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Should the Fed have a consumer protection function?
I'm starting to wonder if the answer should be "no." Say you're on the left and you think that banks have screwed over borrowers and that remedying or preventing this injustice should be a top priority. The Fed is not the place to look to. Barney Frank was exaggerating when he said: "If I was going to list the top 87 entities in Washington in order of the history of their efforts on consumer protection, the Fed would not make it," but he said that for a reason. Most of all, the Fed looks after the stability of the banking system, and the macroeconomy, which in my view is how it should be.
From a market-oriented point of view, the case for a Fed role in consumer protection is simply that the agency is better informed and more competent than Congress or the executive branch, not to mention more insulated from political pressure. But that means -- as we are seeing today -- that Congress will not think the Fed is doing a good job when it comes to consumer protection. The Fed ends up politicized, and under fire, when it should instead be free to pursue its central mission of maintaining macro stability. It might be better to let some other regulatory agency go ahead and make the politically-demanded mistakes here. We don't want Congress to get into the habit of thinking it can tell the Fed what to do.
How many Representatives are willing to stand up and say: "Voters, I feel your pain, but your behavior was stupid and possibly even fraudulent"?
Have you noticed that significant segments of the press seem to be turning against the Fed? We live in dangerous times, and it is unfortunate that the subprime crisis exploded in an election year.
I was surprised by Daniel Gross's piece comparing Bernanke's Fed to FEMA during Katrina, linked to directly above. Other than "report the problem earlier," the key question is what Bernanke's Fed should have done differently. It would be better to focus on that, but of course that's a much harder question to answer. A replacement for Michael Brown -- even drawn randomly from a pool of CEOs or regulators -- would likely be far higher in quality, a replacement for Bernanke would likely be far lower in quality, and that's more important than any of the supposed parallels.
Posted by Tyler Cowen on December 16, 2007 at 07:34 AM in Economics | Permalink
Comments
The Constitution guarantees 'Life, Liberty and the Pursuit of Happiness'. From this wording, the government derives vast powers of protection. They should be the last line of knowledge against well funded external forces that prey on us. If you compare the role of monetary institutions to the Soviet union during the sold war you can see that, in fact, the slow creep of interest rates and unfavorable loan terms has harmed out Constitutionally protected values more than a Bear bomber wing of a troop of Soviet soldiers.
Whose side should the Feds be on? We do not have an anarchy nor should we expect a neutral government - that is not in the Constitution!
This is by no means a new argument or tension but it has slipped a long way. Ignoring some problems can be the same as endorsing them. Lead in children;s toys is the simplest example of that philosophy. Free market versus cheap goods versus balance of payments versus seller restraint versus buyer knowledge versus Government intervention -- where is the leverage point and why. Whose "side" is lead paint on?
Posted by: Gary Bridgewater at Dec 16, 2007 10:09:03 AM
Greenspan commented on NPR regarding the mechanisms of bubble pricking. His comments seem at odds with the Gross interpretation.
Posted by: Eric H at Dec 16, 2007 10:10:18 AM
If you look at the FTC's role in protecting consumers from business opportunity and franchise fraud - a role arguably similar to protection from predatory lending-, you would learn two lessons.
1. It is easy to shut a fraud for failure to comply with regulatory filings.
2. But, the frauds morph into a new but similar scheme.
Since there is no reason to believe that that the Federal Reserve has any more sophisticated understanding of the psychology of fraud than any other regulator, it should be burdened with this responsibility.
Posted by: michael webster at Dec 16, 2007 10:49:57 AM
"...but your behavior was stupid and possibly even fraudulent"?......"
"Fraudulent"!! How was the voter fraudulent? Strong words Tyler.
Posted by: anon at Dec 16, 2007 11:08:27 AM
The Fed's over-riding function is to put paper dollars into circulation. Period. Do you want consumer protection? Why not try allowing private banks to issue paper dollars, thus removing the monopoly power of the central bank. That would do more for "consumer protection" than any Rube Goldberg schemes concocted by the Fed.
Posted by: Mike Sproul at Dec 16, 2007 11:33:23 AM
Well said Mike Sproul! The media antagonizing central banks might actually be positive if it heralds an era of lassez faire monetary policies. Why are economists who typically shrink away from government intervention so tolerant of that in matters concerning monetary policy?
Posted by: Raul at Dec 16, 2007 11:41:44 AM
"How was the voter fraudulent?" - assuming that the bank did NOT actually endorse the documents for the borrower or alter them after the fact (a clear case of fraud covered under current statutes) either that signature constitutes fraud (even if by ignorance) or NO FRAUD TOOK PLACE. That fact that the economic conditions changed so that half of the parties that perpetrated the fraud no longer benefit (what if home prices HAD gone up and the homeowner MADE $20,000...?) doesn't make the original actions any more (or less) fraudulent.
