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In yesterday’s hearings on the disastrous launch of the federal health insurance exchanges, contractors insisted that part of the problem was a last-minute specification from the government:  the feds didn’t want people to be able to “window shop” for health insurance until they had created a profile and entered all sorts of personal information.

That’s understandable.  For this massive social experiment to succeed — or, at least, to fail less badly — young, healthy people need to buy health insurance.  Policy prices for those folks, though, are going to be really high because (1) the ACA requires all sorts of costly coverages people used to be able to decline, and (2) the Act’s “community rating” and “guaranteed issue” provisions prevent insurers from charging older and sicker people an actuarily appropriate rate and therefore require their subsidization by the young and healthy.  To prevent the sort of sticker shock that might cause young invincibles to forego purchasing insurance, Obamacare advocates didn’t want them seeing unsubsidized insurance rates.  Determining a person’s subsidy, though, requires submisison of all sorts of personal information.  Thus, the original requirement that website visitors create a profile and provide gobs of information before seeing insurance rates.

Given the website’s glitches and the difficulty of actually creating a working profile, the feds have now reversed course and are permitting window shopping.  An applicant can enter his or her state and county, family size, and age range (<50 or >50) and receive a selection of premium estimates.  To avoid dissuading people from applying for coverage in light of high premiums, the website takes great pains to emphasize that the estimated premiums do not account for the available subsidies to which most people will be entitled.  For example, to get my own quote, I had to answer a handful of questions and click “Next” a few times, and in the process of doing so, the website announced seven times that the estimated prices I was about to see would not include the generous subsdies to which I would probably be entitled.  The Obamacare folks, you see, want us consumers to know what we’re really going to have to pay.

Or do they?

According to the website, I could buy a Coventry Bronze $15 co-pay plan for $218.03 per month (unsubsidized).  An Anthem Blue Cross Blue Shield Direct Access Plan would cost me $213.39 per month (unsubsidized).  When I went to a private exchange and conducted the same inquiry, however, I learned that the price for the former policy would be $278.66 and, for the latter, between $270.17.  So the private exchange tells me the price for my insurance would be 27% percent higher than the amount Healthcare.gov estimates in its window shopping feature.  What gives?

As it turns out, the federal exchange assumes (without admitting it) that anyone under age 49 is 27 years old.  The private website, by contrast, based quotes on my real age (42).  Obviously, the older a person is, the higher the premium will be.  Since the ACA mandates that individuals up to age 26 be allowed to stay on their parents’ insurance policies, the age the federal website assumes is the very youngest age at which most people would be required to buy health insurance or pay a penalty.  In other words, the federal website picks the rosiest assumption in estimating insurance premiums and never once tells users it’s doing so.  It does, however, awkwardly remind them seven times in fewer than seven consecutive screens that their actual premiums will probably be lower than the figure quoted.

Can you imagine if a private firm pulled this sort of stunt?  Elizabeth Warren’s friends at the CFPB would be on it like white on rice!

Look, the website problems are a red herring.  Sure, they’re shockingly severe, and they do illustrate the limits of government to run things effectively, limits the ACA architects resolutely disregarded.  But they’ll get fixed eventually.  The main reason they’re a long-term problem is that they exacerbate the Act’s most fundamental flaw: its tendency to create a death spiral of adverse selection in which older and sicker people, beneficiaries under the ACA, purchase health insurance, while young, healthy folks, losers under the Act, forego it.  Once this happens, insurance premiums will skyrocket, encouraging even more young and healthy people to drop out of the pool of insureds and thereby making things even worse.  The most significant problem stemming from the website “glitches” (my, how that term has been stretched!) is that they have made it so hard to apply for insurance that only those most desperate for it — the old and sick, the ones we least need in the pool of insureds — will go through the rigmarole of signing up.  On this point, see Holman Jenkins and George Will.

But who knows.  Maybe Zeke Emanuel can fix the problem by getting the Red Sox to sell Obamacare to young invincibles.  (I’m not kidding.  That was his plan for avoiding adverse selection.)

Go Cards!

