With Obama’s recess appointment of a director, the new Consumer Financial Protection Bureau is now operational. Government is again wading into one of the harder questions our society must decide: How stupid we should let people be?
We don’t think about it this way but the health of our economy is in part dependent upon participation by people that lack financial sophistication. If a person had to pass a test on the meaning of “Force Majeure” before taking out a loan there would be far fewer homes, cars and boats sold. Financial regulation is designed to give the financially unsophisticated the ability and comfort level they need to be able to borrow money to build their lives and pursue their dreams, even if the dream is just a new jet ski. Although aspects of the Consumer Financial Protection Bureau legislation are controversial the financial services industry has been supportive of some level of financial oversight to allow and promote broader participation by the financially unsophisticated.
Generally, financial oversight covers two areas: making sure people get the important facts right up front and protecting people from doing something truly stupid – keeping people from borrowing money if repaying that money will cause extreme hardship or even financial ruin. The “facts up front” part isn’t all that controversial – putting the interest rate, term and closing costs on the front page of a loan document is agreeable to pretty much everybody. The “keeping people from doing something stupid” part, however is both hard to define and controversial. The effective annual interest rate for some payday loans is 400%. People who take out payday loans pay a very high cost to borrow the money for a short period of time and for many it puts them on a path of eventual financial ruin. The electricity still eventually gets turned off, they lose their car and their job and eventually wind up destitute. Even with full disclosure of the cost of the loan, the combination of human optimism and lack of sophistication regularly makes people do things that, in retrospect, make them think to themselves “Oh my God that was stupid, what was I thinking?”
So how stupid should we let people be? If we had a truly naked individualism, the answer is “As stupid as they want to be”. We would let people do the truly stupid things that will in all likelihood have a terrible outcome. We would expect that some people would be forced into bankruptcy by taking out a payday loan with a 400% annual interest rate, or that some people would die from getting drunk and popping wheelies on their cycle without wearing a helmet.
The problem, of course, is that we don’t let people die because of their stupidity. The person who bankrupts himself? We give him welfare and food stamps to make sure he doesn’t starve to death. We pay the $200,000 in emergency room bills to save the foolish drunk biker. And “individual” is only a partial description of reality – each individual is part of a family and community that usually shares the cost of the person’s stupidity. Relatives wind up taking care of the motorcycle rider, or chipping in cash to keep the bankrupt person above water. Like it or not, society, small and large, winds up paying for the cost of an individual’s stupidity.
This isn’t an easy question and there are no easy answers. I’m pretty sure there are thousands of people who have taken out a payday loan to keep the electric on, and then because of the fees and interest on the loan were unable to make their mortgage payment and eventually lost their home. But there are probably a few that had an opportunity to buy a used car at a steep discount and sold the car at enough of a profit to pay back the loan and still come out far ahead. Maybe that one payday loan was the starting point of a mini-empire.
Again, this is the challenge – one person’s stupidity is another person’s high risk startup funding strategy. In balancing the rights of the individual against the rights of society there are no easy answers. But it is a conversation that needs to be had.