Credit Conditions in the Absence of Consumer Protection

By Simon Johnson

Even some of our most sophisticated commentators doubt a link between consumer protection and any macroeconomic outcomes. Consumer protection, in this view, is microeconomics and quite different from macroeconomic issues (such as the speed and nature of our economic recovery).

Officially measured interest rates are down from their height in the Great Panic of 2008-09 and the financial markets, broadly defined, continue to stabilize. But are retail credit conditions, i.e., the terms on which you can borrow, getting easier or tougher?

On credit cards, there’s no question: it’s getting more expensive to borrow, particularly because new fees and charges are appearing. Of course, lenders have the right to alter the terms on which they provide credit. We could just note that this tightening of credit does not help the recovery and flies in the face of everything the Fed is trying to do – although it fits with Treasury’s broader strategy of allowing banks to recapitalize themselves at the expense of customers.

But there is an additional question: will these changes in lending conditions be reflected in the disclosed Annual Percentage Rate (APR)? Historically, the rules around the APR – overseen by the Federal Reserve - have not forced lenders to include all charges in this calculation. Why is this OK?

It’s not OK. This would be like cereal manufacturers including only some ingredients on their labels. Or makers of children’s toys not telling you that some dangerous chemicals are involved.

Why has this been allowed to happen? Essentially, because nobody watches out for the consumer of financial products. Our regulation of financial institutions is Byzantine and completely out of date; our banks game the system with impunity (e.g., nationally chartered banks are not subject to state usury laws; see this BusinessWeek article, section on payday loans).

Historically, the most powerful overseers of the system thought that this kind of detail didn’t matter – or that any changes in what banks did were a form of “financial innovation” that must naturally benefit everyone. But this is exactly the attitude that brought us to subprime, Alt-A, and other ”exotic” (i.e., misleading rip-off) mortgages.

And it is, sadly, the attitude among existing regulators that still predominates today. This implicit attitude towards consumers is in no way helpful, if we want an economic recovery, jobs, and a reasonably stable growth going forward. But it’s what we appear to be stuck with.

Our financial regulatory system is a disaster. The Obama administration should have called it by its proper name, proposed to close it down entirely, and argued to replace it with a more integrated and completely rationalized approach. That at least would have moved the bargaining position of the regulators – they would now be too busy trying to save their jobs to oppose Treasury on substance.

If you think I am wronging credit card companies, lenders, or regulators in any way, post details below. And if any representative of these institutions or their associated lobby groups is willing to debate these issues in public, just give me a call.

Comments

[Leftfield:]

I had been persuaded for years that the "financial innovations" taking place were progress in a more capitalist system. Until Wall St. put it's hand out for the public to assume it's losses.
Each "innovation" is a computerized version of the endless ways that have always been to find you've "sold your soul to the company store."
The public has been put on the brown end of a particularly nervy play in that it has been pauperized and marginalized to bail out Wall St.
Usury is as old as money and possibly older. The use of Fed fiat currency and the resultant impoverishment of the former middle class and ascendance of banksters has given rise to countless "innovations" to cover the swindle. Funny money has allowed vast private misallocation and a bloated government all of whom continue to desperately sell out to Wall St. the remaining producers to play more financial games and remain at their accustomed trough.
With real economic signals from real money we would have had real, sustainable growth. Financial "innovations" would have been mostly seen for what they mostly are: A costly swindle.

Aug 11 04:47 AM

[Moon Kil Woong:]

Trust me the Fed will do nothing ever to help consumers of financial products. To think that they will is patently absurd. The Fed is an obstructionist to reform of the worst type. They are above the law, auditors, and not accountable to anyone. And might I add, they are damn proud of their position.

Especially since it comes with the perks of guaranteed monopoly over Treasury auctions, the right to expand their balance sheet unbridled, buy sell or guarantee any loan with taxpayer's guarantees, and destroy the dollar by manipulating rates incorrectly year in and year out. They are the biggest non-governmental agency that has government agency powers. No wonder the average citizen is confused over their role in and out of government.

Aug 11 07:03 AM

[Chris Butler_:]

I agree with the overall direction of your comments: consumers need protection in financial products in much the same way we need protection from, say, food manufacturers. But your example of a cereal box listing its complete contents is not protection per se - it's disclosure. Which do you prefer? Protection or disclosure?

I also have a problem with your naive notion that "any changes in what banks did were a form of 'financial innovation' that must naturally benefit everyone. But this is exactly the attitude that brought us to subprime, Alt-A, and other 'exotic' (i.e., misleading rip-off) mortgages." Exactly how is a mortgage misleading? Or is it just exotic mortgages given to people with poor credit histories that are misleading? How are exotic mortgages misleading (I'm not saying they are not, but aside from a number of cases of fraud, I'm not sure the product itself misleads anyone).

Further, bank innovation is note solely responsible for the sub-prime mortgage mess. How about the societal notion, compounded by Federal legislation, that everyone ought to "participate in the American dream" of owning a house. Let's not forget that at least some of this mess is a result of actually wanting to do something beneficial for the have-nots. It's crazy to assume that the whole problem was borne out of malicious intent. This premise has no basis in fact.

I think it extremely naive, and a bit dangerous, to single out bankers as the sole culprit responsible for this mess. It was a complex problem, rife with enablers and compounded by horrendous errors in risk estimation.

Aug 11 08:35 AM

[It Figures:]

Your cereal comparison is wrong. You cannot eat the cereal without eating all the ingredients. The charges you want incorporated into "APR" are almost all discretionary, and differ by customer, so by their nature they cannot be "rolled up" into a meaningful single number representative of actual cost.

If I pay late all the time and you don't, we have decidedly different costs. The "APR" , by your measure, would be maybe 42% for me, but only 8% for you. So would you average these two results to decide the APR on this product is 25%? Ridiculous.

What you are missing is that CUSTOMER BEHAVIOR DETERMINES THE CHARGES, not some secret and mysterious credit card company conspiracy.

If you want credit users to pay less, support efforts to help them protect themselves from themselves. Disclosure is a good first step. Your idea is not.

Aug 11 10:30 AM