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Cassandra, the Fear of Overregulation, and the CFPB

Popular Media 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.  . . .

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

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Antitrust & Consumer Protection

Debiasing: Firms Versus Administrative Agencies

Popular Media Daniel Kahnemann and co-authors discuss, in the most recent issue of the Harvard Business Review (HT: Brian McCann), various strategies for debiasing individual decisions that . . .

Daniel Kahnemann and co-authors discuss, in the most recent issue of the Harvard Business Review (HT: Brian McCann), various strategies for debiasing individual decisions that impact firm performance.  Much of the advice boils down to more conscious deliberation about decisions, incorporating awareness that individuals can be biased into firm-level decisions, and subjecting decisions to more rigorous cost-benefit analysis.  The authors discuss a handful of examples with executives contemplating this or that decision (a pricing change, a large capital outlay, and a major acquisition) and walk through how thinking harder about recognizing biases of individuals responsible for these decisions or recommendations might be identified and nipped in the bud before a costly error occurs.

Luckily for our HBS heroes they are able to catch these potential decision-making errors in time and correct them:

But in the end, Bob, Lisa, and Devesh all did, and averted serious problems as a result. Bob resisted the temptation to implement the price cut his team was clamoring for at the risk of destroying profitability and triggering a price war. Instead, he challenged the team to propose an alternative, and eventually successful, marketing plan. Lisa refused to approve an investment that, as she discovered, aimed to justify and prop up earlier sunk-cost investments in the same business. Her team later proposed an investment in a new technology that would leapfrog the competition. Finally, Devesh signed off on the deal his team was proposing, but not before additional due diligence had uncovered issues that led to a significant reduction in the acquisition price.

The real challenge for executives who want to implement decision quality control is not time or cost. It is the need to build awareness that even highly experienced, superbly competent, and well intentioned managers are fallible. Organizations need to realize that a disciplined decision-making process, not individual genius, is the key to a sound strategy. And they will have to create a culture of open debate in which such processes can flourish.

But what if they didn’t?  Of course, the result would be a costly mistake.  The sanction from the marketplace would provide a significant incentive for firms to act “as-if” rational over time.  As Judd Stone and I have written (forthcoming in the Cardozo Law Review), the firm itself can be expected to play a critical role in this debiasing:

Economic theory provides another reason for skepticism concerning predictable firm irrationality. As Armen Alchian, Ronald Coase, Harold Demsetz, Benjamin Klein, and Oliver Williamson (amongst others) have reiterated for decades, the firm is not merely a heterogeneous hodgepodge of individuals, but an institution constructed to lower transaction costs relative to making use of the price system (the make or buy decision). Firms thereby facilitate specialization, production, and exchange. Firms must react to the full panoply of economic forces and pressures, responding through innovation and competition. To the extent that cognitive biases operate to deprive individuals of the ability to choose rationally, the firm and the market provide effective mechanisms to at least mitigate these biases when they reduce profits.

A critical battleground for behaviorally-based regulatory intervention, including antitrust but not limited to it, is the question of whether agencies and courts on the one hand, or firms on the other, are the least cost avoiders of social costs associated with cognitive bias.  Stone & Wright argue in the antitrust context — contrary to the claims of Commissioner Rosch and other proponents of the behavioral approach — that the claim that individuals are behaviorally biased, and that because firms are made up of individuals, they too must be biased, simply does not provide intellectual support for behavioral regulation.  The most obvious failure is that it lacks the comparative institutional perspective described above.  Most accounts favoring greater implementation of behavioral regulation at the agency level glide over this question.  Not all, of course.

For example, Commissioner Rosch has offered the following response to the “regulators are irrational-too” critique:

My problem with this criticism is that it ignores the fact that, unlike human beings who make decisions in a vacuum, government regulators have the ability to study over time how individuals behave in certain settings (i.e., whether certain default rules provide adequate disclosure to help them make the most informed decision). Thus, if and to the extent that government regulators are mindful of the human failings discussed above, and their rules are preceded by rigorous and objective tests, it is arguable that they are less likely to get things wrong than one would predict. Of course, it may be the case that the concern with behavioral economics is less that regulators are imperfect and more than they are subject to political biases and that behavioral economics is simply liberalism masquerading as economic thinking.24 My response to that is that political capture is everywhere in Washington and that to the extent behavioral economics supports “hands on” regulation it is no more political than neoclassical economics which generally supports “hands off” regulation. On a more serious note, perhaps the best way behavioral economics could counter this critique over the long run would be to identify ways in which the insights from behavioral economics suggest regulation that one would not expect from a “left-wing” legal theory.

