The Consumer Financial Protection Bureau (CFPB) was set up in the wake of the financial crisis to prevent against the sorts of abuses we witnessed from the mortgage industry during the housing bubble years. The idea was that consumers should not have to worry about buying financial products that jeopardize their financial security, as turned out to be the case with many of the mortgages sold during the bubble years. The CFPB would limit the types of products that could be sold and the ways in which they could be marketed to protect consumers.
This was generally seen as an effort to ensure fairness. Most people are not very educated about financial matters. That is not an indictment of their intelligence; it’s just recognition of the fact that they have jobs and lives. Those who don’t work in finance or a related industry have little reason to become an expert on the industry’s products.
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The CFPB is intended to make sure that these people don’t get ripped off by those who are experts in finance. This sounds like a basic issue of fairness, but it also helps to promote economic growth. The effect of the CFPB on boosting growth is too little appreciated even by those who strongly support the Bureau.
Take the recent decision by the CFPB to ban clauses in financial industry contracts that mandated arbitration and prohibited lawsuits. Richard Cordray, the head of the CFPB, defended his decision by saying that the ruling may cost the industry $1 billion a year, while their profits last year were $171 billion.
While the $1 billion may be small compared with the industry’s profits, it is important to understand where this $1 billion is coming from. If we accept that this rule will effectively be limiting the industry’s ability to “rip-off” their customers, then the $1 billion in reduced profits is about putting $1 billion in consumers’ pockets that never should have been taken away in the first place.
The notion of “rip-off” here is a term in a contract that a consumer may agree to because they don’t understand it. For example, some credit cards have very punitive late charges which their customers may only first realize when they face them. If they understood that the card imposed large charges, they never would have signed up for it.
If the issuers of a credit card know that they will be able to get away with exorbitant late charges if they can find ways to conceal them from their customers, they will have a powerful incentive to find ways to hide the charges in their contract. This means employers and possible psychologists and other experts in order to best design a deceptive contract.
However, if they know that they will never be able to get away with charging excessive fees — for example if they know that the CFPB would rule against them and make them refund excessive charges — then they don’t have incentive to develop deceptive contracts in the first place. They wouldn’t spend the money on the lawyers and other experts to conceal terms in the contract.
This is not only good for consumers; it is good for the economy. We want the financial industry to be devoting resources to finding better ways to serve consumers in order to win business away from competitors, not to figuring out more ways to rip them off. The CFPB should reduce the incentives in the rip-off direction.
This is also a benefit to consumers, not only in getting money back if they have been taken, but in reducing the need to scrutinize the terms of a contract. We don’t want someone buying a house to have to carefully read through hundreds of pages of a mortgage contract. They should be able to know the main terms in a page or two and have the rest of the contract in a standard form that they can be assured does not contain surprises.
It would be a needless waste of people’s time if everyone had to read through all the terms of every contract they signed. The CFPB can save consumers a huge amount of time by effectively examining the terms for them and providing a seal of approval.
By acting as neutral party that ensures the quality of contracts and stands in the way of bad contracts being issued, the CFPB should lead to a more efficient financial sector. Fewer resources will be wasted by businesses trying to rip people off and less time will be needed by customers to avoid being ripped off. For this reason, contrary to the claims of critics, the CFPB should boost, rather than reduce, economic growth.