How Far Should the CFPB Go to Save Consumers from Themselves?

Behavioral economics is one of the hottest fields in academia, and also one of the most controversial.

Researchers in the field are examining how cognitive, social and emotional biases can influence individuals' decision-making. Why, for example, do poor people often get caught in a cycle of debt that has harmful long-term consequences? Why don't Americans save enough for retirement?

To its champions, behavioral economics offers a welcome corrective to the long-standing belief by many economists that individuals are rational actors. But as the field's influence has grown — some of its leading scholars have occupied prominent roles in the Obama administration — so has criticism. Some conservative critics argue that the field is being used by liberals to provide an academic rationale for the policies they prefer.

More than perhaps any other agency, the Consumer Financial Protection Bureau finds itself at the center of this fight. Ultimately the question is: how far should the government go to protect consumers from financial decisions that policymakers deem harmful?

The CFPB's former head of research, Sendhil Mullainathan, is one of the world's leading behavioral economists. Mullainathan teaches at Harvard, and he is the co-author of a new book, "Scarcity," that has important implications for the consumer finance industry.

The book argues that the short-term thinking of many poor people — who worry about how to pay their immediate bills without much regard for their long-term financial outlook — is a psychological consequence of the scarcity they face. Their lack of money taxes their mental bandwidth, and leads them to a narrow, short-term way of thinking.

The book draws analogies between people who are poor, people who are extremely busy, and people who are lonely. In all three cases, people lack something they need, and it clouds their judgment.

"You might see someone who's poor go to the mall and buy something that they don't need," Mullainathan explains. "And you'd be like, 'How can somebody at the edge waste so much money?' Now, picture someone else you know who's so busy, but goes and spends hours wasting time on the Internet. And you might say: 'How could someone who's so busy end up wasting so much time?' And those are so very similar behaviors on some level."

Mullainathan spoke to American Banker on Friday about the book, and about the use of behavioral economics by policymakers. He was on his way to London, where he was scheduled to speak at the Financial Inclusion 2020 Global Forum, which runs through Wednesday.

Below is an edited transcript of the interview.

You seem to agree both with the idea that payday loans tend to be destructive over the long term, but also that they meet real short-term needs. And you hint at ways that you think that the payday loan might be improved. Can you expand on that?
Sendhil Mullainathan: I think of a payday loan a little bit like if one of my undergrads came to me one day before a paper is due and said, "I really need an extension." And I said, "OK, I'll give you an extension, but the paper has to be really, really good." The student would take that deal. And they're taking that deal because it solves their most immediate problem. And they're kind of creating a problem down the road. But they're not really thinking about that.

I think a payday loan is the same thing. And I think that products that would substitute for a payday loan should be ones that not just ban them, because then you haven't gotten rid of the real need they address. And so we should be looking to products that address that need, but don't address it by creating some bigger issue later. One possibility, which has been tried, is one which looks a lot like a payday loan, but takes the extra fees and puts them into a savings account. And what this means is that after a few payday loan cycles, the savings account is now big enough that you're actually in effect now borrowing from yourself.

Can you give me some insight into how behavioral economics is impacting the CFPB's work?
You don't want to use behavioral economics to basically impose your beliefs on other people. I think the dangers in using behavioral economics in policy are all around somebody using it to justify something that maybe they just think other people should do. I have friends who are perfectly happy with the type of food they eat, yet they look unhealthy to others.

I think two kinds of behavioral problems are emerging. The first is: people intend to do one thing, but they do something else. For example, how do we know Americans aren't saving enough? You ask them, and they'll say, 'I'm not saving enough.' You ask them, 'Are you going to save next month?" And they say, 'Yeah, I'm going to try.' And what we know is they're not able to succeed.

The other case I call confusion, where people are clearly just misinformed about certain very important facts about the products they choose. So if you were to get somebody who just took out a mortgage at the teaser rate, and they were to tell you, 'