Consumer Financial Product Safety?
posted by Lawrence Cunningham
The Obama Administration proposes a new federal agency to be called the Consumer Financial Product Safety Commission, designed to contribute prevention to recurrence of financial crises like the current one. Harvard Law Professor Elizabeth Warren gets credit for the idea.
It would regulate things like teaser mortgage interest rates that may induce people to borrow more than they are likely to be able to repay in adverse interest environments. So far, so fine, but proposed legislation suggests it could have a much broader mandate, covering banking, insurance, securities, and including transactions in which people borrow but also save and invest.
It is not obvious why other existing government agencies lack the authority that this agency would assume and, if so, why they failed to exercise it in ways that could have averted the current crisis. But the very breadth of what appears to be the agency’s proposed mandate suggests difficulty deciding what to call it.
The proposed name mimics that given to the Consumer Products Safety Commission, which deals precisely with products people consume. In the financial domain, this analogy does not hold. The title, Consumer Financial Product Safety Commission, may be close to apt, but imperfect, to describe a mortgage loan with a teaser rate: the borrower may in some sense be “consuming,” by using up borrowed funds, a “financial product,” the mortgage loan, and the goal may be to promote “safety,” in some sense.
But that title, even imperfect to describe teaser mortgages, becomes wholly problematic to the extent the agency would get authority to regulate matters like bank accounts, insurance policies or stock portfolios. For that part of the agency’s mandate, something like Retail Investment Quality Commission might be better. Here’s what I mean.
Suppose the agency would purport to protect people who supply financial capital to various financial institutions or intermediaries, like banks, insurers and securities brokers. People who supply capital, whether in checking accounts, through premiums on life insurance policies, or in common equity, are not consumers. To consume means to take in, to use up or to expend. Capital suppliers do not consume; they invest.
Use of the word Consumer in the proposed agency’s title is apparently designed to reflect interest in protecting ordinary people, as opposed to institutions. So the better word to reflect this interest would be Retail. (Again, to the extent the agency would also address people who borrow from those institutions, for home loans or consumer credit, the term Consumer may be apt, if imperfect, but this title is wholly misleading to the extent the agency addresses suppliers of capital.)
The term Product incorrectly reflects the same erroneous notion that people who supply capital do so as consumers of something, like a certificate of deposit, a homeowner’s insurance policy or a share of IBM. Yet this erroneous conception is more pernicious as it reflects a deeper problem, one at the heart of the economic crisis.
It is the widespread tendency to think of financial investment as involving the manufacture and sale of products, like mortgage-backed securities and credit default swaps. But people supplying capital are not acquiring products; they are making investments. To reflect this aspect of any related agency authority, then, a better word choice, as a descriptive and normative matter, would be Investment.
Finally, the term Safety, when used in reference to the activity of retail investors supplying capital for investment, captures only part of the equation. Investment is an inherently risky enterprise and people accept risk, and sacrifice safety, in order to obtain a potentially higher return on investment. They do this when, instead of retaining cash at home, they deposit funds in bank accounts, money market accounts, mutual funds, or brokerage accounts acquiring shares of common stock, to list some investment categories in rough order of risk-return probabilities. The notion of safety is thus crimped. A better word choice here than Safety would be Quality or something of the sort.
Indeed, Quality, or something of the sort, may be a better word than Safety to describe any regulatory effort to protect people making financial decisions, whether investing or borrowing. All such activities are inherently risky and it is probably an illusion to believe that a government can make them safe.
But that simply raises the threshold question, whether this agency is necessary or desirable and whether something like it, if in place years ago, would have been capable of preventing the current crisis. There is reason to be skeptical.
In any event, regulatory reform should attend equally to probable gains that can be achieved and to unintended side effects they risk. Accurate description of what this Commission will purport to do would help minimize its costs.
June 30, 2009 at 1:34 pm
Posted in: Current Events
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Responses (2)
Jake - June 30, 2009 at 6:59 pm
Larry, writing a well reasoned post like this is no way to get the Administration’s attention.
No Load Funds - November 5, 2009 at 5:37 pm
Very interesting idea. On paper it sounds like a good idea. I think government agencies though have a tendency to over regulate and stifle innovation. This all relies on proper implementation.
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