Like it or not, Congress has passed far-reaching financial system reforms over the past year, including new limitations on credit card issuers and the creation of a consumer financial protection watchdog. Critics contend that the new regulations will stifle "financial innovation."
Both sides have debated whether this is true, but even if the reforms do stifle financial innovation in the consumer market, should we care?
While we all love innovation, there have been relatively few advances in the US that have actually helped consumers access and manage their finances better in the last fifty years. The most lasting (the ATM machine in 1961) and the most promising (peer-to-peer lending in 2005) didn't even come from Wall Street.
There is a strong argument that financial innovation in the capital markets is good for society (well, except when it causes the occasional financial crisis). But we ought to be more skeptical about the general consumer market. In recent years, most of the consumer financial innovations have been largely about getting ordinary people to borrow at pricing structures that they don't completely understand. This isn't innovation -- it's excessive complexity.
Some of these infamous innovations include:
Subprime mortgages. While proponents argue that these mortgages would be the only way for the credit-unworthy to buy a home, the problems far outweigh the benefits. For the past decade, consumer advocates have been complaining that mortgage brokers pushed borrowers into subprime loans even when they qualified for a prime loan, a practice called "steering," which is curbed in the latest reform bill.
Some estimate that half of all subprime borrowers actually qualified for a lower rate. Mortgage brokers could pocket a fat commission without taking on any risk if the loan went bad.
While some non-standard mortgages, like adjustable rates, interest-only, and "pick-a-pay," might have seemed attractive to some consumers, many of them didn't even know they had one. A survey conducted by Bankrate just before the financial crisis revealed that 26% of borrowers didn't even know what type of mortgage they had.
Check-cashing and payday loans. These financial services are largely used by poorer Americans who need cash so quickly that they end up taking loans that can be over 3,000% APR in the form of fees or interest. This is essentially kicking people when they're down. Many of their customers could solve their problems simply be applying for a checking account that is free with direct deposit.
There are now more than 22,000 outlets in the country who process over $40 billion in transactions annually. The industry will finally get an overseer with the latest reform.
And there's many more, from the exotic credit cards to the aggressive debt settlement services. They are profitable largely due to opaque pricing structures, not because they address an underserved segment of the market.
A lesson for all of us is that if a new financial product can't be explained in normal-sized font, we should seek the help of a lawyer or expert (who doesn't have a vested interest in the outcome) to make sure we truly understand what we're getting in to.
The bottom line is that our laws will always be a few steps behind our financial innovators. But given their record over the last several decades, it's better for the long-term health of the economy if we watched over them a bit more carefully when they're selling directly to consumers.
No one would ever say that selling a lemon is innovative -- we need real financial innovations that make everyone more prosperous, not just the salesman.
Follow Rohit Chopra on Twitter: www.twitter.com/hitchop
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And what's with lumping payday loans in with subprime mortgages? It's derailing reform from delivering justice for the consumer. We need reform to reign in the Wall Street banks that sunk the economy. We may not agree with their business model, but payday lenders did not create the mess we're in.
Guess the author considers Wall Street's use of "creating value" for its predatory practices well justified too.
"Swindling."
"Fraud."
"Usury."
"Deception."
"Stealing."
"Merciless."
Even: "murder."
No one wants those ancient words to be used, though. "Innovation" sounds so much nicer. It sounds "newer," and doesn't everyone like "new and improved" things?
Well, this is neither new nor an improvement. It is not innovation. It is exploitation. It is crime. Furthermore, it is sustained by the High Crime of Bribery.
Criminals sold other criminals in Washington DC on the idea that laws are unnecessary, and that the laws we have should not be meaningfully enforced. They removed a critical piece of legislation that kept banking, finance, and insurance at arm's length from one another ... a stable tripod became an unstable tower that promptly fell over. No one cared, because they were making "so much (Rumpelstiltskin) money."
The only way to change this scenario is to confront it head-on ... specifically including the enabling crime of Bribery, which turns a government against its citizens. Civil officers who are "on the take" for more than $1 million per person per day (that they ADMIT to!) will do nothing to implement change on their own accord.
Only the teaser rate was affordable.
Countrywide (CWHL) and other lenders did this so the borrower would have to refi in 1-3 years--and CWHL would make fees twice on the same property.
Loading up consumers with un-necessary expense. The most vulnerable consumers.
Angelo Mazilo of CWHL unfortunately, wasn't coordinating with Alan Greenspan. One day Alan got up and decided that the bubble he had created had run its course and he enacted 16 consecutive rate hikes. So, all of those folks in ARMs couldn't be structured into affordable fixed rate loans because the interest rate had now increased.
This started the first wave of forclosures. When banks got clogged up with RE losses and couldn't lend to businesses, it created massive unemployment and the 2nd wave of foreclosures.
That's how we got here.
Regulatory agencies should assure that loans are extended based on documented affordability. Underwriting should be completed to assure affordability at the worse-case scenario interest rate.
It is a cruel joke to call this an "innovation." It was exploitation. people who were looking at home prices rising every year for 30 years. If they didn't buy, next year it would be more unaffordable. They made rational decisions in a market where their interests were unprotected.