Filed under: consumer financial protection bureau, consumer protection, health care, health care reform debate, regulation, truth on the market

My paper with Judge Douglas H. Ginsburg (D.C. Circuit; NYU Law), Behavioral Law & Economics: Its Origins, Fatal Flaws, and Implications for Liberty, is posted to SSRN and now published in the Northwestern Law Review.

Here is the abstract:

Behavioral economics combines economics and psychology to produce a body of evidence that individual choice behavior departs from that predicted by neoclassical economics in a number of decision-making situations. Emerging close on the heels of behavioral economics over the past thirty years has been the “behavioral law and economics” movement and its philosophical foundation — so-called “libertarian paternalism.” Even the least paternalistic version of behavioral law and economics makes two central claims about government regulation of seemingly irrational behavior: (1) the behavioral regulatory approach, by manipulating the way in which choices are framed for consumers, will increase welfare as measured by each individual’s own preferences and (2) a central planner can and will implement the behavioral law and economics policy program in a manner that respects liberty and does not limit the choices available to individuals. This Article draws attention to the second and less scrutinized of the behaviorists’ claims, viz., that behavioral law and economics poses no significant threat to liberty and individual autonomy. The behaviorists’ libertarian claims fail on their own terms. So long as behavioral law and economics continues to ignore the value to economic welfare and individual liberty of leaving individuals the freedom to choose and hence to err in making important decisions, “libertarian paternalism” will not only fail to fulfill its promise of increasing welfare while doing no harm to liberty, it will pose a significant risk of reducing both.

Download here.

 

Filed under: behavioral economics, behavioral economics, consumer financial protection bureau, consumer protection, economics, free to choose, Hayek, law and economics

From the WSJ:

White House regulatory chief Cass Sunstein is leaving his post this month to return to Harvard Law School, officials said Friday.

Mr. Sunstein has long been an advocate of behavorial economics in setting policy, the notion that people will respond to incentives, and has argued for restraint in government regulations. As such, he was met with skepticism and opposition by some liberals when he was chosen at the start of the Obama administration.

As administrator of the Office of Information and Regulatory Affairs in the Office of Management and Budget, his formal title, Mr. Sunstein led an effort to look back at existing regulations with an eye toward killing those that are no longer needed or cost effective. The White House estimates that effort has already produced $10 billion in savings over five years, with more to come.

“Cass has shown that it is possible to support economic growth without sacrificing health, safety and the environment,” President Barack Obama said in a statement. He said these reforms and “his tenacious promotion of cost-benefit analysis,” will “benefit Americans for years to come.”

Even so, conservatives point to sweeping new regulations for the financial sector and health care in arguing that the administration has increased the regulatory burden on businesses.

Mr. Sunstein will depart this month for Harvard, where he will rejoin the law school faculty as the Felix Frankfurter Professor of Law and Director of the Program on Behavioral Economics and Public Policy.

It will be interesting to hear, once Professor Sunstein returns to an academic setting, his views on whether and in what instances — aside from the CFPB — behavioral economics actually had much impact on the formation of regulatory policy within the Administration.

Filed under: behavioral economics, regulation

In the WSJ, Professor Macey takes measure of the CFPB’s new mortgage disclosures and finds them lacking:

The CFPB is proposing to revise the old forms into a new Loan Estimate Form and Closing Disclosure Form. The old loan form had been five pages; according to the agency website, the new one is three. The closing form remains at five pages. That’s a net savings of two pieces of paper. But the agency rules required to implement the new forms weigh in at an astonishing 1,099 pages.

In evaluating the substance of the new disclosure themselves, Macey concludes the new forms are likely to harm consumers rather than help them.

Do the new rules expand consumer choice? They would forbid many borrowers from making smaller payments every month, followed by a single, one-time balloon payment to retire the principal at the end. They also would cap late fees—which means borrowers would be unable to get a lower interest rate on a loan by agreeing to pay a penalty if they don’t make their payments on time.

