from the Philadelphia Fed
— this post authored by Igor Livshits
Since the financial crisis of 2007 – 2008, consumer credit has gotten a lot of attention, especially as it relates to consumer protection. And the attention is not just academic: The Consumer Financial Protection Bureau (CFPB) and the Credit Card Accountability Responsibility and Disclosure (CARD) Act, both instituted after the crisis, have dramatically altered the regulatory landscape of the consumer credit industry.
A guiding principle behind the creation of this new regulatory environment is that consumers need protection from predatory lending practices. This article highlights some of the key considerations underlying the design of such policies and possible pitfalls that arise in implementing them.
In designing any regulation to protect consumers, we need to first answer three questions. First, why do (some) consumers need to be protected? The most basic answer is that (some) consumers make “mistakes,” that is, they make decisions the regulator deems suboptimal. There is a range of causes of these mistakes, including various behavioral biases and a lack of information or attention on the part of the consumer. I argue below that the details of this answer are very important for policy design, as they affect how we answer the next two questions.
Second, whom do the consumers need to be protected from? We consider three possible answers: lenders, more sophisticated borrowers, and themselves.
Third, which policies offer effective protection? Here, the range of answers includes financial education and restrictions on pricing and contracts. The answer depends on the answers to the previous two questions. If the regulations are based on a “wrong” model, well-intentioned policies may backfire, causing harm even to the borrowers they aim to protect. To complicate matters further, protecting some (less sophisticated) borrowers may come at the expense of limiting the (informed) choices of others. As John Campbell put it in his 2016 Ely Lecture, “Financial regulators face a difficult tradeoff between the benefits of regulation to households that make mistakes, and the cost of regulation to other financial market participants.”
[click on the image below to continue reading]
Source
