The Consumer Financial Protection Bureau

The Consumer Financial Protection BureauHow the Bureau is Transforming the Asymmetrical Financial Market for the Consumers BenefitMarisa CarreonHONR 499 Spring 2015

IntroductionBursting of the Housing Bubble U.S. economy felt repercussions from 2007-2010Easy Borrowing Partly funded by foreign savingsBanks making subprime loansMortgage-backed securitiesLow interest rates + increased borrowing = more homes being boughtDecease of housing prices decrease in subprime loan values alsoCredit Crunch to avoid insolvency Consumers had become highly leveraged speculators in a fixed assetBorrowing financed too much of their spending

Reform?The unregulated financial market led to some widespread, negative consequencessubprime loans Whats in a nameRisky borrowing, poorly managed risk by lendersLenders being unclear about loan information to borrowersPredatory lenders seeking profitDodd-Frankmeans of reform of the financial marketConsumer Financial Protection Bureau (CFPB) one of the means of reformProtect consumers from predatory lenders and dangerous financial productsFix market imperfections Asymmetrical information

How to reform and regulateForget about Perfect MarketImplement Behavioral EconomicAssumes several conditionsNo externalitiesNo barriers to entry/exitInability to set market pricesProfit maximizationPERFECT INFORMATIONPareto efficiency achievedNo one other equilbrium w/out someone being worse offThis is not realityEspecially with financial market

More true and better account of actual market behaviorEmphasizes Homo Sapien, not Homo EconomicusPerfectly-rational agent does not existCombines psychology and economicsSeeks to explain economic decision-making process

Behavioral economicsA Brief Explanation of

Bounded RationalityCognitive capacity is limitedBrain powerTimeRationality is bounded by this limited capacityHumans cannot be expected to always solve optimization problemsInstead, we use heuristics or rules of thumb to guess at the optimal solution

http://agilevietnam.com/2012/12/28/understanding-decision-making/

Bounded Willpower

WillpowerEconomically speaking, choosing the optimumBounded by temporalityPeople may think with short-term in mind instead of long-termOr vice-versaDepends on self-control and self-awarenesshttp://picoeconomics.org/HTarticles/Selectionist/Seledtionist.html

Bounded self-interestHumans are not entirely self-interested creaturesShown through cooperationprisoners dilemma gamesUltimatum gamesParents making decisions with their children in mind

http://www.acting-man.com/?p=34313

Behavioral Economics in BankingMarianne Bertrand, Eldar Shafir and Sendhil MullainathanThose without banks accounts are almost always poor?Why?No bank accounts higher out-pocket feesFees with cashing paychecksLack of savingsPay-day loans from lack of creditMore easily available money is more easily spentWhy dont they bank?Associate banks with higher costs=psychological barrierThe opposite is trueSuggest restructuring fees and forms to be simpler, easier to understand

Simpler DisclosuresSimpler disclosure forms enable better understanding Consumer Financial Protection Bureau created new disclosure formsInvolved mortgage brokers, lenders, borrowers, and settlement agents in redesign

http://www.consumerfinance.gov/knowbeforeyouowe/#disclosure

B. Economics in financial regulationBarr, Shafir and Mullainathan in 2008 look at behaviors role in making financial decisionsPolicy should be formed with this role in mindBounded rationality and bounded willpower Limit ability to make best decisionSalient features may inform decisionLow or remarkable prices

B. Economics in financial regulation Part of determining how to regulate financial markets is understanding which mistakes consumers tend to make and why.What leads to theMisunderstanding compound interestsHow could predatory firms use this?

B. Economics in financial regulation-SuggestionsChanging the RulesEnforcement of Federal Consumer Financial LawsIncreasing regulationIncreasing supervision and enforcement of lawsMost effective when used in conjunction with changing the scoringLack of regulation affects both borrowers and lenders, specifically high-road lendersChanging the ScoringChanging how profits are made in financial sectorMoving profits away from low-road competitorsPredatory lenders gaining revenue from subprime loansChanging penalties for violators

B. Economics in financial regulation-SuggestionsOpt-out options Defaults for financial products can be made to be the best, most optimal decision.Could also be a standardized one size fits most productIf they want to follow another option, they can opt-out of the defaultCan opt-out at anytime, whether default payments are too high or too lowChange behavior of both consumers and lendersFraming-creates a way of perceptionCan be framed poorly (not showing optimal choice for consumer)Salient features stand out and call to fast thinking mode of consumersCan be framed well (showing most optimal choice for consumer)Disclosures-better, more streamlined disclosures frame relevant information to help consumers choose

Basis ideasElizabeth Warrens Brainchild

Elizabeth warren

Senator from MassachussettsProfessor from Harvard Law SchoolPublished authorTwo Income TrapA Fighting Chance (her autobiography)Popularized idea of the Consumer Financial Protection bureau

http://www.bostonherald.com/news_opinion/us_politics/2013/10/elizabeth_warren_surges_in_new_prez_poll

Discussion of the financial marketFinancial products and services were vastly unregulated as compared to physical consumer goods Physical products regulated under the Consumer Product Safety Commission (CPSC)Innovation has incorporated factors of safetyPart of passing regulations and selling product soonerWhy shouldnt financial products have something similar?Innovation longer, more incomprehensible contracts that were nonnegotiable Regulation better innovation and better productsAt the time, lenders were in a race to the bottom

The two income trapOne of Warrens published worksOne of the main reasons behind her advocating for consumer safetyEven though families with 2 incomes would seem safe from bankruptcy, her research showed they were in ways more vulnerableThe safety net was not much of a safety net because of the extreme payments required by their loansIf one income earner failed, then there was very little to no financial cushions

Behavioral economics behind the cfpb

Sendhil mullainathanEconomics Professor at HarvardBehavioral EconomistPart-time assistant director of researchPoverty Impedes Cognitive Function Social experiment with farmers before and after harvestBefore Harvest: lower cognitive functions and worse mental processingAfter Harvest: better mental processing and cognitive functionsFinancial stress impedes cognitive functions

Appeal to ethosCFPB strives to be transparent and easy to work withWebsite appeals to younger audience and also presents transparency to the publicConsumerfinance.gov

CFPB organization

ConclusionEnforcement and SuccessesThe Bureau has shown several instances where they enforce consumer financial law on lenders and affected consumers receive money backComplaint systemProven to be very popularAmount of complaints almost doubled from 120,000 to 200,000 from July to September 2013Doubled again (400,000) by July 2014New agency showing new, effective methods of regulation