Democrats in Congress are taking a page from the drug war playbook to see if they could apply it to new financial regulation.
The drug war model was suggested by Harvard professor Dan Carpenter, University of Iowa law professor Katherine Porter and others, as part of the Tobin Project, an alliance of academics seeking to shape debate on public policy. The Controlled Substances Act instructs the Food and Drug Administration to parse drugs into five separate categories, known as Schedules, based on their harmfulness, usefulness and risk of abuse.
Rep. Brad Miller (D-N.C.), in coordination with policymakers at the Treasury Department, is considering their proposal and the possibilities of applying it to financial regulation. (Read the papers that are influencing the discussion.)
"In the [drug-regulation] statute there's this gradation of five tiers of regulation, how strict the regulation is," says Miller. "And it's based upon the risk of harm and the usefulness. So aspirin is useful, doesn't have any recreational applications and if you wanna buy it over the counter, you can. LSD is harmful and has no medicinal value. It only is recreational. It's prohibited in every circumstance, and then there's stuff in between."
LSD is in Schedule I while aspirin isn't scheduled at all. Highly risky investment products -- say, adjustable rate loans where the borrower provides little documentation of income and only pays a portion of the interest for the first several years -- would be placed in a higher schedule and more strictly regulated. A standard 30-year fixed rate mortgage to a borrower with well-documented ability to pay could be in a lower tier and encounter less red tape.
Lenders, says Miller, could use form contracts that have been pre-approved in cases where the products are standard or familiar. "They would actually issue a form contract and say, 'If you use this contract you will get in no trouble with us. If you want to do something different, then there's the possibility of disapproval. And you've got to advertise it; you've got to let consumers know in a really conspicuous way, that they're using a form that's not approved by the regulator,'" said Miller, pointing out that the regulatory proposals were "just discussions" at this point.
The approval process touched on by Miller relates to another FDA-related regulatory approach. Today, a lender can gin up whatever exotic product it can think of and sell it to any customer willing to take it. Miller and other Democrats are looking at slowing that process down. Much as a new drug must first be tested and deemed safe, so would a new financial product.
Elizabeth Warren, head of the Congressional Oversight Panel, has advocated for a Financial Product Safety Commission modeled after the existing Consumer Product Safety Commission. The new ideas being floated would still create an FPSC, but model it instead on drugs. The reason is simple: A toaster that catches on fire is a bad toaster, no matter who uses it. But some drugs are safe for some people while dangerous to others.
"Pharmaceuticals, like credit products, are not easy to categorize as safe or dangerous on an across-the-board basis. The task is to calibrate the product to the consumer and to balance the benefits of use against the risks. The FDA has to contend with the hard reality that some people are willing to suffer grave side effects to cure grave diseases, just as some people are willing to suffer severe financial distress to relieve severe privations," writes Porter in a paper that has influenced Miller's thinking.
The problem with the consumer commission, writes Porter, is that the "agency largely uses a binary approach, either banning or approving products, without promulgating guidelines for their use."
Sending new financial products through government hoops would slow down innovation but lessen systemic risk. It was the exotic innovation, after all, that got the U.S. economy into this mess in the first place. The FDA approach might be one way to keep the system healthier.
"In order to get the drug approved, drug manufacturers know that they really need to come in with a lot of data. And then the approval can be limited. It can be limited to use in a certain market for a certain time, and there can be conditions on the approval," says Miller. "The analogy is that a consumer financial product -- retail financial product -- could be allowed a limited market, initially, for a limited time. And then see what the experience is during that period. That is a profound change from what we've had before."
It's not the kind of change House Republicans can believe in. Rep. Mike Pence, a leading conservative Republican from Indiana, responded to the idea by telling HuffPost he wants "...the government out of the business of picking winners and losers and assessing risk. I think the American people want a refereed private sector, but I think there's an awful lot of fatigue about government intrusion into various aspects of the economy."
My book, This Is Your Country On Drugs: The Secret History of Getting High in America, is now available. And, for the record, I asked Miller if he was sure LSD has no medicinal value. "If you want to defend the use of LSD, you go right ahead, but I'm not going to. My name is on a ballot and yours is on a byline. There really is a difference," he quipped.