The new rules restrict loan-modification fees, which means mortgagors will offer fewer options to do so. They restrict penalties on borrowers who pay off their home loans early. These prepayment fees compensate lenders for the risk of lower returns on their loans. Without this protection they will either decline to offer loans to some borrowers or charge a higher interest rate.

The government’s proposed rules require high-risk customers in high-cost loan markets to meet with financial counselors before taking out a loan. The regulators also want to expand dramatically the number of mortgages classified as high cost. But financial counselors will have to be compensated, whether their advice is good or bad. The law deprives these consumers of the right to do their own homework.

Oddly, hidden on the new disclosure forms is the Annual Percentage Rate. For decades the APR was front and center on government-mandated disclosure documents. It is the single number that shows borrowers the cost of borrowing including such factors as the interest rate, certain fees, and the maturity structure of the loan.

The CFPB claims its consumer testing showed people didn’t understand the APR. Yet if someone is trying to compare two loans—one with a lower interest rate and $15,000 in fees, the other with lower fees but a higher interest rate—it’s not possible to determine which loan is cheaper without the APR.  The new rules do not attempt to generate a single number that can be used for comparison purposes and instead focus on various components of the loan such as fees, penalties, interest rates and maturity separately. This makes it harder, not easier, for borrowers to compare mortgage options.

Ultimately, we will be able to evaluate the impact of these new disclosures empirically by watching the results of the CFPB’s “experiment.”

Filed under: consumer financial protection bureau, consumer protection, economics

Yale Law Journal has published my article on “The Antitrust/ Consumer Protection Paradox: Two Policies At War With One Another.”  The hat tip to Robert Bork’s classic “Antitrust Paradox” in the title will be apparent to many readers.  The primary purpose of the article is to identify an emerging and serious conflict between antitrust and consumer protection law arising out of a sharp divergence in the economic approaches embedded within antitrust law with its deep attachment to rational choice economics on the one hand, and the new behavioral economics approach of the Consumer Financial Protection Bureau.  This intellectual rift brings with it serious – and detrimental – consumer welfare consequences.  After identifying the causes and consequences of that emerging rift, I explore the economic, legal, and political forces supporting the rift.

Here is the abstract:

The potential complementarities between antitrust and consumer protection law— collectively, “consumer law”—are well known. The rise of the newly established Consumer Financial Protection Bureau (CFPB) portends a deep rift in the intellectual infrastructure of consumer law that threatens the consumer-welfare oriented development of both bodies of law. This Feature describes the emerging paradox that rift has created: a body of consumer law at war with itself. The CFPB’s behavioral approach to consumer protection rejects revealed preference— the core economic link between consumer choice and economic welfare and the fundamental building block of the rational choice approach underlying antitrust law. This Feature analyzes the economic, legal, and political institutions underlying the potential rise of an incoherent consumer law and concludes that, unfortunately, there are several reasons to believe the intellectual rift shaping the development of antitrust and consumer protection will continue for some time.

Go read the whole thing.

Filed under: antitrust, behavioral economics, bundled discounts, consumer financial protection bureau, consumer protection, economics, federal trade commission

Richard Cordray’s nomination hearing provided an opportunity to learn something new about the substantive policies of the new Consumer Financial Protection Bureau.  Unfortunately, that opportunity came and went without answering many of the key questions that remain concerning the impact of the CFPB’s enforcement and regulatory agenda on the availability of consumer credit, economic growth, and jobs.

Read the full piece here. 

