Disclosure's great, but what consumers really need is protection

Is it possible to imagine an economy that does not run on consumer credit?

Credit is the grease that smooths the way for consumption — everything from toilet paper to TVs to tractors. Extending credit and allowing access to borrowing is the load-bearing beam that holds up the structural house of the U.S. economy. If you take away credit — or provide credit without adequate underwriting constraints, as happened leading up to the 2008 financial crisis — the house crumbles.

Credit has become so deeply ingrained in the American psyche that even policy discussions about extending credit are framed around the nation’s core concepts of freedom and individual responsibility.

That tension between protecting consumers and promoting responsibility is at the center of “Democracy Declined: The Failed Politics of Consumer Financial Protection.” The author, Mallory SoRelle, an assistant professor at Duke University’s Sanford School of Public Policy, argues that over the past 60 years policymakers have largely placed the responsibility for protecting consumers from harmful credit products squarely on the shoulders of individuals rather than the government — a decision largely at odds with other developed nations.

Lawmakers have long resisted stronger consumer protection laws because they fear such laws would restrict access to credit, and less access to credit means less consumer spending — which is bad for a consumption-driven economy. The result, she argues, is a legal framework that prioritizes access to credit over consumer protection.

Surprisingly, SoRelle traces the origin of what she calls the “political economy of credit” to the Great Depression and the New Deal in the 1930s. FDR wielded considerable political capital in that era, but it was not unlimited. Extending credit, SoRelle argues, was a more politically palatable way of getting spending power to the masses than the alternative — namely, establishing a more robust and vigorous welfare state.

Public Works Administrator Harold Eccles exemplified this approach by steering policy toward encouraging the “consumption” of personal loans through banks. Wary of getting the government directly involved in the housing market in 1933, Eccles, then an assistant to the Treasury secretary, pushed for a federal backstop against losses. That approach, he argued, achieves a similar effect while spending far less than if the government originated loans itself.

Prioritizing lending over direct government intervention had advantages and disadvantages in its own time. The New Deal’s lending-first approach fostered the blossoming postwar middle class in a variety of ways, from expanded homeownership to previously unavailable education opportunities. But it also institutionalized horrible prejudices against Blacks and other minorities in the form of redlining and outright discrimination.

We then fast forward 30 years to the legislative fight in 1968 over the Truth in Lending Act. At the time, lawmakers were primarily concerned with protecting the national economy “and its constituent financial institutions rather than the welfare of individual borrowers,” SoRelle writes.

As a result, TILA mandated the “informed use of credit” that laid the groundwork for how the federal government would protect consumers going forward. By focusing almost exclusively on the disclosure of information, SoRelle writes, policymakers ensured that “the onus was in the hands of borrowers to make smart decisions.”

That precedent of defining consumer protection as a matter of disclosure remains the cornerstone of consumer protection laws to this day. Of the 18 consumer regulations that were passed from 1968 to 2008, almost all adopted financial disclosures as the sole or primary form of consumer protection. More explicit restrictions do exist in some cases, but the message is clear: Financial disclosures became the de facto way for the government to protect consumers.

That approach satisfies lenders and lawmakers, SoRelle argues, but at the expense of consumers. Confining the question of whether a loan is “fair” or “unfair” to whether consumers were given accurate information limits lender liabilities and creates an incentive for them to make those disclosures as opaque as possible — hence the term “fine print.”

A decade after the Consumer Financial Protection Bureau was created in 2010, many of its rules still focus on financial disclosures. Only recently did the CFPB’s own task force suggest that the disclosure of financial information is not a substitute for protecting consumers from harm.

But since the turn of the century, expanding credit to low-income borrowers has emerged as a major profit center for the lending industry. “Access to credit” has likewise become a popular mantra among many lawmakers, fintech firms and even some consumer advocates, who think accessing credit will solve more problems than it creates.

Today, there is a brewing backlash against relying on disclosure as the centerpiece of consumer protection, and it has been brewing for some time, SoRelle writes. Back when Elizabeth Warren was a professor and not a senator, she decried the use of financial disclosures in the fight over the creation of her brainchild the CFPB: “Financial products have become more dangerous in part because disclosure has become a way to obfuscate rather than to inform.”

SoRelle’s recounting of the history of consumer protection in America is rich, but has its flaws. She too easily dismisses the influence of banks, lenders and lobbyists in shaping the debate around credit and consumer protection policies in the New Deal era. (A more conventional analysis of the New Deal policies and how business interests sought to crush them can be found in Kim Phillips-Fein’s excellent “Invisible Hands: The Businessmen’s Crusade Against the New Deal.”)

SoRelle also airs out her frustration with what she describes as a widespread failure among well-funded nonprofits to mobilize citizens to demand more consumer protections. She seems genuinely puzzled that consumers are more likely to contact their bank or lender to complain about a product or service than to call their senator or representative and ask for tougher regulations.

“The majority of policies obfuscate the role of government in consumer credit regulation, thus privatizing the use of credit for most borrowers,” SoRelle writes.

“Democracy Declined” provides much-needed context toward understanding how consumer protection policies have been shaped by lawmakers’ broader focus on credit and the economy. But the question remains: Whose job is it to protect consumers from taking on too much credit?

Lenders and fintech firms — and, frequently, we at American Banker — talk about the need for equal access to credit as synonymous with equal access to critical goods and services. But credit is inherently biased against people who need it and in favor of those who don’t. Given the much-cited Federal Reserve statistic that 40% of Americans do not have $400 to cover an emergency expense, it perhaps makes more sense for policymakers to examine whether consumers are able to make rational financial choices when taking on more credit.

Expanding credit alone, without further protections, will simply lead to more debt-laden consumers. That’s the problem. But it isn’t clear who will solve it.