The standard account of regulation focuses on problems of market failure. One form of market failure stems from information scarcity or informational asymmetries. Regulations can deal with this kind of market failure by requiring information disclosure using standard metrics, often in a form that is assessable to relatively unsophisticated actors. This form of regulation can be quite useful in promoting mutually beneficial exchanges between consenting adults. Example: the Federal Trade Commission’s Used Car Rule requires dealers to post a buyers guide on used cars that inform the customer of basic information (e.g., is it being sold “as is” or is there a warranty). Presumably, this reduces informational asymmetries and facilitates exchanges. Regulation by information can also reduce more intrusive expressions of government power. For example, the Securities and Exchange Commission requires firms to disclose their financials so that potential investors can make informed decisions. It does not, however, bar firms with a higher probability of bankruptcy from entering capital markets. Regulations facilitate exchanges and regulation by information does so with minimal state intrusion.
Paul Krugman has a piece today in the NYT (“Friends of Fraud”) decrying the GOP threats to block the confirmation of Richard Cordray as head of the Consumer Financial Protection Bureau created under Dodd-Frank. Having lost the battle over Dodd-Frank, they want to strip the new bureau of its independence and are using the appointment to leverage the changes in question. Krugman’s take:
What Republicans are demanding, basically, is that the protection bureau lose its independence. They want its actions subjected to a veto by other, bank-centered financial regulators, ensuring that consumers will once again be neglected, and they also want to take away its guaranteed funding, opening it to interest-group pressure. These changes would make the agency more or less worthless — but that, of course, is the point.
How can the G.O.P. be so determined to make America safe for financial fraud, with the 2008 crisis still so fresh in our memory? In part it’s because Republicans are deep in denial about what actually happened to our financial system and economy. On the right, it’s now complete orthodoxy that do-gooder liberals, especially former Representative Barney Frank, somehow caused the financial disaster by forcing helpless bankers to lend to Those People.
Elizabeth Warren (the policy entrepreneur who fought for a new consumer protection agency) was an expert in bankruptcy (before winning the Senate race) and she documented the large percentage of prime borrowers who were directed into subprime vehicles (I don’t recall the exact figure, but I believe it was around 25 percent). Others signed on to mortgages they didn’t understand, in part, because the terms of the agreement and the consequences were sufficiently obscured by the issuers. The problems of information asymmetry were significant, particularly for the less sophisticated borrower.
A few points of clarification: I think Dodd-Frank was bad legislation for a host of reasons that are beyond the scope of this posting. I do not think that the evil mortgage broker exploiting the hapless rube was the source of the financial crisis. Nor would I agree with Krugman’s portrayal of the crisis. There was so much more going on in this tale of crony capitalism, transfer-seeking, and failed regulation. But there is good evidence that many (not all) borrowers were exploited in ways that cost them dearly. I am at a loss to understand why the regulation of the kinds of mortgage instruments that are sold and the information provided to borrowers is so objectionable, particularly when (as noted above) it can facilitate functioning markets.
Quick question to the skeptics: when is the last time you read the information that was provided before you clicked “accept” and upgraded to the newest version of iTunes or installed the newest fix to whatever problem was discovered in your word processing or spread sheet program? Do you know what you agreed to? Now imagine a relatively unsophisticated borrower signing off on a 20-page document, having concluded that the mortgage broker told them all they needed to know about the agreement.
Bottom line: even those who support market governance can make a compelling case for regulation, particularly when it involves the provision of information that facilitates voluntary exchanges.
Question: is there a credible argument to be made against the Consumer Financial Protection Bureau? Note: the claim that all regulation is bad is not a credible argument.
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