Monday, May 9, 2011
Free Marketer Supports Consumer Financial Protection Bureau
The Senate Republicans have pledged to block the appointment of a director for the Consumer Financial Protection Bureau (CFPB). They claim that they have objections to the structure of the agency. Others claim that the Republicans are just trying to scuttle an agency whose formation they could not block last year.
I would like to make the point here that those who support free markets should support the existence of a consumer protection agency. In a free market a producer sells his/her product to a customer in a mutually voluntary transaction. Each party acts in his/her own best interest. The net result is that this process leads to a rational allocation of resources by each party individually and by the society collectively.
In order for this process to work effectively both parties must understand the transaction that they are entering into. There are many transactions however where this is not possible. While the CFPB’s role is limited to protecting consumers in their dealing with financial companies, let us consider an example of a familiar non-financial company transaction. Apple compels the many millions of individuals who wish to use itunes to digitally sign a 30 to 40 page single-spaced legal agreement. Few read, or could understand, this agreement that one may surmise that Apple had a staff of expensive lawyers draft. It is not feasible, nor would it be efficient, for each individual to hire an attorney to review this and similar agreements that one must sign for a variety of online services, financial services, etc. For all one knows, in the middle of such an agreement the vendor might state that the vendor assumes title to the customer’s house.
The lengthy obtuse legal agreements involved in such transactions lead to a type of market failure. It is not logistically nor financially feasible to have such agreements reviewed by an attorney representing the consumer each time a consumer becomes involved in a transaction involving such an agreement.
Even the preeminent free market advocate, Milton Friedman, believed that “market failure” is a basis for government intervention. A government agency steps in as the consumers’ representative, not to set the terms of the transaction, but to make sure that the terms and risks are made clear to the consumer. For example, an individual taking on a mortgage should clearly understand the repayment terms, the interest rate being paid, the risk that he/she might not be able to make the payments and the consequences thereof. Similarly, the terms and risks of credit cards should be stated in clear terms that the consumer can understand. The terms and risks should be stated in a uniform way so that consumers can comparison shop. Financial companies should make their profits by providing financial services, not by deceiving their customers regarding the terms of the transactions. The financial collapse that started in 2008 was in part attributable to hard-driving mortgage brokers convincing customers to take on terms and risks that they did not understand.
Elizabeth Warren is an articulate advocate for the CFPB. From what I know of her, I think that she would be an outstanding director.
Of course, any government agency can be mismanaged and one can certainly argue about the best structure for such an organization. Also, such an agency should continually prospectively test the rules and regulations that it implements in terms of their desired and undesired outcomes.
However, the need for the government to play a role in consumer protection should be clear even to the most devoted advocates of free markets – like me.