President Trump’s recent executive order spelling out core principles on financial regulatory policy included the tenet of empowering consumers “to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth."
The principle of informed consumer choice comes right out of the capitalist handbook. And I am a card-carrying capitalist. The tenet goes that it is better to let customers choose their products and services than for the government to do it for them through regulation.
But in financial services, consumer choice is a slippery slope and policymakers should be wary of equating the notion of informed consumer choice with that of enabling more consumer choices. Indeed, in the areas of credit and investments, standardization of choices has merit, particularly when consumers are restricted by their own financial means.
The administration’s regulatory principle on empowering consumers to make choices only makes real sense for those who are well off — who have choices. There are plenty of financial products for them to choose from, but they do not need government help to be offered even more. On the asset side, in addition to individual stocks and bonds, they have thousands of mutual funds and ETFs available at the click of a mouse. On the liability side, they have all manner of choices of credit cards that pay them bonuses for use, home loans to suit their individual needs and cheap credit for automobiles.
The same cannot be said for the middle class let alone those of modest means. On the asset side, they have little to invest. There, they need simple choices, not more choices.
On the liability side, they are not always good credit risks. Therefore they usually are not offered a wide range of beneficial choices. Most of the borrowing choices that are readily available are either high cost or unnecessarily complex.
Except for homes and cars, most people should not borrow except for emergencies, and they should save enough so that in most simple emergencies they can draw on savings rather than having to borrow at the high rates that emergencies usually involve.
Financial health is a process that necessarily involves some products, but it is the process of budgeting, discipline and saving, not the products, that create financial health. And this process toward financial health does not require financial expertise. Discipline and a steady job are the keys.
And yet, the financial services industry makes available options to consumers that they should have no business entertaining. The biggest risk is for consumers to be fooled by products that suggest an easy path to wealth.
No, I am not saying consumers lack intelligence. I am saying only that unless one is expert about complicated financial concepts, one is easily misled. And even many people who have studied finance have been misled, too. Bernie Madoff’s victims included many who “should have known better.”
So what does this mean for public policy?
First, policymakers should actually protect ordinary consumers from an excess of choice. This protection should come from authorizing and providing a safe harbor for a limited menu of clearly spelled-out products. Other products should be lawful but should bear a warning that they are for people with financial expertise and resources.
Products could be added to the authorized “simple” list if they pass muster as both simple enough and understandable enough.
To be fair, there is room for financial innovation to benefit middle- and lower-income consumers, particularly in some of the newer technologically driven account and budgeting tools (more on this later), but the products that these consumers need do not have to be innovative, especially in their lending and investment options.
Innovative financial products have all too often been designed by marketers to obscure the costs. The only material question is price (interest rates, for the most part). But clever marketers seek to make prices look lower. In order to prevail in competition without providing a better price, one has either to put lipstick on the pig or to provide better service. Better service usually is difficult and expensive. Therefore putting lipstick on the pig earns a higher profit. Regardless of appearances, there really are not many choices among consumer financial products. The apparent choices are merely different shades of lipstick; the pig is still underneath.
But one might ask: Doesn’t fintech hold great promise to help consumers of varying financial background choose from an array of products?
I agree that fintech is promising, but its promise is in the areas of means of delivery and software designed to help consumers know where they stand. In the consumer world, a payment is a payment, an asset is an asset, and a debt is a debt. What fintech does is make the payment quicker, more secure and cheaper, and to enable the consumer to see her assets and debts in real time at a glance. Fintech also may be able to deliver asset or liability products more efficiently, but there need be nothing tech-y about the actual products.
So what consumers need is not more choice. They need more clarity, which necessarily requires less choice.
The theory of consumer choice in a market economy is not merely to make consumers feel good. The theory is that the aggregate of all consumer choices allocates resources optimally. That is, in a market economy, the government does not have any better idea than a consumer as to what is desirable or efficient. Therefore, the reasoning of choice goes that enabling consumer choice is a good that should be maximized. Competition, moreover, reduces prices.
The problem is not with that theory. It is a sound theory. But as President Trump’s “core principle” naively assumes, it depends on the consumer being informed. It is an unrealistic goal to inform a consumer about a financial product that is too complex, expensive or risky for that consumer.
Broadening choice is simply the wrong benchmark for consumer financial regulatory policy.