot possibly bring themselves to care about all those little people. The micro effect – the people put at risk, made materially poorer, because of financial services that don’t serve – is irrelevant to our elites. We stopped caring in 1982 when we decided that unions were passe.

To Najdorf: you forget that market failure is real. What people need is education AND CHOICE. I can’t get a checking account from a national, full service bank that doesn’t have deceptive overdraft rules, and I can’t get a VISA card that doesn’t have “gotcha” payment credit timelines. And I do financial transactions for a living – God help the average person. That’s why plain vanilla was so important.

The real systemic problem that a strong CFPA would control is that 1) right now in our economy, vast capital resources are expended not in creating value, but in fleecing our citizens and 2) millions of our fleeced citizens are in underwater houses and can’t move to improve their productivity and personal wealth, and 3) those fleeced citizens are poorer, and can’t save or invest as much, and may not be able to educate their children optimally. Those are drags on our national GDP that linger for decades.

Posted by Dollared | Report as abusive
 

Fundamental simplicity and transparency should be the ruling calculus for regulating all financial products, and most especially when dealing with retail products.

To argue otherwise is disengenuous.

Posted by Beezer | Report as abusive
 

sorry, disingenuous

Posted by Beezer | Report as abusive
 

dollared: I don’t forget that market failure is real – I suggest it as a possible rationale for Felix’s current unpremised conclusion. But you can’t just envision your ideal world and then regulate it into existence. If you want to make real change you have to articulate what is problematic about the state of affairs, why the market can’t correct the problem, and why more regulation will be able to correct the problem. There may be evidence to support all three of these premises – but no one on this blog has convincingly presented it.

Everyone likes simplicity and transparency. The problem is if I have to offer you a simple credit card, it comes with a $200 annual fee and a 25% interest rate. Do you still want it? No. If you wanted it, a company would already be offering it to you. Elizabeth Warren talks about this problem when she explains her efforts to market plain-vanilla products to banks – the banks don’t make any money and customers don’t want the products. If you don’t like the terms offered by ruthlessly competitive financial markets, you probably shouldn’t use credit. Banks competed so aggressively to offer more favorable credit terms that almost all of them have been losing money for the past several years. Unsecured consumer credit is unbelievably risky under our existing bankruptcy and debt collection laws (which protect consumers from most of the harshest consequences). As a result banks have to charge a lot for it to make a profit. Even a well-run bank like Chase is running 10%+ charge-offs and losing money on credit cards.

If you don’t want to deal with overdraft or interest fees, you can get a debit card that doesn’t allow POS overdrafts or an AMEX card that requires you to pay off the balance monthly. If you have any amount of discipline you can even get a regular credit card and when the bill comes every month, pay it. It’s possible to create online, mail or phone reminders. It’s possible to automate payments. You can then spend only the money you actually have, rather than other people’s money. No one NEEDS revolving credit. If you play with it, you’d better inform yourself and take responsibility for the consequences.

There are a lot of complex terms on a credit card, but all of them arise when you start pushing the limits of paying your debts. This is the price you pay for the cheapness of transactional credit and electronic payments. If you can’t handle this sort of debt, avoid it. It’s that simple.

Posted by najdorf | Report as abusive
 

I find this interesting. The big bonuses in the financial services sector come because the money-makers are the smartest guys in the room. But, when shifting one’s justification for the bank’s behavior over the last two decades to the question of regulation, it turns out that the customer is as ‘smart’ as anybody in the bank. Wow! Who knew that they could just recruit the janitor to do the financial work.

Of course, translating an asymmetrical information relationship into smart and dumb terms is, from the intellectual viewpoint, simply stupid, but from the publicity viewpoint, it is a winner – as it plugs into the rightwing pretense that the libertarians are just against ‘paternalistic’, nanny state government – instead of government action that is actually adjusted to the new conditions set by financial ‘innovations’.

I’m disappointed in Loewenthal, who is usually a clear writer, and who certainly knows the difference between smart/dumb and specialized knowledge/client. It is as though the better business bureau shouldn’t interfere with ripoff car mechanics because it patronizes their customer as “dumb”.

In a struggle in which billions of dollars of rents go to the banks for no productive activity whatsoever – such as the charges for debit card overruns – there will be plenty of propogandists willing to blur the issue. A shame that Roger is one of them.

Posted by rogerg | Report as abusive
 

Najdorf,

you lost me at “plain vanilla credit card would have a $200 annual fee and 25% interest.”

Talk about unsupported assumptions! And why would the bank be unable to afford to offer me a more reasonably priced card based on its steady stream of 3% of my $20,000 in annual purchases? It can afford it, but it doesn’t have to right now.

I believe in the market system. But it has to be regulated to avoid deliberate obfuscation of non-negotiable terms. Mandate a plain vanilla card with fair terms and transparent interest rates. I’ll guarantee you I’ll have a free/12% card within 30 days.

Posted by Dollared | Report as abusive
 

dollared: If you’re actually someone who spends a lot and pays your balance every month, you can get a credit card with no annual fee and 12% interest RIGHT NOW. The terms you’re so exercised about only kick in if you don’t pay, and yes, I do think there’s good evidence for the fact that no-fee, unsecured, easy-to-use, easily-dischargeable 12% credit is not, should not, and will not reasonably ever be available to people who can’t pay their bills. We could regulate its availability, but then we’re regulating either the failure of most banks or the need for government to subsidize the availability of cheap consumer credit.

The marketplace and government are able to cooperate in many fields to offer products that everyone wants at extremely cheap prices. You can go to any store and buy milk at a cheap price and it’s almost certain that it won’t kill you and will taste at least ok. Left to their own devices some % of capitalists would sell you tainted milk, but we have enough government regulation to mostly stamp out that problem. Unfortunately, debt with no defined investment or capital asset purchase function is not such a product. It will always be expensive and the people who sell it to you will always be trying to extract more of your money. It’s not a failure of competition – the market is full of competition and banks compete aggressively on what consumers care about – hence cheap mortgages, no-fee accounts, low introductory interest rates, etc. If there was any money to be made running a bank that more precisely suits your ideology, someone would already be doing it. If you regulate your desired bank into existence in a way that overrides an already large and competitive market, you are unlikely to get superior overall outcomes. Regulate disclosure, promote education, create clearinghouses, punish fraud – all good jobs for government. Writing credit card terms is not a good job for government.

Posted by najdorf | Report as abusive
 

OK Nadjorf, please provide a link to my plain vanilla free/12% card with the one page card agreement – no arbitration, predictable – and fair- fees structure with no unilateral ability to change terms, etc. You won’t find it offered by any major commercial bank. That’s why regulation is needed.

“Regulation” means that the government does have to involve itself in writing card agreements, or- in writing regulations that override unfair agreements.

You really need to avoid the fantasy marketplace and learn about the one that actually exists. try this:
http://www.gotchacapitalism.com/

Posted by Dollared | Report as abusive
 

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