For my money, I find this reply altogether unconvincing.  It amounts to the claim that government agencies can be expected to have a comparative advantage over firms in ameliorating the social costs of errors.  The fact that government regulators might “get things wrong” less often than one might predict is besides the point.  The question is, again, comparing the two relevant institutions: firms in the marketplace and government agencies.  “We’re the government and we’re here to help” isn’t much of an answer to the appropriate question here.  There are further problems with this answer.  As I’ve written in response to the Commissioner’s claims:

But seriously, human beings making decisions “in a vacuum?”  It is individuals and firms who are making decisions insulated from market forces that create profit-motive and other incentives to learn about irrationality and get decisions right — not regulators?   The response to the argument that behavioral economics is simply liberalism masquerading as economic thinking (by the way, the argument is not that, it is that antitrust policy based on behavioral economics has not yet proven to be any more than simply interventionism masquerading as economic thinking — but I quibble) is weak.

As calls for behavioral regulation become more common, administrative agencies are built upon its teachings, or even more aggressive claims that behavioral law and economics can claim intellectual victory over rational choice approaches, it is critical to keep the right question in mind so that we do not fall victim to the Nirvana Fallacy.  The right comparative institutional question is whether courts and agencies or the market is better suited to mitigate the social costs of errors.   The external discipline imposed by the market in mitigating decision-making errors is well documented in the economic literature.  The claim that such discipline can replicated, or exceeded, in agencies is an assertion that remains, thus far, in search of empirical support.

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

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Antitrust & Consumer Protection

Organizational form affects decision making

Popular Media The new Consumer Financial Protection Agency seems designed to be accountable to no one… Read the full piece here.

The new Consumer Financial Protection Agency seems designed to be accountable to no one…

Read the full piece here.

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Antitrust & Consumer Protection

Comment to the Federal Reserve Board on Regulation II: Where’s the Competitive Impact Analysis?

Popular Media I have submitted a comment to the Federal Reserve Board concerning Regulation II, along with the American Enterprise Institute’s Alex Brill, Christopher DeMuth, Alex J. . . .

I have submitted a comment to the Federal Reserve Board concerning Regulation II, along with the American Enterprise Institute’s Alex Brill, Christopher DeMuth, Alex J. Pollock, and Peter Wallison, as well as my George Mason colleague Todd Zywicki.  Regulation II implements the interchange fee provisions of the Dodd-Frank Act.

The comment makes a rather straightforward and simple point:

We write to express our concern that the Federal Reserve Board has not to date taken the prudent and, importantly, legally required step of conducting a competitive impact analysis of Regulation II, which implements the interchange fee provisions of section 1075 of the Dodd-Frank Act (Pub L. 111-203). We consider this to be one of the most significant legal changes to the payment system’s competitive landscape since the Electronic Funds Transfer Act in 1978. This dramatic statutory and subsequent regulatory change will undoubtedly trigger a complex set of consequences for all firms participating in the payment system as well as for consumers purchasing both retail goods and financial services. The Federal Reserve’s obligation to conduct a competitive impact analysis of Regulation II is an appropriate and prudent safeguard against legal change with potentially pernicious consequences for the economy and consumers. Given the Board’s own well-crafted standards, we do not believe it is appropriate for the Board to move forward in implementing Regulation II without the required competitive impact analysis.

The rest of the comment appears below the fold.

The Board’s bulletin setting forth its role in the payments system lays out the policy that the Fed is supposed to follow “when considering … a legal change … if that change would have a direct and material adverse effect on the ability of other service providers to compete effectively with the Federal Reserve in providing similar services due to differing legal powers or constraints or due to a dominant marketing position deriving from such legal differences.” The bulletin explicitly promises that “[a]ll operational or legal changes having a substantial effect on payments system participants will be subject to a
competitive-impact analysis even if the competitive effects are not apparent on the face of the proposal.”

There is little doubt that Regulation II qualifies for the required competitive impact analysis by this standard as it will likely have a “substantial effect on payment system participants.” Further, several aspects of the proposal impose “differing constraints” on different institutions. The proposal, for example, exempts Fed-sponsored payment systems such as the A C H system from the scope of the regulation while sweeping in alternate payment providers, even though such provider systems are functionally indistinguishable in relevant respect.

The bulletin goes on to provide details of the required competitive impact analysis. For example, the Board must “first determine whether the proposal has a direct and material adverse effect on the ability of other service providers to compete effectively with the Federal Reserve in providing similar services.” If so, the Board must then “ascertain whether the adverse effect is due to legal differences or due to a dominant market position deriving from such legal differences.” If legal differences or a dominant market position deriving from those legal differences are detected, the analysis must then turn to assessing the benefits of the proposed legal change and determining whether those benefits could be “reasonably achieved with a lesser or no adverse competitive impact.” Indeed, the bulletin indicates that “the Board would then either modify the proposal to lessen or eliminate the adverse impact on competitors’ ability to compete or determine that the payments system objectives may not be reasonably achieved if the proposal were modified.” As the bulletin anticipates, such a detailed and careful analysis is fully appropriate to better understand the competitive impact of a significant legal change in the payment system before it is implemented.

As Federal Reserve Board Governor Sarah Bloom Raskin observed in recent Congressional testimony, “Commenters also have differing perspectives on the potential effect of the statute and the proposed rule on consumers,” and “the magnitude of the ultimate effect is not clear and will depend on the behavior of various participants in the debit card networks.”

