Monday, July 25, 2011

Hopes for the Consumer Financial Protection Bureau

The Consumer Financial Protection Bureau (CFPB) officially opened its doors on July 21, 2011. Established by the Dodd-Frank Act, we finally have an institution that, as the name says, will be devoted to protecting consumers. This is an important milestone. It is not possible to live in a world of individual responsibility without at the same time having a structure in place to protect consumers. This is not just a political choice, it is an inevitable step to take when we put people in charge of their financial well-being. The shift in responsibility from governments and employers onto individuals has stemmed from changes in the age composition of the population (an increasingly elderly population) and in the increased mobility of the labor markets (which requires that pensions be portable), and I do not see a way of going back to a system dominated by, for example, defined benefit pensions. But consumers face a formidable task, particularly now that financial markets around the world have become very complex and the choice of financial products has dramatically expanded.

I have several hopes for the Consumer Financial Protection Bureau.

• First, I hope they will set the right expectations about what they can accomplish, in particular in the short run. Protecting consumers is a very complex task; it requires a combination of both regulation and financial education, and it will take time to get that combination right. Having the Bureau does not make people smarter overnight, and—given widespread financial illiteracy—the Bureau has a challenging task in front of it. I can already envision front-page news articles the next time we will experience financial troubles (and there is trouble to come; more on this below), which will argue that despite the existence of the CFPB, we have not prevented financial woes. Having the CFPB does not mean that consumers will not make financial mistakes or that the supply of financial products will have no flaws. While the Dodd-Frank Act provides guidelines on what the Bureau should do, it is very important to make clear what it can realistically aim to accomplish in the short run.

• Continuing on the previous point, I hope that the Bureau will devote ample attention to financial education. One of its mandates is to promote financial education but, as we know, education inevitably takes time—and no one has time; no one can wait. But, as Federal Reserve Chairman Ben Bernanke has said, “well-informed consumers, who can serve as their own advocates, are one of the best lines of defense against the proliferation of financial products and services that are unsuitable, unnecessarily costly, or abusive.” We need an institution that has the brains, the courage, and the vision to think beyond the short run. In this respect, the Bureau could set itself apart from other institutions intent on pleasing people, politicians, or voters, with no consideration for the future. Myopic policies are costly and these costs will eventually be paid (young people, be warned). Most of our financial decisions have to do with transferring resources to the future (for example to pay for expenses after retirement or for children’s college education), and we need institutions with a long planning horizon.

• Third, I hope that the Bureau will pay careful attention to what has happened during the recent financial crisis but it will also look ahead and be proactive in addressing potential future problems. There are early indications of serious problems brewing inside the Defined Contribution pension system. There are also problems regarding how people assume and manage debt. These are issues that emerge when looking at data, and is important to use that evidence for prevention.

• Finally, I hope the Bureau will focus its efforts on those who need protection the most. While everyone will benefit from the existence of the Bureau, it is clear that there are vulnerable groups in society that deserves particular attention. These groups include not only the young and the old, which have been shown to display alarmingly low levels of financial knowledge, but also women, those with low educational attainment, and African-Americans and Hispanics. Again, the data speak clearly about who the vulnerable groups are and also provide suggestions on how to protect those vulnerable groups.

The CFPB is an institution that can make a difference in people’s lives. I want to remind you that we are all consumers; we all make financial decisions; we all need fair treatment in the market and financial products that serve our needs well; we all have grandparents, children, and female and minorities friends who are part of those vulnerable groups. Personal finance is, well, “personal.” We should not forget about that, and we should take time to recognize that with the CFPB we have made one important step forward. It’s about time.

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