Outcomes vs. Principles: Why Disclosure Doesn't Work

By James Kwak

Felix Salmon has a good example of why disclosure (the preferred consumer-protection regime of free-market conservatives and bankers) doesn’t work, courtesy of Ryan Chittum. The topic is no-interest balance transfers offered by credit card companies.

As Salmon points out, most people probably realize what the game is. That is, most people know that banks aren’t in the business of lending money for free; they know that the bank is betting that it can raise the interest rate before they pay off the balance. It’s possible that you will end up getting a free loan: “If you’re smart and disciplined and lucky, you might be able to game the system and pay no interest at all on that balance. Bank of America, for its part, does its very best to make you think that you’ll be able to do just that, essentially getting one over on The Man.” But the bank knows it has the numbers on its side; and most consumers know it too, because they know that’s the only reason the bank would make the offer.

And people take the bait anyway, because they think they’re the exception. “Most people, when they sign up for one of these offers, think that they’ll successfully game the system. But of course most of them are wrong.”

The people who think that disclosure solves everything, like Peter Wallison, are remembering only half of what they learned in first-year micro. In order to get utility-maximizing outcomes, you need perfect information and rational decision-making. Disclosure gives you information about the product you are buying, but it doesn’t make you a rational actor – especially not when you have to make predictions about your own future behavior. Remember, not only are we a species in which 90% of people think they are above-average drivers, but 85% of people in hospitals who just caused auto accidents think they are above-average drivers. (Sorry, I can’t remember where I heard that – it was recently, probably on an NPR show.)

I suspect that the real divide in the battle over the Consumer Financial Protection Agency is between outcomes and principles. CFPA supporters believe that policies should attempt to achieve the best possible outcomes for the largest number of people; if the number of people harmed by a product exceeds the number helped, then it should be banned, or at least made harder to buy. CFPA opponents believe that policies should faithfully reflect certain principles; in this case, people should be free to make their own financial choices, even if in aggregate most people will make bad choices, and they should bear the consequences of those choices.

This is a fairly common way that policy debates break down these days. Sex education and contraception are the best example, but there’s a similar fault line when it comes to guns, drugs, and crime, among other things. It’s also an indication that the debate can never be resolved by any amount of empirical data.

Comments

[markfl:]

Consumer Reports posted an online Q+A with some arguments for and against CFPA. One argument is that consumer legal contracts are too complex. That's true of nearly every consumer contract. Many, like cell phone contracts, have arbitration clauses. That's really a function of the legal system. The author of the contract is essentially bound to cover every contingency to defend himself from potential litigation.
I'm not really sure how another federal agency addresses these issues. The problem stems from the statutes congress itself wrote.

"CR: The American Bankers Association says a new law establishing the CFPA would render moot all consumers laws promulgated by Congress, including the new Credit CARD Act. Your comments?"

I basically agree with the ABA. The administrative agencies have simply written regulations to enforce new statutes written over the last two decades.
blogs.consumerreports....

Aug 13 03:58 AM

[Leftfield:]

Great point: You need both good information and rational decision-making.
FYI: My father, before he died, had successfully juggled $70k credit card balance for many years with the free balance transfers. I don't think he ever slipped or I would have heard about it.

Aug 13 08:02 AM

[c smith:]

So now "the government" is supposed to protect us from other's financial irrationality? If so, we may as well shut down the entire financial system, because one man's deal of the century is another's "irrationality". Whatever happened to freedom and risk taking?

Aug 13 03:33 PM

[nym:]

c smith, tell it to the big banks.

Aug 13 09:07 PM

[TinyTim:]

And it's the job of the salesman to sway people away from rational decision making with imperfect information.

Aug 13 09:49 PM