In response to my recent blog post, “Modified Plans for the Consumer Agency Still Doomed to Fail,” I received an email from Reuters blogger Felix Salmon that questioned the idea that consumer protection and prudential protection can coexist. In layman’s terms, Felix’s challenge was that what’s bad for the card issuer is inherently good for the consumer and vice versa. Given that this is a question that many people likely have, my response to Felix follows:
It’s important to remember that one of the best ways to protect consumers is to prevent them from securing loans that they clearly cannot afford (i.e. “toxic loans). As you very well know, when someone gets a loan that is significantly higher than what they can afford, they get into all kinds of trouble, including being forced into bankruptcy and/or foreclosure. As it stands now, prudential protection and consumer protection are combined, and there are various regulatory agencies that have the knowledge, experience and authority to prevent toxic products to the market. Unfortunately they’ve been asleep at the wheel. Under the CFPA prudential protection and consumer protection will be split. This means that the very agency responsible for protecting consumers won’t have the required data or experience, not to mention the authority, to protect consumers against toxic products.
Just imagine that Greenspan had done his job and forbidden all the “toxic mortgages” (i.e. no documentation, negative amortization, etc.). What better consumer protection for all the millions of people whose lives have been ruined because they signed up for loans that were clearly unjustified based on their income and assets?
Consumer protection extends beyond preventing consumers from signing up for “toxic loans”. What I mean by this is that companies that produce financial products can operate in two different ways, as it relates to how they charge consumers for their services. The first is to deceive and confuse consumers and take products to market that are full of hidden terms and fees. The alternative is being upfront in terms of disclosure and marketing products that are simple and easy to compare against the competition’s.
As far as prudential protection is concerned, you get the best results by having financial institutions operate transparently. A consumer set that is fully informed and capable of making smart decisions is a consumer set that is more likely to pay back the money banks lend them, and this ensures the long-term stability of the banks themselves.
From the perspective of the banks, you are right, weak companies will prefer to continue to operate in a deceiving manner because doing so makes it easier to compete. However, strong, efficient and innovative companies will lean towards clarity and transparency because it allows them to more easily differentiate themselves from the competition.
At the end of the day, banks have to charge for their services no matter how many restrictions are placed on them. What needs to be addressed is how they operate and how they charge for those services. So to sum it up, prudential protection is completely aligned with not only consumer protection, but also the interests of any inherently solid financial institution.