Gary: Beside the fact that the Constitution and Bill of Rights are generally considered to define the role of OUR government vis-a-vis ourselves those rights you mentioned restrict the ability of our government to restrict our ability to pursue life, liberty and happiness (as opposed to ensuring the same for every person). That said, I would be MUCH more comfortable if the government was treated as a "FIRST" line of defense. WE are our own last line of defense. Empirically, government cannot protect us from all known and unknown forces; but if we as individuals take more responsibility to understand the consequences of our actions and accept that bad things DO get past the layer of government regulation, then we will be less likely to avoid pain and loss when that happens.
If in making a large and life changing decision as buying a house I cannot reasonably protect myself I should HIRE (with my money) someone with fiduciary responsibility and unaffiliated with the selling parties to advise and/or represent me. I must also understand that if that person says I cannot buy a home with my income/assets that I pay them, say "Thank You" and move on with my life, saving more money and working on getting a raise so that later I can buy that home I wanted.
Given the proportion of home sales transactions to the general population and the fact that the current mess is only present because of a widespread failure on the part of individuals to look our for themselves as described above, how is more regulation better (cost/benefit) or effective than what I describe above? Given that governments "authorize/process" titles why not require a certified and verified "buyer's fudiciary agent" signature on a purchase agreement before transferring title?
Posted by: David Johnston at Dec 16, 2007 11:44:49 AM
I've come to the conclusion that "consumer protection" restrictions are without any kind of market imperfection argument. Sure information is "imperfect," but that does not make a meaningful category of market failure. For a free rider or externality problem, there is at least a logic of the government, using coercion, transcending the problem and possibly remedying it. But there is no logic whatsoever that the government has information that others lack. The various consumer protection restrictions are meant to assure quality and safety, but there is no logic whatsoever behind the idea that the government's coercion somehow supplies assurance better than the voluntary alternatives. There is a demand for assurance, and that gives rise to a supply of assurance. There is no argument in support of the government supplying this assurance in a way superior to the voluntary alternatives. Really none. "Consumer protection" is sheer quackery. FDA, occupational licensing, OSHA, CPSC, all quackery.
Posted by: Daniel Klein at Dec 16, 2007 11:50:22 AM
Daniel: The issue of information is not necessarily one of access but one of funding (both monetary and non-monetary). I would much prefer the government to tackle lead-paint issues where many of the products come from foreign countries since they can leverage non-financial aspects in getting foreign manufacturers and governments to comply with US law. As your entire point resolves around relatives can you say that government regulation ALWAYS results in weaker assurances? The government is one possible source of assurance for buyers; there are others. The problem with government is that because government regulation is funded indirectly there is less feedback as to the desire/ability of government to regulate a specific area and change is generally slower compared to alternative sources.
There is no silver bullet and ultimately consumer protection comes down to protecting oneself since NO ONE ELSE (government, corporations, even non-profits) really care about you SPECIFICALLY (they care about groups of people and what works for the group may not work for you).
Posted by: David Johnston at Dec 16, 2007 12:07:30 PM
David: I agree. My only grouse is with the double standards that prevail: When a homeowner defaults it is "fraud" BUT similar institutional defaults get off lighter. Say, a bank run. The paternalistic tone there goes "tsk tsks why do you guys panic" almost as if the people demanding their money were misguided.
Or the liquidity crises that hit the SIVs. If, consequently, they cannot fulfill their obligations that ought to be "fraud" too. Hear that word in those stories, anyone?
Posted by: Raul at Dec 16, 2007 12:24:33 PM
Reply to the first comment quoted as follows [replies in brackets]:
The Constitution guarantees 'Life, Liberty and the Pursuit of Happiness'. [The Constitution does NOT "guarantee" anything] From this wording,[taken from the Declaration of Independence - not the Constitution]the government derives vast powers of protection [As drafted and adopted, it created LIMITED powers in the government so defined]. They should be the last line of knowledge against well funded external forces that prey on us. [The Federal Government we have was not "instituted among men" to provide "consumer protection," which is solely a device to create political constituencies for political ends] If you compare the role of monetary institutions to the Soviet union during the sold war you can see that, in fact, the slow creep [in which direction in which periods?]of interest rates and unfavorable [sic - ??] loan terms has harmed out [sic - our] Constitutionally protected values [the Constitution only limits the use of the mechanisms of the Federal Government - or at least used to; presumably leaving "values" to individual determinations] more than a Bear bomber wing of [sic - or] a troop of Soviet soldiers.
