Are consumers "protected" when they are denied the opportunity to buy products and services that are available to others? Is that what consumers want? Does it matter what they want?
These are the questions raised by the Obama administration's proposal for a Consumer Financial Protection Agency (CFPA). Traditionally, consumer protection in the United States has focused on disclosure. It has always been assumed that with adequate disclosure all consumers - of whatever level of sophistication - could make rational decisions about the products and services they are offered. No more. If the administration's plan is adopted, many consumers will be told that they cannot have particular products or services because they are not sophisticated, educated or perhaps intelligent enough to understand what they have been offered.
Conservatives have always argued that liberals are elitists who do not respect ordinary Americans; this legislation seems to prove it. For example, the administration's plan would allow the educated and sophisticated elites to have access to whatever financial services they want but limit the range of products available to ordinary Americans.
This unprecedented result comes about because, under the proposed legislation, every provider of a financial service (a term that includes organizations as varied as banks, check-cashing services, leasing companies and payment services) is required to offer a "standard" product or service - to be defined and approved by the proposed agency - that will be simple and entail "lower risks" for consumers. These standard products are called "plain vanilla" in the white paper that the administration circulated in advance of the legislation.
Thus, the obvious question: Once the CFPA has prescribed what is a lower-risk and simpler mortgage loan or other product, who will be able to buy the more complex products that are tailored to a consumer's specific needs? Providers can offer such a product, but going beyond the standard plain-vanilla product is likely to entail substantial risks. The provider that sells a more complex product to a consumer who is not ultimately deemed to be capable of understanding the product's risk or complexity could face an enforcement proceeding from the agency (fines, civil penalties and cease-and-desist orders are authorized in the draft legislation), an action by a state attorney general enforcing the agency's regulations (specifically permitted in the legislation), and a civil suit by a consumer or a class of consumers who claim they did not understand the risks associated with the non-plain-vanilla product or service.
Apparently, adequate disclosure will not be the answer to the provider's dilemma. As outlined in the white paper, no amount of disclosure can adequately protect consumers against complexity: "Even if disclosures are fully tested and all communications are properly balanced, product complexity itself can lead consumers to make costly errors."
How would a provider be expected to determine whether a product that involves more risk or complexity than the plain-vanilla version is suitable for a consumer? The white paper offers this: "The CFPA should be authorized to use a variety of measures to help ensure (non-plain vanilla) mortgages were obtained only by consumers who understood the risks and could manage them. For example, the CFPA could impose a strong warning label on all (complex) products; require providers to have applicants fill out financial experience questionnaires; or require providers to obtain the applicant's written 'opt-in' to such products."
Of course, if the issue is whether the consumer understood the risks of the more complex product, strong warning labels or written "opt-ins" simply raise the same question and will not be a defense for the provider. And one can only imagine the humiliation of the consumer who must fill out a questionnaire to establish his capacity to purchase anything more than the plain-vanilla product.
So who will be able to get those more complex products and services? Not ordinary Americans, whose lack of financial sophistication will make the risks of selling to them too great for most providers. The more complex products, the ones that are better tailored to the needs of the particular consumer, will be offered only to the more sophisticated and better educated - in other words, to the nation's elites. In this way, and for the first time in our history, the government will force a major sector of the U.S. economy to deny products and services to a large proportion of the population - not because the products or services are inherently dangerous, like drugs or explosives, but because in the view of the Obama administration no amount of disclosure can make some Americans capable of understanding what they are buying.
The writer, who served as general counsel of the Treasury Department from 1981 to 1985 and White House counsel from 1986 to 1987, is a senior fellow at the American Enterprise Institute. He is scheduled to testify before the Senate Banking Committee on this topic Tuesday.
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