Wow, I got a lot of excellent responses to my piece on weak cognition and the financial industry. After Andrew Sullivan referred to it as a litmus test, there were responses from E.D. Kain, Megan McArdle and Jason Kuznicki at CATO.
In case you are wondering, the credit card industry is in fact data-mining the hell out of you to learn how much they can get from you if you hit hard times, giving them a massive information asymmetry. Check out this New York Times magazine article, What Does Your Credit-Card Company Know About You?, for more specifics.
But on point, I would have gone ahead and written out the second half of that argument if I knew so many libertarians would have been reading it. From Megan McArdle:
I’m not sure why this is supposed to be a hard question for libertarians. I mean, I might argue that preventing people from ripping off the marginally mentally impaired would, in practice, be too difficult. Crafting a rule that prevented companies from identifying people who are marginally impaired might well be impossible–I’m pretty sure that if I wanted to, I could devise subtler tests than “What day of the week is it?” And while the seniors lobby is probably in favor of not ripping off seniors, they’re resolutely against making it harder for seniors to do things like drive or get credit, which is the result that any sufficiently strong rule would probably have.
But it’s pretty much standard libertarian theory that you shouldn’t take advantage of people who do not have the cognitive ability to make contracts. Marginal cases are hard not because we think it’s okay, but because there is disagreement over what constitutes impairment, and the more forcefully you act to protect marginal cases, the more you start treating perfectly able-minded adults like children.
I agree with all of that except that it would be difficult to prevent. Not prevent fully, but prevent in large part. It’s a bad idea to set a single rule for these situations, because you’d be treating healthy, perhaps even risk-seeking, adults as if they were mentally ill. Is there any way we can use markets to solve this problem?
Good Enough Vanilla Options
Guess what: we can! And that solution would be mandating financial services to provide Vanilla Option financial products. Boring, low-reward trap-free products you’d probably have to pay a yearly fee for.
So much of our financial services are predicated on tricks and traps but also have a lot of benefits. You get free checking, but if you overdraft you lose more than you gained. Now with a vanilla option, you could pay more upfront to not take the risk of losing later. This is banking how it used to be, boring. And this is exactly the kind of product that people with weak cognition would want to have available. Someone approaching older age, but before getting there, could opt for the “extra boring” financial services package. People buy renter’s insurance; some might view a yearly-fee on their checking account or credit card as a “trap insurance.”
And not just them: Me too! And I’m a fairly smart guy. And probably tons of you. Wired had a fascinating piece on the “Good Enough Revolution”, and I’m sure market research people at these financial services places are hearing a ton about how everyone would really just like a simpler product that they can worry less about, rewards be damned. Is “Good Enough” Financial Products better marketing than “Vanilla”?
If this solution is so market friendly, then why doesn’t it already exist? As this excellent paper, “Shrouded Attributes and Information Suppression in Competitive Markets” points out, (MR summary here) the markets have a terrible time creating a vanilla option. Especially when confused or cash-constrained consumers subsidized sophisticated and rich consumers, there’s no incentive for the sophisticated to move. And a bank advertising something as being “trap-free” might be the product with the most traps in it, hidden deep within a terms of service that lawyers could read any such way. Having a credible stamp by the government saying “boring” is one way to cut through this double trap problem.
Here might be where I disagree with libertarians. Megan wonders if I am a paternalist. I’m not sure. Quick thought experiment: I’m the King of Rortybomb Island, and you want to open a casino on my island. I know many people will enjoy this, but many people won’t be able to prevent themselves from going to the casino, no matter how much they hate themselves in the morning. So what I propose is that you can open your casino, but you have to maintain a list of people who voluntarily want to never be allowed into the casino, no matter how much they beg when the time comes. The person can’t get off the list in a short period of time, it’s fairly binding.
We can also assume, reasonably, that people with a gambling addiction/problem are the most profitable to the casino, so there’s no way you and your casino backers would voluntarily, outside public pressure or government influence, create this list. So the government forces them to create it to get a business license.
I think that’s an awesome solution to the problem above. My question: is this paternalistic? Specifically, is this paternalistic towards consumers of gambling services? I don’t think so. In fact, I think the exact opposite: it makes markets more complete, and thus more efficient and reflective of information.
Back when the New Dealers were creating the idea of a regulatory state, post-NRA they came up with the idea that monopolies and big concentration of firms were ok and didn’t need busting or regulation as long as they didn’t harm consumers, and they determined that consumers weren’t harmed as long as prices were competitive. The problem is that they didn’t envision the idea that prices could be made lower upfront, making it look very competitive, by punching up the risk on the back-end. People with minor gambling problems want to be able to “buy” the option of never gambling being prevented from buying that hurts him as a consumer. People who don’t want the hassle and the risks of high-end financial services should be able to “buy” a generic product.
The price of these services may be very competitive; the market for buying a level of risk in your financial services is not. People in the United States need financial services, and if people are willing to pay an annual fee to not worry about getting nailed on every little, last, fee, and that product isn’t provided by the market in order to push consumers into more damaging forms of services, that’s a form of hurting consumers. And that’s when a government reaction is needed.