Whose side should the Feds be on? [Try reading the legislation which established and as now modified now defines its functions. The answer lies there.] We do not have an anarchy nor should we expect a neutral [as between what forces] government - that is not in the Constitution! [Au Contraire - that is precisely the point of the structure of the Constitution, as a body of "General Rules.]
This is by no means a new argument or tension but it has slipped a long way. [No, not far away, as the Political Class grows here as it has in France] Ignoring some problems can be the same as endorsing them. [Hardly!] Lead in children;s toys is the simplest example of that philosophy. Free market versus cheap goods versus balance of payments versus seller restraint versus buyer knowledge versus Government intervention [intervention based on what knowledge?]-- where is the leverage point and why. Whose "side" is lead paint on? [Reflection after a small sherry and a warm bath will likely lead to the conclusion that physical facts and circumstances in human interactions can not all be reduced to simplistics of "sides" in arguments about dealing with conflicting interests.]
R. Richard Schweitzer
s24rrs@aol.com
Posted by: R. Richard Schweitzer at Dec 16, 2007 12:47:41 PM
David Johnston: Are denying that the rationales for the restrictions administered by the FDA are quackery? Ditto occupational licensing, OSHA?
Posted by: Daniel Klein at Dec 16, 2007 1:20:05 PM
To Daniel Klein:
I'm sympathetic to your arguments about the government not being privy to more information than either side in an argument, but I think you can make a market failure argument still. If coercion can be used to force transparency at lower cost, we may be able to get to a better outcome with government than otherwise. In particular, if the borrower takes costly actions to hide the truth from the lender and the lender takes costly actions to find the truth about the borrower, or vice versa, then the threat of enforcement might be enough to induce the borrower to tell the truth in the first place. If the costs of the level of enforcement required to induce truth are less than the costs incurred first in hiding the truth and second in seeking it, then government intervention improves efficiency.
Note that this doesn't depend on the government having better information, just using its threat of coercion as a way to induce people to reveal it.
Also my personal sense is that the costs of truth-hiding and truth-seeking are relatively low in the mortgage industry--credit scoring seems to work pretty well--and the costs of enforcement are likely to be high. In other words, I don't think the logic applies here, but I don't think the reason you outline is correct.
Posted by: mike at Dec 16, 2007 2:19:01 PM
Mr. Sproul Wrote:
"The Fed's over-riding function is to put paper dollars into circulation. Period. Do you want consumer protection? Why not try allowing private banks to issue paper dollars, thus removing the monopoly power of the central bank. That would do more for "consumer protection" than any Rube Goldberg schemes concocted by the Fed."
NO! The over-riding function of the Fed is to preserve the viability of the banking system. That is the function set by the establishing legislation, and as modified, to be carried out with two balanced objectives (neither of which concerns issuing circulating paper currency).
Paper currency is credit. See, "General Idea of the New System of Finances" John Law 1720 (originator of the first viable system of "paper money" standing as credit). Note there the function of "Legal Tender" for specific forms of credit.
With all due respect for Hayek's well reasoned proposals for private banks to issue circulating currency, that has been accomplished through - credit cards, which have now become a part of the monetary measures as had demand deposits earlier. The merchants accept the credit of the bank, which accepts the credit of its customers, and no circulating paper currency is involved, with greater convenience of transactions and electronic transfers. What the Fed would create are credit balances, not circulating paper (ask the U.S. Printing Office). How those balances are deployed, if at all, seems to be the real issue.
The U.S Treasury can issue circulating paper currency, and in my lifetime has done so.
Issuance of circulating currency by private banks faces not only the "Legal Tender" problem, but that of conforming to a uniform (generally accepted) denomination in "dollars." The last private bank to be allowed to issue its own notes (without the current 100% tax on such issues) was The First National Bank of Waco Texas, which met a regional need at the time. The ability of private banks (of any kind) to issue credit instruments that might circulate as paper currency is subject to severe doubt - given that they would not directly stand behind the issuance of commercial paper (using SIVs) a similar type of transferable credit. If offered, no banks today would undertake issuing circulating currency.
R. Richard Schweitzer
s24rrs@aol.com
Posted by: R. Richard Schweitzer at Dec 16, 2007 5:06:12 PM
Mike:
Government enforcement isn't the issue, it is the rules being enforced. If people want and voluntarily agree to some contextually defined "transparency", then we may hope government enforces the terms of contract. That's not "consumer protection" rules. It's just ordinary contract enforcement. "Consumer protection" rules are ones that restrict the agreements that would-be traders can or cannot make. If the government requires something that its operatives call "transparency", that would be a "consumer protection" law. Can anyone give an example of where it is good that the government impose such restrictions? The powerful response is, even if the "transparency" is a good thing, why impose it? Where is the argument for government heroics in forcing people to do something that some happen to think would be good for them. All of the virtues and advantages of voluntary processes win this race.
