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Save Us From Ourselves?
By Jonathan Salem Baskin

The New Financial Services Watchdog Has An Insurmountable Task Ahead Of Her

Elizabeth Warren has begun her leadership of the new Consumer Financial Protection Bureau ("CFPB") with calls to top bankers and a meeting to begin developing new mortgage disclosure rules. She explained her mandate at the mortgage meeting: "It is no secret to this group that consumers need good information so that they can make good decisions, and that's what this undertaking is about. It's about how it is that we think about what information consumers needs, and when they need it, to make the best possible financial decisions."

Good luck with that.

It's not that clearer and more transparency with consumers isn't long over due in the mortgage business. Anybody who has ever bought a home knows that the paperwork is endless, much of it incomprehensible, and the sundry fees that pop up during the process seem endless. Complex loans can catch even the savvy purchaser unawares when rates change, and a good friend in the industry suggests to me that this isn't always accidental. Much should be done to improve disclosure rules and simplify that which is disclosed, and financial institutions should aggregate consumer information so their loan writers can avoid deals that could be considered little better than entrapment.

But I don't think the government can guarantee that people will make wise financial decisions

We marketers have been trying to do it for consumer goods and services for a few generations, and the results have been uneven, at best. Purchase decisions are rarely rational and no amount of information seems to change that fact. Worse, too much information makes is less likely that decision-making will make sense, and the readily availability of stuff online allows people to use opinions in lieu of facts, thereby substituting attitudes and awareness for true knowledge.

Even the act of buying is an irrational moment, according to the behavioral scientists. It's an event, like a hiccup, that suspends a lot of otherwise rational attributes and releases its own influences. That's why some people get a rush from buying things, and why it makes others physically ill.

The proposition that consumers can be somehow "protected" from making bad financial decisions gets harder once you start looking beyond mortgages to stock investing, insurance buying, and credit card usage. Image the truly transparent ads:

  • Stocks: "You can't begin to hope to know what will affect the price of a stock, let alone when it will move up or down, and past performance is no indicator of future value. From your vantage point it's all pretty much random."
     
  • Insurance: "What you pay in premiums has no connection to how much coverage you need, other than the less you pay isn't a deal as much as a guarantee that you won't get reimbursed for anywhere near as much as you think you should."
     
  • Credit cards: "When you leave a balance on your account you are borrowing money at a rate you can't afford, which is a good indication that you couldn't afford to buy whatever you bought in the first place."

I wonder if such declarations wouldn't be ignored just like the warnings on cigarette packages.

Consumers regularly buy things for the wrong reasons, which means that the reasons aren't necessarily wrong perhaps as much as not what they should be in an ideal world. People buy expensive running shoes because they think they'll make it easier to start jogging (they don't). They purchase cosmetics to fight aging (they can't) and clothing to make them look more mature or successful (it doesn't). And they buy things hoping that the pleasure of buying will continue after their purses and wallets are closed (it mostly never does).

No amount of education can change these facts; they're the principles upon which our financial system is based.

Interestingly, when it comes to financial services, the varying ways people perceive risk is what makes markets. One investor might think that the orange crop will rival last year's bumper production, while another fully expects a meteor to hit Florida and turn it into juicy pulp. Neither is wrong, nor right, and their different expectations move one to be a seller of a futures contract and the other to be a buyer. Stock markets exist as far tamer versions of such transactions, and insurance policies are written because insurers are placing bets on the chance occurrences that the insured may or may not value in the same way.

Ms. Warren not only can't change these facts, but we might not want her to do so. If anything, perhaps she should focus on the government's knowledge and awareness of what’s going on. Individual investors and companies will continue to do smart things and dumb things. Our recent financial morass was less the result of these time-honored traditions, and more the fault of a government that either didn't understand, or turned a blind eye, to what was going on.

Added: 24th September 2010

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