There has been plenty of Hurricane Irene blogging, and some posts linking natural disasters to various aspects of law and policy (see, e.g. my colleague Ilya Somin discussing property rights and falling trees).   Often, post-natural disaster economic discussion at TOTM turns to the perverse consequences of price gouging laws.  This time around, the damage from the hurricane got me thinking about the issue of availability of credit.  In policy debates in and around the new CFPB and its likely agenda — which is often reported to include restrictions on payday lending — I often take up the unpopular (at least in the rooms in which these debates often occur) position that while payday lenders can abuse consumers, one should think very carefully about incentives before going about restricting access to any form of consumer credit.  In the case of payday lending, for example, proponents of restrictions or outright bans generally have in mind a counterfactual world in which consumers who are choosing payday loans are simply “missing out” on other forms of credit with superior terms.  Often, proponents of this position rely upon a theory involving particular behavioral biases of at least some substantial fraction of borrowers who, for example, over estimate their future ability to pay off the loan.  Skeptics of government-imposed restrictions on access to consumer credit (whether it be credit cards or payday lending) often argue that such restrictions do not change the underlying demand for consumer credit.  Consumer demand for credit — whether for consumption smoothing purposes or in response to a natural disaster or personal income “shock” or another reason — is an important lubricant for economic growth.  Restrictions do not reduce this demand at all — in fact, critics of these restrictions point out, consumers are likely to switch to the closest substitute forms of credit available to them if access to one source is foreclosed.  Of course, these stories are not necessarily mutually exclusive: that is, some payday loan customers might irrationally use payday lending while better options are available while at the same time, it is the best source of credit available to other customers.

In any event, one important testable implication for the economic theories of payday lending relied upon by critics of such restrictions (including myself) is that restrictions on their use will have a negative impact on access to credit for payday lending customers (i.e. they will not be able to simply turn to better sources of credit).  While most critics of government restrictions on access to consumer credit appear to recognize the potential for abuse and favor disclosure regimes and significant efforts to police and punish fraud, the idea that payday loans might generate serious economic benefits for society often appears repugnant to supporters.  All of this takes me to an excellent paper that lies at the intersection of these two issues: natural disasters and the economic effects of restrictions on payday lending.  The paper is Adair Morse’s Payday Lenders: Heroes or Villians.    From the abstract:

I ask whether access to high-interest credit (payday loans) exacerbates or mitigates individual financial distress. Using natural disasters as an exogenous shock, I apply a propensity score matched, triple difference specification to identify a causal relationship between access-to-credit and welfare. I find that California foreclosures increase by 4.5 units per 1,000 homes in the year after a natural disaster, but the existence of payday lenders mitigates 1.0-1.3 of these foreclosures. In a placebo test for natural disasters covered by homeowner insurance, I find no payday lending mitigation effect. Lenders also mitigate larcenies, but have no effect on burglaries or vehicle thefts. My methodology demonstrates that my results apply to ordinary personal emergencies, with the caveat that not all payday loan customers borrow for emergencies.

To be sure, there are other papers with different designs that identify economic benefits from payday lending and other otherwise “disfavored” credit products.  Similarly, there papers out there that use different data and a variety of research designs and identify social harms from payday lending (see here for links to a handful, and here for a recent attempt).  A literature survey is available here.  Nonetheless, Morse’s results remind me that consumer credit institutions — even non-traditional ones — can generate serious economic benefits in times of need and policy analysts must be careful in evaluating and weighing those benefits against potential costs when thinking about and designing restrictions that will change incentives in consumer credit markets.

Filed under: behavioral economics, behavioral economics, consumer financial protection bureau, consumer protection, contracts, cost-benefit analysis, credit cards, economics, regulation

There is an embarrassing blind spot in the behavioral law and economics literature with respect to implementation of policy whether via legislation or administrative agency.  James Cooper and William Kovacic — both currently at the Federal Trade Commission as Attorney Advisor Commissioner, respectively — aim to fill this gap with a recent working paper entitled “Behavioral Economics: Implications for Regulatory Behavior.”  The basic idea is to combine the insights of public choice economics and behavioral economics to explore the implications for behavioral regulation at administrative agencies and, in particular given their experiences, a competition and consumer protection regulator.

