Buyer, Be Aware

By and large, these searches failed. The stories of the housing bust tended to be more complicated. Many borrowers stretched to buy homes, figuring that they would be making more money soon enough or that housing prices would keep going up. In Southern California, one homeowner told me he was well aware that his monthly payments would eventually balloon. He thought everything would work out, though, because he assumed that ever-rising home values would allow him to refinance. Much of the country shared this belief.

Banks, mortgage brokers and real-estate agents were only too happy to encourage these fantasies, of course. In many cases, their encouragement crossed the line into malfeasance. But the bubble grew as large as it did because this malfeasance fed on human frailty, naïveté and even irresponsibility.

This summer, with the bubble long gone, Congress and the Obama administration enacted a sweeping new law meant to change the business of lending and borrowing money. The part of the law that will directly affect the most people will be the new Consumer Financial Protection Bureau, which has already been the subject of heated debate. And the central question facing the bureau will be how to distinguish between corporate malfeasance and consumer frailty.

It is not an easy task. For as long as there has been money, people have been doing stupid things with it. We borrow more than we can afford. We pay higher interest rates than we need to. We play the lottery. The new consumer bureau can prohibit some of the banks’ worst practices. But figuring out precisely where to draw the line will be much more nuanced than the past year’s black-and-white, left-and-right debate over whether an agency should exist at all.

Elizabeth Warren — the Harvard law professor who first proposed such an agency, in a 2007 article in the journal Democracy — has pointed out that the history of consumer financial protection is a history of “thou shalt not.” The government bans lenders from doing something, and the banks stop. Quickly, however, they come up with new ways to separate people from their money. Last year’s credit-card legislation, for example, cracked down on overdraft fees (the frequently steep charges for people who tried to withdraw more money on a debit card than they had in their account). Banks have responded by raising other fees.

This is why the thou-shalt-not approach, Warren says, “means you’ll always be behind.” Or, as Richard Thaler, the University of Chicago behavioral economist, puts it, “Regulating what financial companies can and cannot charge for is a losing game, because they’ll always think of something else.”

Their agreement on this point is notable, because Warren has come to represent the muscularly progressive vision of the new bureau, while behavioral economists like Thaler (who is close to several Obama advisers) are seen as more technocratic. And there is no doubt that the bureau will need to make judgment calls that some regulators would make differently than others. But the basic vision for the bureau is not in dispute, at least not among the people who are likely to run it under Obama.

The overriding goal of the bureau will be to help people understand their financial choices. More often than not, it will allow banks to continue a given practice — but force them to explain, in clear terms, what it means for consumers. Earlier this summer, I refinanced my mortgage and was reminded yet again of how much modern finance depends on obfuscation. Nowhere in the pile of documents was there a simple explanation of the only information that mattered to me: how much the bank was charging in fees, how much the lawyer was charging, how much the government was charging and how much my monthly payment would fall. Instead, I was confronted with a blizzard of terms that I did not fully understand: origination, title services, release tracking and the like.

Done right, the new bureau can begin to change this. It can require banks to speak in the language of customers, not internal bureaucracy. Another part of last year’s credit-card legislation offered a preview. As of February, banks have had to give people the often-bracing calculation of how much it will cost them to pay off their balance if they make only the minimum monthly payment, as well as how many years it will take. To see if such steps are working — and to keep pace with Wall Street ingenuity — the new bureau will have a research budget allowing it to test whether consumers truly know what they’re signing up for.

The ultimate goal is pushing banks to compete in ways that benefit consumers, rather than having them compete over which methods can most cleverly fool consumers. If people know the true costs of their mortgages, credit cards, debit cards and mutual funds, they are more likely to gravitate to those offering low costs and good benefits. This will have the added feature of reducing the enormous, historically abnormal profits that Wall Street has enjoyed in recent years. It is also the way a market is supposed to work.

Still, no matter how well we grasp the implications of fees and interest on our credit cards, we may still decide to use a card to buy a new television or kitchen we can’t really afford. The new consumer bureau will not try to stop us. And it almost certainly will not be enough to prevent another bubble, in some other realm, sometime in the future.

But that is probably not a realistic goal anyway. Prohibition, after all, has a decidedly mixed record. A better goal may simply be making sure we understand what we are doing and hoping that is enough to make us a little less frail. By David Leonhardt, The New York Times