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Beyond Disclosure: CFPB Wrestles with Choice and Suitability

Adam Rust's picture

Posted December 2, 2010

When is it appropriate for a government agency to spell out the type of products that appear in the marketplace? The upcoming rulemakings on the CFPB seem destined to pit consumer advocates against banks, and the preference among lawmakers for either "suitability" or "choice" will probably provoke much of the contention.

Although the Dodd-Frank bill established the CFPB, much remains to be done to determine what it will mean. From its initial conceptualization, the CFPB has promised to revitalize the power of consumer disclosures.  Elizabeth Warren spoke at the Consumer Federation of America's annual conference in Washington, DC this morning and she reiterated her faith in the power of disclosure to protect the public. At once excited but simultaneously weary, she made an effort to emphasize that she believes that most Americans will appreciate the results of the new bureau once they can see its benefits.

"Do you hear people saying that the Consumer Product Safety Commission should do less to protect the safety of infants in their

cribs?" Warren gave plenty of examples of successful improvements to products that people use in their everyday life. Because of consumer protections, carmakers don't send their vehicle off the line with faulty brakes. Aspirin isn't filled with baking soda. The fabric that we use for safety belts is strong.

Industry and advocates seem ready to build a consensus around more disclosures. Speaking at the CFA conference, Wayne Abernethy agreed that it was very useful, as a person with food allergies, to be able to identify the ingredients used to make his food.

But Abernathy took the next step to challenge where we go from just including more disclosures. Does a disclosure go hand-in-hand with shaping the products in the marketplace, or is it merely a warning? If it is just a warning, does that mean that exotic and potentially dangerous financial products should remain freely available?

All this points to a new thing for rulemakers to disagree upon. There is disclosure within a "suitability" framework, but there is also disclosure in a free choice system. 

That is why it wasn't surprising that Abernathy sided with choice. Keeping with the food story, he said that he liked to have the option to pick unhealthy food.  In other words, he wanted to know if his food was suitable for his needs, but he also liked to have the choice to decide for himself. 

These two concepts will emerge as rivalrous ideals during the coming rulemaking period for the Dodd-Frank bill.  

Suitability or Choice

Which view is the most appropriate for the protection of consumers?

Let's stick with the food analogy that Abernathy started. It is helpful in understanding how consumers can be served. How does the production of food differ, and how is it similar, with the delivery of financial services? '

There are some important differences. 

For one, the competition among companies to supply food is usually far more competitive than there is in the supply of mainstream financial services. In America, it is hard to find a zip code where the Big Four don't have majority of bank branches.  That is why the Big Four are making about two-thirds of all mortgages right now, and why three have broken the ten percent deposit rule. I can pick from 500 wineries and 60 breweries at my local grocer. I can get canned corn, frozen corn, corn on the cob, corn niblets, corn chips, blue corn tortillas, corn dogs, hominy, corn meal, corn bread....and there's a good chance that each of those products will be sold by a different company, and that most of those products will be supplied by several brands. Oh, and then there's the organics.

Scale matters. Food is a much more personal product.  There is only one end user for an ear of corn. That's not true with a mortgage. There can be lots of "users," from the homeowner that gets the loan in the first place all the way to the investors that buy those loans in MBS-bundles. The need to reliably repackage loans into new securities imposes a need for product homogeneity. 

Even when an MBS has a diverse mix of ARMs and fixed rate products, those loans are still sold in strips that break them down into sortable divisions. Thus, the securitization markets thwart some of the ability to have variety

When a market for a food product is dominated by just a few (like banking) producers, the results aren't that great. Think about your eggs.  Just a handful of megafarms produce a large share of our nation's eggs. How's that working? How do you feel about your ability to distinguish their relative safety? How about with chicken or pork. Do you know the difference between the pork at Smithfield Foods (#1), Triumph Foods (#2), and Seaboard Foods (#3)? Each one has hundreds of thousands of sows, ready for your table. 

You probably feel much better about the organic eggs that you can pick up at the farmer's market. There are probably ten different suppliers at my farmer's market. It's a very competitive environment.

We can't ignore the appeal of having a lot of choices. Americans love all kinds of food. Government policy tries to give them that choice. The USDA provides room for food stamp users to select from most of the items in the grocery store aisle.

Even when food and finances differ, there are instances when suitability trumps choice as a follow-through on disclosure.  We have disclosures for food - think of nutrition labeling. We have disclosures for finance, too. There's the Schumer Box, for instance, and the new debt repayment language on your credit card statement. But those are the exceptions to the rule. It takes two hours to read your mortgage. Your lawyer might want to help, but he or she is probably not willing to spend that kind of time. There's too much information, but very little communication. I don't know what disodium EDTA sodium nitrate is, but I have been told that it is in my breakfast bar. I'm eating it anyway. Same with those Carolina red hot dogs. 

Is it a satisfying outcome if  my kid flunks out of school because I fed him a breakfast bar and a hot dog?

That's the rub. The suitability argument is a tough one to make. Some people are going to want to ban those Carolina red hot, I mean, those stated-income negatively amortizing option-ARM loans. Other people are going to say that warning the borrower is enough.

These forces explain the lack of a plain vanilla mortgage in the marketplace. Barney Frank made an attempt (somewhat) to require lenders to offer a simple and completely homogenous mortgage product. It would have meant that a plain vanilla at BB&T was the same as the plain vanilla at Chase and the same as the plain vanilla at First Horizon. He lost that effort, and the government hasn't been able to require lenders to create that product. Moreover, in the choice framework that remained, there was no subsequent plain vanilla innovation. The oligopolist suppliers never offered it.