Tough luck for financial consumers

Last Thursday, a new Bill, Financial Choice Act, was passed by the US House of Representatives. The Bill, which will now be debated in the Senate, is a frontal attack on the Obama-era financial regulations, created to prevent a recurrence of the horrendous losses and pain inflicted by the global financial crisis, with the US as its epicentre. That crisis was caused by mutating risky home loans into a stream of toxic derivatives in the labs of global investment banks and were then gleefully traded by testosterone-fuelled traders, blinded by greed. The result was a massive destruction of wealth across the world and it made at least two countries go bankrupt. The crisis set off a chain of regulatory changes across the Western world. The US got a Consumer Finance Protection Bureau (CFPB) and the UK completely revamped its regulatory system, relieving the domain regulators of the job of handling consumer issues and creating a Financial Conduct Authority (FCA). The FCA monitors all financial firms from the consumer angle. The new US Bill will destroy these safeguards put in place for consumers.

Those consumer safeguards were not legislators’ knee-jerk palliatives for anguished citizens who lost their homes and livelihoods to Wall Street’s greed. They were the result of a profound philosophical change in the regulatory approach. Note that both the US and UK now place a much greater emphasis on controlling the misconduct of a few profit-oriented business entities rather than educating millions of savers and investors. This simply makes so much more intuitive sense. If you want people to use clean water, do you set up a centralised filtration for the city, or supply dirty water to each home and get them to learn how to filter their own water? When the governments of the US, Australia, the UK, Canada, and other countries adopted a pro-consumer regulatory approach, they were indicating that two planks of conventional regulatory philosophy — buyer beware and regulation through disclosure and transparency — had become rather shaky.

They were always shaky; we just didn’t have a theoretical framework to understand it. The rise of behavioural finance as a discipline, which explained human irrationality, provided that framework for a rethink. For three decades after the Berlin Wall fell, regulators believed in “light-touch” regulation. The belief was that technology and globalisation would create more financial products and more options, reduce costs, improve lives, all of which need to be supported by light-touch regulation. Who knew that in 2008, a UK regulator would be driven to say “you have to assume that you don’t have rational consumers. Faced with complex decisions or too much information, they default... They hide behind credit rating agencies or behind the promises that are given to them by the salesperson.” This, despite the fact that repeated excesses over those three decades were due to such irrationality. 

Over three decades, behavioural scientists showed us that investors are inherently irrational when making financial choices, which invariably involves doing calculations (some quick, some elaborate). How many of the average savers can calculate the impact of inflation, returns, and risk? Making the correct choices is often also a product of handling emotion — fear and greed — and, most importantly, handling volatility. But we are born to hate volatility; we love linearity and predictability — and hence opt for fixed-income products. So, the doctrine of ‘buyer beware’ made little sense in real life and calling the new US Bill Financial Choice Act is a travesty. 

While buyers of financial products have been grappling with these behavioural problems in choosing investment products, sellers of financial products offered an array of ‘hot products’ aimed at consumers — while disclosing their complexity and risk in fine print. Every successful sale to a consumer resulted in hefty sales incentives for clever and accurate targeting. It took the 2008 crisis to show the world how farcical the disclosure/transparency doctrine was as a regulatory bedrock. But the US is now ready to junk all the great insights in order to “jump start economic growth”. Ed Mierzwinski, consumer program director at USPIRG, an advocacy organisation, has been quoted as saying that the Bill “would leave the successful CFPB as an unrecognisable husk”.

The Indian financial sector and its regulation are heavily influenced by the West, especially the US. Unfortunately, despite being the mother lode of democracy, transparency, and consumer power in many ways, the US has been a rather poor protector of the main stakeholders in the financial sector — the consumers. India still has in place a tired adaptation of the notion that disclosure is enough and the buyer must beware. We continue to regulate in silos — different departments of the ministry of finance, different independent regulators, and a patchwork of grievance redress systems — although many selling points are the same (banks). It is time we incorporated the behavioural-based regulatory philosophy, keeping in mind what the financial consumer really needs.
 

The writer is the editor of www.moneylife.in

Twitter: @Moneylifers