I’m thinking about this topic in drafting my book’s chapter on the current regulatory environment. For those who have commented on my first post, thanks so much for the input. I’ll welcome more ideas.

A core dilemma in consumer financial protection is how much the government should protect people from themselves, given that over-protection can do as much damage as under-protection by raising costs and drying up markets that consumers want and need. This issue arises most dramatically regarding expensive products aimed at vulnerable consumers, where regulators worry that people can easily be preyed upon or are simply at high risk of making “bad choices” that will hurt them. An example is payday and other short-term lending, with which the CFPB regulation-writers are currently grappling. Should the government bar some options outright because too many people who choose them suffer harm, or should people be free to make such choices, or is the answer somewhere in the middle?

Even among mainstream consumers, there is a thorny question on how to assign “fault” when consumers have difficulties. People get hurt in their financial dealings for a range of reasons involving varying kinds of fault by them and by others. Sometimes they just make poor choices – spending, borrowing, or paying too much, saving too little, signing up for a financial product without studying it or comparing options – even though the financial products they’re using are completely fair. At the other end of the spectrum, sometimes people are intentionally preyed upon by unscrupulous providers that target and trick and exploit consumers who are vulnerable due to lack of education or sophistication, or are financially desperate. In between, there is a wide spectrum of scenarios in which people get into bad situations where the fault, if there is some, could be thought of as shared. Yes, the consumer could have done a better job of reading and understanding the product terms, but likewise the provider, knowing most people will not understand a complex product, could have made the terms more clear. Most of these situations have, at their core, the problem that the consumer does not thoroughly understand the product. Classic market forces often fail in consumer financial transactions because the “willing buyer and willing seller” do not have equal knowledge. The seller almost always has an advantage.

Most financial transactions live in this murky middle ground. Providers correctly meet legal requirements but offer complicated products they know most consumers don’t understand. Consumers largely ignore the disclosures and sign up without comprehending the product, based on their trust in the provider and generally being too busy to delve into detail. Buried in the product’s complexity are, often, features that work to the provider’s advantage. The consumer could theoretically have found these features and sought to negotiate them or to find another provider, but didn’t. Then something happens to bring this feature to the surface, and the consumer feels harmed. Whose fault is that?

Before the financial crisis, the prevailing view was these kinds of problems were consumers’ fault – that if the provider had met the technical legal requirements,caveat emptor should rule. Post-crisis, the regulators, and especially the CFPB, are emphasizing that products also must not be “unfair.” Despite some legal case history on UDAAP (the ban on unfair, deceptive, and abusive practices), it is not clear how these emerging standards should apply.

The issue can be framed as a question: which party should have to be the active player, and which can be passive, in assuring that consumers have good outcomes? Must the provider actively try to assure that consumers understand all adverse product terms, and maybe even try to assure that people make “good” choices, or even make the choices that are “best” for them? Or should the provider be free simply to offer products that meet legal requirements, and put the onus on the consumer to be the active player who must understand and choose well?

Again, the latter system has largely prevailed in the past and hasn’t worked terribly well, as evidenced in the subprime mortgage crisis, for one. However, forcing the provider to be responsible for customers making “suitable” choices (a concept that shapes securities law), raises profound questions as well in terms of consumer freedom, risks of adverse customer stereotyping, the huge difficulties of enforcing subjective standards, and the potential to drive providers out of important markets due to fear of regulatory risks they can’t assess.

And what if the regulators decide, instead, to divide up responsibility between the customer and provider differently based on types of products, providers, and consumers? How should they decide – using what criteria – on where to draw those lines?

Again, please share your thoughts and stories with me, whatever your perspective and experience may be.

photo credit: Matt Van Buskirk