Consumer Financial Protection: Revisiting the Scene of the Crime

By James Kwak

Mike Konczal has a post featuring the Grayson/Clay/Miller amendment to the current Consumer Financial Protection Agency proposal. The basic idea is that the agency would be required to do a periodic, statistical analysis to identify those financial products that were most implicated in causing bankruptcies and foreclosures in each state. The CFPA would then have to announce what these products are and who sold them, and could then take corrective action to restrict those products.

This reminds me of something that Andrew Lo said in his Congressional testimony back in November, of which I’ve discussed other aspects in the past. Lo recommended creating a Capital Markets Safety Board modeled on the National Transportation Safety Board:

“[T]he financial industry can take a lesson from other technology-based professions. In the medical, chemical engineering, and semiconductor industries, for example, failures are routinely documented, catalogued, analyzed, internalized, and used to develop new and improved processes and controls. Each failure is viewed as a valuable lesson, to be studied and reviewed until all the wisdom has been gleaned from it, which is understandable given the typical cost of each lesson.

“One successful model for conducting such reviews is the National Transportation Safety Board (NTSB), an independent government agency whose primary mission is to investigate accidents, provide careful and conclusive forensic analysis, and make recommendations for avoiding such accidents in the future. In the event of an airplane crash, the NTSB assembles a team of engineers and flight-safety experts who are immediately dispatched to the crash site to conduct a thorough investigation, including interviewing witnesses, poring over historical flight logs and maintenance records, and sifting through the wreckage to recover the flight recorder or ‘black box’ and, if necessary, reassembling the aircraft from its parts so as to determine the ultimate cause of the crash. Once its work is completed, the NTSB publishes a report summarizing the team’s investigation, concluding with specific recommendations for avoiding future occurrences of this type of accident. The report is entered into a searchable database that is available to the general public (see http://www.ntsb.gov/ntsb/query.asp) and this has been one of the major factors underlying the remarkable safety record of commercial air travel.”

Lo was talking more about financial crises than about individual bankruptcies, but the analogy still holds. If a regulator notices that a lot of people are dying in a particular kind of accident in a particular kind of car, it will investigate to find out what is going on.

Now, the statistics could actually be a bit tricky. It’s entirely possible that the most toxic products on the market will not be the ones that are involved in the most bankruptcies and foreclosures. Most bankruptcies are (I believe) caused by illness, job loss, or divorce, which strike people independently of whatever mortgage they happen to have. If we just count up the mortgages of people who go bankrupt, we might find that more had 30-year fixed mortgages than had option ARMs, simply because more people in general have 30-year fixed mortgages than option ARMs. But for now I will make a bold assertion that these statistical problems could be addressed — it doesn’t seem like the world’s most complicated model to estimate.

The Grayson/Clay/Miller amendment attempts to sidestep the banking industry’s main contention, which is that the CFPA will have a “chilling” effect on financial innovation. It also plays a kind of “sweeper” position (”free safety” is the American football metaphor) in that it can catch products that do not on their face seem all that bad, but turn out to be homewreckers later. The common-sense argument for it is that no one could reasonably oppose a provision that simply asks the CFPA to investigate existing problems and clean up after them. Still, the industry will no doubt come up with arguments against it. That, at least, is what Felix Salmon assumes, reading the overall trends.

Comments

[Graham and ...:]

The reason why financial failures are not documented and corrected is because "too much" (money) is at stake for the affected individuals.

Oct 21 11:14 AM

[User 503037:]

The CFPA would have authority to determine which products consumers can choose from. In short, the bill would create a regulatory overlay of the entire business community, extending far beyond traditional financial services. We need to take control of consumer choice. How does CFPA affect you? www.friendsoftheuscham...

Oct 21 12:17 PM

[Value Added:]

This is truly frightening and another power grab by the current administration. The CFPA will set the rules, bypassing the constitutional powers of Congress to set laws regarding commerce. Hey, if you can't afford the payments, don't take the loan. If life's circumstances cause you to default, you have my sympathy. But you do not have my endorsement to enlarge the powers of government and reduce the freedoms of its citizens.

What we truly need is a protection agency to protect us from our own government and those who think it can solve every individual's problems. Formerly that was the voting process, but even that is in danger of being hijacked. Remember the Constitution.

Oct 21 12:39 PM

[Tesa:]

James Kwak, I agree, its more than logical to remove poorly engineered products whether they were developed to exploit the markets or not. The public is protected from poor technology through documentation and statistical analysis. Batteries in the laptops that blow up are recalled and yet the financial industry expects their poorly engineered products to be consumed without scrutiny.

Oct 21 12:59 PM

[tripleblack:]

So long as the same group set up to wield the new regulatory power ignores such abuses as "dark pools", its hard to give them any respect, much less trust.