Posted by: Daniel Klein at Dec 16, 2007 6:05:18 PM
I disagree. I think it's extremely fortunate that this disaster is unfolding in an election year because this disaster is the Republicans' fault. They need to be stripped of power, and elections are the only way to do that.
The Republican Congress and the Republican President failed to protect consumers against risky mortgages. Alan Greenspan, the Republican chairman of the Federal Reserve, somehow didn't notice that unregulated, high rolling mortgage lenders were causing massive inflation in the housing market. In fact, Greenspan actively contributed to the inflation by encouraging borrowers to take out those same, bad loans. Greenspan failed to prevent this disaster, actively contributed to it, and failed to help clean up afterwards. Greenspan's complete denial of responsibility is just the ultimate mark of a Republican.
The Republican breakdown of consumer protection has caused an unprecedented disaster for the macroeconomy. The sooner they are stripped of power, the better.
Posted by: Jalmari at Dec 16, 2007 6:43:58 PM
I may be misunderstanding the argument here but:
Of course the Fed should not have a consumer protection function anymore than the United States Marine Corps should have a consumer protection function; it's not their friggin' job. Now there are a whole bunch of people at, for instance, HUD and the FTC whose job *is* to provide a consumer protection function and whom have been absolutely negligent in their jobs for the last few years.
Now to be fair, I still am not sure how much a vigorous enforcement mechanism may have helped, when going against the twin forces of
1) the blind mathematical ignorance of most American consumers these days
2) the dumb lazy greed of the purchasers of these mortgages.
Posted by: Kolohe at Dec 16, 2007 6:55:34 PM
I'd like to clarify that I meant purchasers of mortgage-backed securities in #2 above
Posted by: Kolohe at Dec 16, 2007 6:59:57 PM
Daniel: I am not attempting to speak to any particular department or regulatory body but addressing your general point regarding the desirability of government to act as a regulatory and advisory body.
Posted by: David Johnston at Dec 16, 2007 7:01:53 PM
I wouldn't call Gross "significant." I've long been puzzled by Tyler's affection for Gross's work. Perhaps this column will push Tyler toward a more accurate (in my view) assessment of the merits.
Posted by: Thomas at Dec 16, 2007 8:21:53 PM
Competitive currencies are essentially what we had prior to the Constitution, in the form of colonial scripts. By most accounts, including Franklin's, it worked magnificently. The problems with it were, 1.) it was expensive and complicated to manage exchange, 2.) it was harder for the rich to exploit the money supply through marginal reserve banking when they actually had to compete. Thus, Hamilton, and his wealthy cronies (who had already run one attempt at a central bank into the ground) managed to get the Constitution adopted (barely) with the express purpose of instituting a central bank. Today, computers and electronic banking would make exchange a simple and inexpensive matter. Competition could solve the rest. The Fed is an anachronistic institution from a mercantilist age. It is time to move on.
Posted by: David S. at Dec 16, 2007 10:57:09 PM
The rate of inflation prior to the Fed was almost non existent. Compare this to what the Fed has done since its inception where they have reduced the dollar to a mere 4 cents. In regards to the business cycle, remember the great depression? Guess who controlled the money supply..... The Fed. Not only is their existence unconstitutional, and should be sent packing for this, they do a horrible job for the citizens of our great country.
Posted by: David Friedman at Dec 16, 2007 11:51:28 PM
The business cycle is not a feature of free markets. It's caused when banks create multiple property titles (deposits) to the same property (reserves) for which they have been granted a legal privilege to do so by their largest customer: the government. Crises under such a system are inevitable, providing the impetus for a central bank and a fiat currency with no bounds to the inflation. These are not features of a free society and the rule of law. Abolish the Fed, legalize contracts in gold, eliminate taxation on gold "capital gains" when the paper depreciates, and elect Ron Paul for presidency.
Posted by: Ludwig von Mises at Dec 17, 2007 12:15:33 AM
"marginal reserve banking" seems like the biggest fraud perpetrated on people. Does anyone have any justifications for that? I have always wondered....Is there an economist who can take a "pro-marginal reserve banking" position or is that impossible?
Posted by: Raul at Dec 17, 2007 12:16:49 AM
Raul, there are such economists such as Keynes, and the politicians love and exalt them for justifying their misdeeds. Only Austrian Economics provides the basis for understanding the deleterious effects of the "partial reserve" system on society.
Posted by: Ludwig von Mises at Dec 17, 2007 12:22:23 AM
