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If Not Health Care Reform...

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While the media ponders the fall of the Obama administration as do-nothing senators and faint-hearted representatives erect barriers to health care reform, quite a different storm is If brewing in the House Financial Services Committee. There, committee members have heard testimony from the Fed Chief Ben Bernanke and the Treasury Secretary, among others, about President Obama's plans for financial regulatory reform. For his part, Bernanke came out, as many others have, against the linchpin of the reform proposal: a Consumer Financial Protection Agency that would regulate financial products and establish minimum standards for mortgages and other loans.

The success of this proposal is, indeed, a better litmus test for Obama's political health than health care reform because, unlike any other significant legislation considered by Congress this year, the administration presented a fully drafted bill to Congress. For health care and climate change (and likely for the comprehensive immigration reform bill that will be considered early this fall) President Obama declined to offer specific legislative language, preferring to lay out "principles" for his preferred programs.

So far, resistance to the Consumer Financial Protection Agency is fierce. Conservatives like Texas Representative Jeb Hensarling argue that the CFPA will limit consumer choice and stifle innovation, even claiming that such an agency would have outlawed ATMs, frequent-flyer miles, and debit cards.

Richard Posner, writing in The Wall Street Journal on Wednesday, espouses a similar view, but ascribes to CFPA-supporters a dismal view of humanity. He writes:

The plan of the new agency reveals the influence of "behavioral economics," which teaches that people, even when fully informed, often screw up because of various cognitive limitations.

Certainly, one of the goals of the CFPA is to permit consumers to make smarter decisions about financial products. And this is done not just by improving the information available to them, but by, for example, banning dangerous products.

But the agency is not designed to eliminate bad decisions made by dumb, irresponsible borrowers. Far from it, the CFPA targets dumb, irresponsible lenders. The agency's champion, TARP overseer and Harvard law professor Elizabeth Warren, described the aims of the agency in a 2007 article for Democracy:

To be sure, creating safer marketplaces is not about protecting consumers from all possible bad decisions. Instead it is about making certain that the products themselves don't become the source of the trouble.

Posner and others use behavioral economics to rally against the CFPA because they believe the field channels government bureaucracy to limit the choice of individuals who, even if of limited cognitive ability, would make better decisions without regulation. In fact, the agency targets deceptive products. Indeed, it is difficult to see how removing dangerous mortgages and credit cards from the marketplace does anything to individuals' decision making at all, besides make it less likely that they will take out a loan they cannot afford.

The Obama administration is currently losing its argument for the CFPA. It is suffering under some of the same criticisms as its health care reform plan: in particular, that choice will be limited by minimum regulatory standards. The criticism is a false one. But, as the administration falls back on its success at saving the economy from the brink as its primary accomplishment, a victory on financial regulatory reform will be essential.