Oct 21 03:04 PM

[THofler:]

The incidence of auto accidents is far higher with teenagers. Should the NTSB demand that only autos with 90 hp or less be sold to teenagers?

Inappropriate use of statistics has been commonplace in the realm of employment discrimination. If a wide majority of auto mechanics are male, can we conclude that the industry is sexist? I can't wait to see the statistical abuses if the abomination that is the CFPA comes to pass.

PS: I think there were more than a few real estate speculators who walked away from their no money down mortgages.

Oct 21 10:52 PM

[Moon Kil Woong:]

Financial institutions create financial products for the explicit purpose of shifting risk and losses onto those who are less competent to realize it. Their argument is that it prevents them from doing what they are paid to do. That is the chilling effect that they are speaking of.

Gone are the days where all banks were aggregators of wealth so that it can be distributed for the good of society. Big banks feel that is paltry low level business that community banks should provide. They would much rather figure out how to securitize everything and dump them on poor unsuspecting pension funds while getting insurance companies to become casinoes so they can bet on the American homeowners demise like Goldman Sacs.

We need a financial consumer regulator and I don't mean the SEC which does nothing but collects extortion money in penalties without regulaton, rules, or enforcement, not the Federal Reserve that is part and parcel to the problem because they only have banking interests in mind (After all they are essentially the head of the American big bank cartel. What do you expect?). Such a proposal is long overdue.

Oct 22 04:01 AM

[S. A. Boyko:]

Markets are complex systems. If there is complexity, there is uncertainty. In “We’re All Screwed (reference below), I argue against governance policies that conflate “risk” and “uncertainty.” The inability to move away from the risk-uncertainty conflation affects not only capital market governance but the environment, homeland security, education, and healthcare. The gravamen of this problem stems from our policymakers being almost exclusively deterministically trained—law, accounting, and economics. They therefore have difficulty identifying, analyzing, and solving issues that are increasingly becoming more indeterminate.

What we need now is capital market governance of randomness—a blueprint for fundamental change to the legacy, one-size-fits-all deterministic governance regime. Trying to have a one-size-fits-all governance, is analogous to writing one driving manual for the US and UK. In “We’re All Screwed,” I describe how to segment the market into predictable, probabilistic, and indeterminate regimes to do the right things for governance effectiveness and how to do things right for governance efficiency.

The legacy governance system for the US capital market is in disrepair. To achieve real regulatory reform, policymakers have to move beyond form to substantive issues. Unless experimentations to the legacy, one-size-fits-all deterministic regime take place, our capital market will be caught in a recursive loop of errors of commission (boom-bust bubble inefficiencies) and errors of omission (externality market inefficiencies). Such inefficiencies will eventually render our source of economic wealth ineffective.

If this happens, we’re all screwed.

Stephen A. Boyko

[e-mail]

Author of “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System”
w-apublishing.com (www.w-apublishing.com/...)

Book Review: Brenda Jubin, Ph.D Thursday, October 8, 2009
readingthemarkets.blog...
Boyko, We’re All Screwed!

Oct 22 10:32 AM

[S. A. Boyko:]

Markets are complex systems. If there is complexity, there is uncertainty. In “We’re All Screwed (reference below), I argue against governance policies that conflate “risk” and “uncertainty.” The inability to move away from the risk-uncertainty conflation affects not only capital market governance but the environment, homeland security, education, and healthcare. The gravamen of this problem stems from our policymakers being almost exclusively deterministically trained—law, accounting, and economics. They therefore have difficulty identifying, analyzing, and solving issues that are increasingly becoming more indeterminate.

What we need now is capital market governance of randomness—a blueprint for fundamental change to the legacy, one-size-fits-all deterministic governance regime. Trying to have a one-size-fits-all governance, is analogous to writing one driving manual for the US and UK. In “We’re All Screwed,” I describe how to segment the market into predictable, probabilistic, and indeterminate regimes to do the right things for governance effectiveness and how to do things right for governance efficiency.

The legacy governance system for the US capital market is in disrepair. To achieve real regulatory reform, policymakers have to move beyond form to substantive issues. Unless experimentations to the legacy, one-size-fits-all deterministic regime take place, our capital market will be caught in a recursive loop of errors of commission (boom-bust bubble inefficiencies) and errors of omission (externality market inefficiencies). Such inefficiencies will eventually render our source of economic wealth ineffective.

If this happens, we’re all screwed.

Stephen A. Boyko

[e-mail]

Author of “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System”
w-apublishing.com (www.w-apublishing.com/...)

Book Review: Brenda Jubin, Ph.D Thursday, October 8, 2009
readingthemarkets.blog...
Boyko, We’re All Screwed!


