Disclosure is Not Enough

There are few scholars I respect nearly as much as Richard Thaler (University of Chicago) and Cass Sunstein (Harvard), and none more. Their new book, Nudge, is chock-full of new ideas, and they pulled off quite a feat by winning the favor of both the Tories in the UK and of Obama in the US. However, even the best and brightest can get off on the wrong foot. Their claim, in a recent Wall Street Journal op-ed, that more and better disclosure is the best way to deal the current financial crisis, is wrong-headed.

Thaler and Sunstein suggest that those who sell mortgages, issue credit cards, and market cell-phone plans (among other goods) should be required to disclose in simple and digestible terms the true cost of the service in question, including late-fees and other surcharges likely to be incurred, as well as a pattern of the customer's own previous consumption of the product at issue. They realize that consumers are likely to be unable to properly process such information on their own -- a point they have helped prove beyond reasonable doubt in their contributions to a field of study referred to as behavioral economics. Thaler and Sunstein however presume that websites will spring up to help people figure out what is what, thus ensuring that consumers avoid sub-prime mortgages they cannot possibly afford, credit cards that charge more than the Mafia, and other such traps which, together, are currently threatening the stability of the entire financial system.

The authors conclude that requiring disclosure might eventually make other regulations unnecessary, by making "consumers better shoppers, enabling them to be their own regulators." Indeed, they dismiss current attempts by regulators to ban unscrupulous activities as a "whack-a-mole game." But, Thaler and Sunstein disregard that whether disclosure works or not depends largely on exactly the kind of regulation they dismiss: penalties for violation of the rules, and serious enforcement efforts by the government.

The fact is that disclosure is readily manipulated. Corporations have long been required to issue audit statements, but unless you are an accountant and lawyer -- and often even if you have these kinds of training--you cannot make heads or tails out of these statements, with their reservations hidden in footnotes and behind technical terms. Nor can one trust statements made even by the top management. Short days before Bear Stearns, Fannie Mae and Freddy Mac collapsed, their executives told the world that all was dandy. Without stiff penalties for manipulation of the information disclosed, the consumers are up a creek without a paddle.

The notion that consumers would be saved by private sector web pages that will spring up to make a buck by helping consumers to "read" their mortgage statements and the small print on their credit card statements and other such information, is rather naïve. First, how are consumers to tell which of these web pages are on the up and up, and which are themselves manipulative, serving the same people who issue misleading information in the first place? Nor do Thaler and Sunstein explain why such web pages would spring up to help consumers now when they failed to show up to protect people against corporations pushing sub-prime mortgages on those who could not possibly make the needed payments, or to protect people from signing up at a very low starting rate on a credit card only to find out that in the following months the rate is reset much higher.

There are few areas in which one can learn better how inadequate disclosure per se is than the requirements of political election campaigns to list the sources of contributions. Political Action Committees (PACs), composed by special interest groups, regularly adopt names that very effectively conceal whom they are pushing for. For instance, try to guess with which political party the following PACs are affiliated: "All America," "America's Foundation," "American Dream," "America Works," and "American Leadership Council." (Answers: D, R, R, D, R). The "Competitive Enterprise Institute"? It represents the major oil companies, and so on. Moreover, when disclosure laws are said to be violated by a political campaign, the matter goes before the deadlocked, minimally staffed, under-funded Federal Election Commission. If the commission does manage to find a grossly misleading disclosure, it is often months too late, well after the election is over.

If disclosure is to work, there must be clear requirements to ensure that disclosed information is digestible by people who have only elementary education and that a jury would not find it deliberately deceptive; significant penalties for those who deliberately provide false or misleading information; and well-staffed and funded agencies to enforce these requirements. Better yet, we need some of the old-fashioned kinds of regulation that will ban nefarious practices such as investing funds entrusted to financial institutions for safe keeping in highly risky assets, will separate commercial and investment banking, and will require that all financial institutions maintain a solid level of capital. There is room for disagreement about the details. However, to rely on disclosure per se -- and on private sector web pages to back it up -- is as naïve as it is insufficient. Disclosure requires backbone, and the financial crisis shows that there is fair range of business practices that are best banned.

Amitai Etzioni is a University Professor at The George Washington University and author of The Moral Dimension: Toward a New Economics.

Comments

[sourceview]

As much as I respect Etzioni, I must protest his current narrow perspective. Perhaps he should go back several decades in thought space and again focus on the big picture.

[Stanley]

How's this all add up? If you look at the number of foreclosures, it is not historically that high. If you take all the people in trouble and just give them the money lost it doesn't add up to the real problem. It's a misnomer to call this a housing crisis.

There are a supposedly 2 million weak loans who may be in foreclosure and if the housing market drops 10% with an average price of about 200k per house. 2 million x 20k = 40 billion

The math only ads up to 40 billion of real losses. Yes there is still a liquidity issue but its still firmly collateralized by a house and land. The liquidity risk is 2 million x 180k or just 360 billion of cash needed in the system to keep it all liquid.

The problem really is if you leverage the same 2 million problem loans, meaning borrow against the income from the mortgage and then lend it out, and do it again thirty times, which is the case, then the 40 billion balloons to a 1.2 Trillion dollar problem.

So the Fed is not really helping homeowners in need but criminally negligent lenders and accountants who incorrectly assigned risk, accounted for it on the balance sheet and then leveraged it out of pure greed.

This is an accounting and accountability problem and calling it a housing crisis is all a snow job.

[NABNYC]

Disclosure gives way to clever new ways to hide information and fool people. Or, in the alternative, so what if it's disclosed -- people have no other options. Your credit card "disclosure" may say that if you default they will raise the interest rate to 40%, but if all the other credit cards do the same thing, the consumer has no choice.

Disclosure in campaign contributions is the same: nonsense, lipstick on a pig if I may. They all take money, all take bribes, all vote as instructed. So what does it do the citizen to know that?

We need basic laws to stop the looting of our country. No compensation above $250,000 should be allowed as a business expense write-off. All compensation above $250,000 should be taxed at 90% and require a 90% shareholder approval. No more private secret investment vehicles which allow the famous to hide their nasty dealings. No more off-shore tax avoidance. No more private charities. Tax estates over $1.0 million at regular income tax rates. Eliminate the separate treatment of capital gains and include it in income. No more subsidies for the corporations. No more business write-offs for nonsense, like tax breaks for oil corporations. No business should be allowed to give money to any politician or political party, PAC, or anything else. They're not really "persons" for purposes of elections -- they don't get to vote. So let's cut the nonsense and get them out of politics.

[budderbean]

I am one that has fallen victim to the credit card scam.. The scam of giving me one in the first place. And the game they play to stack the cards in their favor. Security? They don't secure the cards against identity theft. You have to pay extra for that... If you don't they slip it in to see if you catch it. Somebody eles is using my card and I'm responsible? All work no play fir me... And the credit card company gets it's money?

Quick question (brain hurting) Since China is buying up all these loans. Will the call their collection call center be in China Now?

Yes I did Buy Some goods with the cards.. But those where at the cox stores.. I know what I bought and I do have and do honor those commitments. (big heavy word).
But the discover The MICKEY mouse card, (I wanted a WHAT ME WORRY? card) and the Barclay's Mastercard have all played trick on me. $250 cash with-drawl from and ATM I never received because I didn't gave a password. The machine didn't let me get the money.. but I got charged anyway.. Little things like that.. And then when you contest it they sit in their crystal tower and grin,. Humm Glass house' Glass house' may break but crytstle towers fall and break to.