Consumers Need Protection from the CFPB

A new paternalism is on the rise.

Using the insights of behavioral economics, agencies like the Environmental Protection Agency and the Consumer Financial Protection Bureau have been regulating the economy in ways never witnessed before. These agencies seek to identify perceived shortcomings on the part of the consumer rather than address shortcomings in the marketplace. In other words, consumers are now being regulated because they are considered to be less attentive to detail — and therefore more likely to make harmful choices — than government officials.

This reorientation of regulatory strategies was spurred by the realization that people, by nature, are not always rational in their choices. According to some experts, consumers tend to save less than they should. They tend to overestimate their future ability to pay the bills and underestimate the debt obligations they place on themselves when taking advantage of credit opportunities. At least, this is the reckoning of the group of academics and policymakers responsible for regulating consumer credit in this country.

One of the latest targets of such regulators is payday lending. Payday lenders usually offer a two-week loan, with the interest plus fees of that loan amounting to around $15 for every $100 borrowed. The loans are typically paid back in full around the time of the borrower's next payday.

Nonetheless, the CFPB has released a 1,300-page statement excoriating this industry for what is seen as predatory lending that takes advantage of the average borrower's low cognitive ability. The policy response is yet to be defined but it will likely include measures like limiting the number of rollovers.

In reality, the profile of a typical payday loan customer is someone who has low income and lacks access to more mainstream credit products like credit cards and home equity lines. Their cognitive abilities seem fairly consistent with other credit users; only their economic circumstances differ.

In effect, the alternatives available to payday lending customers do not include the type of credit products regulators enjoy. Rather, they include a series of less desirable credit products, such as overdraft fees, credit card cash advances, pawnshops or selling off their possessions. Removing one or more of these sources of credit doesn't fix the problem; it only forces customers into a less preferred alternative.

For a self-described "21st century agency that helps consumer finance markets work by making rules more effective, by consistently and fairly enforcing those rules, and by empowering consumers to take more control over their economic lives," the CFPB has made a series of moves that do less to empower consumers and do more to take away what limited credit options they have.

The CFPB is a virtually independent $600-million agency, and its budget is not subject to oversight from Congress. It's no wonder the agency has reacted to its mandate provided by the Dodd-Frank Act by issuing rulings — and thinly veiled threats — to a wide swath of the marketplace, including parts it was told not to interfere with, such as auto lending.

Government agencies running amok are hardly novel. What's new about this particular agency is how it tinkers with regulating the marketplace. The agency essentially chooses products — or even entire categories of products — that a consumer may have trouble understanding. It then targets the firms that offer these products by putting regulatory and other market pressures on them to obstruct, reduce or terminate their respective businesses.

Recently, a federal appeals court ruled that its structure is unconstitutional; however, that is just a start to ensuring that consumers are protected from a consumer protection agency.

It is one thing to have an agency championing consumer protection against fraud, but it's quite another to have one looking out for consumers' perceived lack of willpower or intelligence. It is akin to accepting that agency officials are capable of making better decisions for us than we are for ourselves.

As former EPA administrator Brian Mannix wrote in 2010:

The chief danger is that regulatory agencies will take the irrationality of consumers as sufficient reason, by itself, to intervene in markets, and will give primacy to the government's own judgment of what is good for us.

This explains why the CFPB wants to drive out certain options altogether rather than approach problems in a nuanced and data-driven manner. It's much easier to vilify market services with labels like "predatory lending" and "shrouded fees" in an effort to intimidate them out of existence than it is to appreciate the exact manner in which these credit forms are utilized by actual consumers.

Protection is important: It's why governments exist. But for a government agency to operate effectively there must be institutional checks and balances.

Adam C. Smith is an associate professor of economics and director of the Center for Free Market Studies at Johnson & Wales University.