On Oct 21 11:14 AM Graham and Dodd Investor wrote:

> The reason why financial failures are not documented and corrected
> is because "too much" (money) is at stake for the affected individuals.

Oct 22 11:14 AM

[BRUCE E. W.:]

I wasn't going to comment until I read your entry post Mr. Boyko. I am a research anthropologist. I fully agree that the linear thinking process of deterministic conditioning with a redundant inclination to reductionism is a regressive source of failure at a fundamental cognative level. Consequentially a compulsive consensus forming consciousness pervades the business model and drives the capital demand for maximizing into a somewhat self destructive and almost self induced "recursive loop of errors" that compete for power and inclusive membership in an ironic game of exclusivity. It all tends towards cross purposes and counter productivity.

However, I think the abstract "complexity: that programs this schema is much more simple at its base. We have a hundred years of behavior modification at the foundation of American Business management conditioning. Systems theory initiated a change and somewhere around the 60s and 70s a new power order of "technocracy" began to simply usurp the business power model by tactical and practical priorities in the markets. What Mr. James Kwak refered to in the early paragraphs, I recognized immediately as an engineering theoretical paradigm of great merit called "continuous learning systems." The point of which is to say that it prioritizes problem solving; resolutions and solutions over knee jerk conditioned reflexes (chaseing the ghost of pure profit).
I am not so sure your "legacy" perspective isn't just plain redundancy. I do think, however, that the idea of employing self correcting initiatives are a smart thing to be evaluating at this time. Certainly consumer protection at all levels is the point of entry on this matter in very real substantive ways (but still requiring "means").


On Oct 22 10:32 AM S. A. Boyko wrote:

> Markets are complex systems. If there is complexity, there is uncertainty.
> In “We’re All Screwed (reference below), I argue against governance
> policies that conflate “risk” and “uncertainty.” The inability to
> move away from the risk-uncertainty conflation affects not only capital
> market governance but the environment, homeland security, education,
> and healthcare. The gravamen of this problem stems from our policymakers
> being almost exclusively deterministically trained—law, accounting,
> and economics. They therefore have difficulty identifying, analyzing,
> and solving issues that are increasingly becoming more indeterminate.
>
>
> What we need now is capital market governance of randomness—a blueprint
> for fundamental change to the legacy, one-size-fits-all deterministic
> governance regime. Trying to have a one-size-fits-all governance,
> is analogous to writing one driving manual for the US and UK. In
> “We’re All Screwed,” I describe how to segment the market into predictable,
> probabilistic, and indeterminate regimes to do the right things for
> governance effectiveness and how to do things right for governance
> efficiency.
>
> The legacy governance system for the US capital market is in disrepair.
> To achieve real regulatory reform, policymakers have to move beyond
> form to substantive issues. Unless experimentations to the legacy,
> one-size-fits-all deterministic regime take place, our capital market
> will be caught in a recursive loop of errors of commission (boom-bust
> bubble inefficiencies) and errors of omission (externality market
> inefficiencies). Such inefficiencies will eventually render our source
> of economic wealth ineffective.
>
> If this happens, we’re all screwed.
>
> Stephen A. Boyko
>
> [e-mail]
>
> Author of “We’re All Screwed: How Toxic Regulation Will Crush the
> Free Market System”
> w-apublishing.com (www.w-apublishing.com/...)
>
>
> Book Review: Brenda Jubin, Ph.D Thursday, October 8, 2009
> readingthemarkets.blog...;max-results=7
>
> Boyko, We’re All Screwed!

Oct 23 01:51 AM

[BRUCE E. W.:]

This is rediculous and empirically invalid. Statistics are certainly abused across the board. To use that truism and generalization as your proof that the CFPA will inevitably be tyranical. This flies in the face of reason and seems to be an outright confrontational ploy for strategic hostility It is hard to see how it would help serve an industry that will be inundated with hard facts of real life incidence and prevailance to remedy. The hostile environment presented in some degree to render the SEC impotent and pliable immediately comes to mind. Apparently you decided to use "statistics" to your advantage to "prove" your point, without even using any statistics itself. How Very ingenuous but.... statistically rediculous. Your appeal to futility is a failure in judgement.


On Oct 21 10:52 PM THofler wrote:

> The incidence of auto accidents is far higher with teenagers. Should
> the NTSB demand that only autos with 90 hp or less be sold to teenagers?
>
>
> Inappropriate use of statistics has been commonplace in the realm
> of employment discrimination. If a wide majority of auto mechanics
> are male, can we conclude that the industry is sexist? I can't wait
> to see the statistical abuses if the abomination that is the CFPA
> comes to pass.
>
> PS: I think there were more than a few real estate speculators who
> walked away from their no money down mortgages.

Oct 23 02:24 AM