Here is the abstract:

Behavioral economics (BE) examines the implications for decision-making when actors suffer from biases documented in the psychological literature. These scholars replace the assumption of rationality with one of “bounded rationality,” in which consumers’ actions are affected by their initial endowments, their tastes for fairness, their inability to appreciate the future costs, their lack of self-control, and general use of flawed heuristics. We posit a simple model of a competition regulator who serves as an agent to a political overseer. The regulator chooses a policy that accounts for the rewards she gets from the political overseer – whose optimal policy is one that focuses on short-run outputs that garner political support, rather than on long-term effective policy solutions – and the weight she puts on the optimal long run policy. We use this model to explore the effects of bounded rationality on policymaking, with an emphasis on competition and consumer protection policy. We find that flawed heuristics (e.g., availability, representativeness, optimism, and hindsight) and present bias are likely to lead regulators to adopt policies closer to those preferred by political overseers than they otherwise would. We argue that unlike the case of firms, which face competition, the incentive structure for regulators is likely to reward regulators who adopt politically expedient policies, either intentionally (due to a desire to please the political overseer) or accidentally (due to bounded rationality). This sample selection process is likely to lead to a cadre of regulators who focus on maximizing outputs rather than outcomes.

Here is a little snippet from the conclusion, but please go do read the whole thing:

The model we present shows that political pressure will cause rational regulators to choose policies that are not optimal from a consumer standpoint, and that in a large number of circumstances regulatory bias will exacerbate this tendency. Our analysis also suggests special caution when attempting to correct firm behavior as regulatory bias appears likely more durable than firm bias because the market provides a much stronger feedback mechanism than exists in the regulatory environment. To the extent that we can de-bias regulators – either through a greater use of internal and external adversarial review or by making a closer nexus between outcomes and rewards – they will become more effective at welfare-enhancing interventions designed to correct biases.

Thinking about the implications of behavioral economics at the regulatory level is incredibly important for competition and consumer protection policy (think CFPB, for example).  And I’m very happy to see scholars of Cooper and Kovacic’s caliber — not to mention real world agency experience to bring to bear on the problem — tackling it.   For full disclosure purposes, I should note that I have or am currently co-authoring with each of them.  But don’t hold that against them!  Its a thought provoking paper upon which I will have some more thoughts later on, as well as tying it in to some of the work I’ve done on behavioral economics.  For example, Judd Stone and I explore a related problem of the implications of firm level irrationality — both for incumbents and entrants — in this piece, and find the implications for antitrust policy less clear (and in some cases, absent) than have behavioral antitrust proponents.  See also Stone’s post during the TOTM Free to Choose Symposium on BE and Administrative Agencies.

Filed under: antitrust, behavioral economics, consumer financial protection bureau, consumer protection, federal trade commission

In the Huffington Post, Marcus Baram warns against those who claim to be concerned about over-regulation on Wall Street and in the consumer protection sphere.  Baram writes:

Today, Wall Street is again on the attack against a regulatory overhaul that includes more stringent investor and consumer protections. Though the financial landscape is far different and the details of the proposals have changed since 1912, the industry is using much of the same alarmist rhetoric to oppose new regulations and rules.

JPMorgan chairman Jamie Dimon recently complained that proposed rules on derivatives, capital buffers and too-big-to-fail banks are bad for America. Wall Street could lose customers to European banks, he said.

Baram includes economist, and my co-author, David S. Evans in his list of those “crying wolf” over over-regulation:

At a congressional hearing on the Consumer Financial Protection Bureau, banking consultant David S. Evans attacked the “hard paternalism” of its interim director Elizabeth Warren. He cautioned that the bureau “could make it harder and more expensive for consumers to borrow money.”

Such Cassandra-like warnings are common in the history of financial regulation.

I think Baram might want to have this one back if given the chance.  His point is that the Dimon and David Evans and others are concerned about imposing an enormous regulatory burden are wrong.  Of course, I am no scholar of Greek mythology, but I seem to recall that Cassandra was right!  Her curse was that nobody believed her accurate predictions about the future.  Baram may have stumbled upon something here.

But more seriously, at a time when the unemployment rate is over 9%, when the intellectual architects of the CFPB were quite frank about favoring a regulatory approach that would restrict access to consumer credit (see here), and when the flow of credit is critical to economic growth and recovery, one has to be pretty deeply committed to the cause to so brazenly ignore predictions that massive regulatory structure just might hold the economy back.

Evans’ testimony at the House Hearing on the CFPB is available here.

Filed under: consumer financial protection bureau, consumer protection, economics, regulation