We agree with Governor Raskin’s observations and conclude that an economic impact analysis of the competitive effects of Regulation II, while a complex endeavor, is a critical one to protect competition in the payment system and consumers. We urge the Board to conduct an impact analysis of Regulation II and to make this analysis available for public comment before implementation of Regulation II.

Interesting readers can search for other comments here.

 

Filed under: banking, consumer financial protection bureau, consumer protection, credit cards, economics, regulation

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Antitrust & Consumer Protection

The Limits of Behavioral Law and Economics, Australia Edition

TOTM At the excellent Core Economics blog, Andreas Ortman discusses an Australian policy debate involving the Review of the Governance, Efficiency, Structure and Operation of Australia’s Superannuation System . . .

At the excellent Core Economics blog, Andreas Ortman discusses an Australian policy debate involving the Review of the Governance, Efficiency, Structure and Operation of Australia’s Superannuation System (also known as the Cooper Review), and more specifically, retirement savings and the superannuation system.  The Cooper Review drafters contend that the behavioral economics literature strongly supports a mandated default option (MySuper).

Read the full piece here.

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Financial Regulation & Corporate Governance

Dodd-Frank and Criminal Consumer Protection Liability

TOTM Tiffany Joslyn provides a useful summary of the criminal provisions of the Dodd-Frank Act at the Federalist Society National Federal Initiatives Project.  One of the . . .

Tiffany Joslyn provides a useful summary of the criminal provisions of the Dodd-Frank Act at the Federalist Society National Federal Initiatives Project.  One of the things Joslyn points out is that the Act includes new criminal consumer protection liability…

Read the full piece here

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Financial Regulation & Corporate Governance

Ginsburg and Wright on A Taxonomy of Behavioral Law and Economics Skepticism

TOTM The behavioral economics research agenda is an ambitious one for several reasons.  The first reason is that behavioral economics requires a theory “true” preferences aside . . .

The behavioral economics research agenda is an ambitious one for several reasons.  The first reason is that behavioral economics requires a theory “true” preferences aside from – and in opposition to — the “revealed” preferences of the decision maker.  A second reason is that while collecting and documenting individual biases in an ad hoc fashion can generate interesting results, policy relevance requires an integrative theory of errors that can predict the sufficient and necessary conditions under which cognitive biases will hamper the decision-making of economic agents.  A third is not unique to behavioral economics but is nonetheless significant: demonstrating that behavioral economics improves predictive power.  The core methodological commitment of the behavioral economics enterprise — as with economics generally at least since Friedman (1953) —  is an empirical one: predictive power.  Indeed, no less than  Christine Jolls, Cass Sunstein and Richard Thaler have described the behavioralist research program as the economic analysis of law “with a higher R-squared,” that is, “a greater power to explain the observed data.”

Read the full piece here.

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Financial Regulation & Corporate Governance

Judd Stone on Behavioral Economics, Administrative Agencies, and Unintended Consequences

TOTM Professors Henderson and Ribstein touch on two theoretical failures of the behavioralist movement which both reveal the prematurity of ‘behaviorally-informed’ regulatory proposals: the behavioralist assumptions . . .

Professors Henderson and Ribstein touch on two theoretical failures of the behavioralist movement which both reveal the prematurity of ‘behaviorally-informed’ regulatory proposals: the behavioralist assumptions that (1) behavioral biases theoretically necessitate, or at least enable, public intervention, and (2) governmental entities can net improve individual outcomes over the status quo of unfettered, if limited, human capabilities.  I think both of these observations highlight the shocking dearth of theoretical exploration amongst behavioralists thus far.  I want to focus on connecting these assumptions to the connection between behavioral economics and administrative regulation.

Read the full piece here

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Financial Regulation & Corporate Governance

Richard Epstein on The Dangerous Allure of Behavioral Economics: The Relationship between Physical and Financial Products

TOTM Few academic publications have had as much direct public influence on the law as the 2008 article by my NYU colleague Oren Bar-Gill and then . . .

Few academic publications have had as much direct public influence on the law as the 2008 article by my NYU colleague Oren Bar-Gill and then Harvard Law Professor Elizabeth Warren.  In “Making Credit Safer,” they seek to combine two strands of academic thought in support of one great cause—more regulation of financial markets.  They start with the central claim of behavioral economics that sophisticated entrepreneurs are able to take advantage of the systematic foibles of ordinary people, by rigging their products in ways that work systematically to their own advantage.  By plying ordinary individuals will carefully packaged payment contracts, firms can undercut the central postulate of rational choice economics that all voluntary transactions produce mutual gains for the parties.  In its stead we get the wreckage of families and fortunes brought about by unscrupulous bankers in search of a buck.  Warren and Bar-Gill repeatedly talk about the importance of empirical evidence.  Her own work, however, is exceptionally shoddy, as Todd Zywicki has recently pointed out in the Wall Street Journal.

Read the full piece here

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Financial Regulation & Corporate Governance