Friday Interview: New Rules More About Control Than Protection | Eastern North Carolina Now

    Publisher's note: This post was created by the staff for the Carolina Journal, John Hood Publisher.

Economist Smith pans federal agency formed in wake of financial crisis


Adam Smith
    RALEIGH - Regulators in Washington, D.C., believe the federal government needs to play an active role in protecting American consumers' finances. Adam Smith believes the regulators' efforts lead to negative unintended consequences. Smith, assistant professor of economics and director of the Center for Free Market Studies at Johnson & Wales University, recently shared his concerns during a conversation with Mitch Kokai for Carolina Journal Radio. (Click here to find a station near you or to learn about the weekly CJ Radio podcast.)

    Kokai: I understand that this ... really emanates from some of the work that you're seeing of this relatively new group called the Consumer Financial Protection Bureau. First of all, remind us: What is this group, and what is it up to?

    Smith: This group came out of the Dodd-Frank reform bill and was one of the more appealing to populist beliefs about what caused the financial crisis - that it was consumers getting harmed by banks, and that they needed an agency that would look solely after their interests.

    So it was a very popular part of the Dodd-Frank reform bill, and because of it coming out of the crisis, once it emerged, it immediately, you know, sunk its teeth into the market and has become something of a powerful player in Washington.

    Kokai: Now I would imagine that most people who haven't really studied this would think, "Well, consumer financial protection, that makes sense." Some say [it is] good for the government to be involved, but you raised some concerns about the way this group has gone about its work.

    Smith: The problem is, is that what they report to do is, of course, work in consumers' interest. And there are occasional forays into the market that I think that's true, when they're hunting out fraud, for example, or if they're making sure that contracts are being abided by, by the banks and so forth. I think that's all well and good.

    Where the agency has gone awry, I think - and I should say this is the majority of their work - is where they label certain credit practices as bad, period. You know, these are bad credit practices.

    Kokai: So it's not just the person being a bad actor, but the practice itself is bad?

    Smith: The practice itself is flawed and should be removed from the market altogether, despite what consumers think. Because the real secret behind the agency - or maybe not so secret, but at least, what I see as an economist - is they are coming from a school of thought called behavioral economics. And behavioral economics is all about consumers not being so intelligent about their decisions.

    And so an assumption with this agency is that consumers are essentially children, and they don't know any better. And so certain credit practices are inherently bad and will exploit them, and need to be removed from the marketplace.

    But, of course, they're not offering any alternative to those credit instruments. They're just saying these are bad, and, you know, getting rid of them will make everything better in this market environment.

    Kokai: Now you mentioned behavioral economics. For those in our audience who are not particularly familiar with the term, they might know the book Nudge. ... What is the impact of behavioral economics on this approach? Is this having a negative impact on what this group ought to be doing?

    Smith: It's hard to disassociate the two, because [Massachusetts Sen.] Elizabeth Warren, who was obviously the champion of the agency, wrote a strongly argued and very important paper that basically set up the agency, and the paper was filled with behavioral analysis.

    See, what behavioral economics has done is it's questioned the traditional assumption of economics that we are, for the most part, rational in our decision making. And where they've, I think, made some great contributions is showing, yeah, there are certain patterns that people have where we aren't completely rational, OK?

    We all know that we're not always rational and so forth, but the problem is, is that you're finding certain, you know, quirks that humans have, and then immediately assuming that you can use that information to tailor policy ... toward the marketplace.

    But it doesn't all quite fit together, and what pops out of that is not the kinds of careful analysis of human behavior that the academics are performing. It's more just another excuse for very heavy-handed regulation, that ends up not looking at all like its source material.

    Kokai: One of the other concerns I've heard about behavioral economics is it basically, as we said from the book title, nudges or steers people toward certain conclusions, things that they will do, and someone, somewhere, has to be the one who decides: Where are we going to steer them? Where are we going to nudge them? [This] is definitely, completely different from what the market would come up with, isn't it?

    Smith: Correct, so not only are they deciding what's best for all consumers - something that I think even [Richard] Thaler and [Cass] Sunstein, the authors of Nudge, would disagree with - but usually these nudges become shove-like very quickly. So, for example, when you say this credit practice is bad, so we eliminate it, that's not a nudge. We're not nudging people away from a bad credit practice.

    And the few times, I should say, that they have employed nudges, consumers have surprised them. One example is they said that, well, consumers are overusing overdraft protection, so what we're going to do is we're going to require every customer to opt in to overdraft protection, which they felt would clearly reduce the number of people who used the service.

    Turned out [that] wasn't true. Everyone opted back into overdraft protection, especially the people who were using it the most before. Again, obviously, they think it's a valuable service.

    Kokai: Now moving forward, we have this Consumer Financial Protection Bureau, for good or ill. What should they be doing, rather than having this behavioral economics analysis guiding their acts?

    Smith: I don't think, as I was saying before, given the link between the two, I don't think you can break them apart. I think it is what it is. I would say, though, that - the Wall Street Journal just wrote a piece on this, it's a long shot - but it's possible that the agency could be constrained in a way that it really always should've been, but, unfortunately, because of the environment surrounding the financial crisis, didn't happen. And that is, having a bipartisan commission that oversees the agency's policies and so forth, and, most importantly, having control over their budget.

    Right now, Washington has absolutely no control over this agency's budget. It's housed within the Federal Reserve and cannot be touched, even by the Federal Reserve itself. I mean, they're basically cowboys out there, playing whatever game they want to play with no oversight whatsoever.

    Kokai: Do you have a sense ... that something will be done? Is there enough of an outcry against this, or is this something that's going to be a hard sell for the politicians to change?

    Smith: Right now, it's deeply partisan, but the Republicans at least have sense enough to know that this is not a good thing, and that what these people are doing is not in the interest of consumers. And so, there does seem to be a lot of momentum against it from that side.

    On the other hand, Democrats are very favorable of the agency and don't want to see its powers curtailed. On the other hand, how important is that to the Democrats? I feel like there's an opportunity for them to kind of trade up for a larger issue in this case, whereas Republicans, I think, would have a nice victory on their shoulders if they could get that passed.
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