|by Jason Steele|
The most recent financial reform legislation contained a provision to create a Consumer Financial Protection Bureau (CFPB). The idea is to create a government agency that will be analogous to the Consumer Product Safety Commission, overseeing financial products just like dangerous tangible products are regulated. Among other things, this agency will be able to continually regulate the credit card industry without an act of Congress. By doing so, it will fix the inherent flaw of the CARD Act, the propensity of banks to “innovate” new ways of circumventing the intent of the law.
Who Will Head The Agency?
A bureaucracy is only as good as it’s leader, and President Obama has made a choice that will ensure that the agency will live up to it’s potential. Furthermore, the founder of a government agency leaves an indelible stamp on it’s culture and mission for generations. Who could doubt that the FBI would not be what it is without J. Edgar Hoover. Today, President Obama nominated Elizabeth Warren to oversea the creation of the CFPB. To understand why she is an outstanding nominee, it helps to read her 2007 testimony before Congress on the subject of the CARD Act. At eight pages, it is a relatively easy read, yet you don’t even have to absorb the whole thing to know that she “gets it” when it comes to protecting consumers. For example, take these paragraphs from the second page:
….the most valuable customers are not those who pay in full each month. Instead, the customers who generate the real profits for the credit card companies are those who stumble and slide, who make payments and miss payments, and who end up paying default rates of interest and penalty fees. To maximize profits from this group, the credit card issuers have a second tier to their business model: they load their initial card agreements with tricks and traps so that they can maximize income from interest rates and fees.
This is where the market breaks down. In a perfectly competitive market, both firms and consumers have the information they need to make sound economic decisions. Because these tricks and traps are effectively hidden from customers—invisible until they bite, that is—credit card issuers face no economic penalty in the marketplace for including them in card agreements. If the consumer can’t tell a safe card from a dangerous one, then the marketplace will not reward the safe card issuer by increasing volume.
She refers to “tricks and traps with such ease and frequency that it would not surprise me if she actually coined the term. In fact, in her statement today, she said, “The time for hiding tricks and traps in the fine print is over.”
What Fine Print?
I have a hard time imagining that the old trick of promising one thing and hiding the opposite in the fine print is going to fly under Warren. In her testimony she says:
Anyone who has ever tried to read a credit card agreement knows that the terms are simply incomprehensible. The inserts sent along with monthly bills to amend the card agreements are filled with language even a lawyer would have difficulty parsing. In such an environment, the average consumer doesn’t have a prayer.
Customers are kept in the dark about these practices, until it is too late. According to the Wall Street Journal, in the early 1980s, the typical credit card contract was a page long. But by the early 2000s, that contract had grown to more than 30 pages of incomprehensible text. The additional terms were not designed to make life easier for the customer.
Risk Based Pricing?
There are still some free market extremists out there who believed that the tricks and traps were merely a legitimate form of risk based pricing. To them she responds:
This is not risk-based pricing. A risk-based pricing model is about the lender’s assessment of the likelihood of repayment at the inception of the loan, with subsequent calibration as more information is available. Anyone who has a small child, a dog, or a dead relative who has received a pre-approved credit card offer understands that the initial loan is not risk-based. Instead, the model posits putting cards in the hands of every consumer, then maximizing revenues with every possible trick and trap once the customer has begun using the card. Charges for late fees or over-limit fees reflect a price the company believes it can charge without causing the consumer to cancel the card. Interest rate increases may be related to changes in credit, but they may also be related to factors that bear no relationship to the likelihood of repayment or, in some cases, to no change at all in the customer’s risk profile. The tricks and traps are profit-taking, pure and simple.
The greatest day for consumer protection in my lifetime was the day that President Obama signed the CARD Act. His nomination of Elizabeth Warren to create the CFPB may turn out to eclipse that.