Josh Dowlut's  Instablog

I attended last night’s town hall meeting with Elijah Cummings and Elizabeth Warren. Warren has been tasked to head the new Consumer Financial Protection Bureau. Its basic goal is to consolidate the functions of 7 existing agencies under the umbrella of one “super-agency” that is tasked with protecting consumers. One prominent and specific goal of the agency is to improve the transparency and understanding of financial disclosures, everything from mortgages, to credit cards. It’s clear that she, her agency, and its main goals have a lot of popular support, based on the raucous, overflow crowd that repeatedly broke into applause.

I agree with the basic diagnosis, but vehemently disagree with the prescription.

It is absolutely true that the financial markets have and continue to suffer from the market failure of information asymmetry. This asymmetry is the deliberate design of banks. Many loan disclosures intentionally obfuscate the true terms and costs of the loan. Most of these practices constitute fraud by the reasonable-man standard, and government has a legitimate purpose in preventing fraud. The question is how best to do this?

Even the most well intentioned and informed government agency (and Warren’s agency very well may be just that) is not the best method of creating market transparency, understanding, and symmetric information between producer and consumer. The best solution is to remove the profit motive to obfuscate and conceal information.

An unsecured loan should always be an unsecured loan, not a loan that is secured against your future wages and any bank account you have. A secured loan should only be secured against the specific asset that is pledged through a security instrument, not the pledged asset plus a bank account, plus future wages for the next 12 years, plus the ability to renew a judgment past 12 years as is the case in MD. Banks should never be bailed out. Eliminate these tools for banks to extract a pound of flesh from those who have defaulted, and you will align the banks' interests for clear, transparent, symmetric information with consumers' interests.

Short of outlawing the practice of effectively turning unsecured debt into secured debt through wage and account garnishments, disclosure, or a separate security instrument is necessary. Current loan agreements read something to the effect of “if you default, we reserve the right to collect to the fullest extent of the law.” The average consumer (the reasonable man) understands that a default on unsecured debt will result in bad credit and the inability to borrow again for a period of time. The average consumer also understands that a default on a loan secured by a car will result in the loss of the car, and a default on a loan secured by a house will result in the loss of the house. He does not understand that he is effectively pledging all of his liquid assets and a third of his future earnings through the garnishment process. Require clear bold disclosure of this term, or even better, a specific security instrument the same as the one that pledged a security interest in the car or the house.

Banks essentially are trying to lend without risk. Make a bad loan? No worries; just forcibly take it. The only thing the lender really has to worry about is the cost effectiveness of the cost to collect, and the possibility of long term unemployment and destitution. Anything short of that and the lender is getting paid through the assistance of the force of government. Lending is inherently risky. To try to eliminate that risk is to allow bankers to print money for themselves. 

The ultimate trump card that consumers have is FU, I’m not paying. To eliminate this option is to shift power away from consumers, and toward banks. Rather than creating a brand new federal agency that will attempt to micromanage the lending process, a much better alternative would be to have the government stop being the strong arm henchman of the banking industry.  Courts are even issuing body attachments and arresting people over unpaid debts, setting bail equal to the amount owed, andturning bail money over to creditors.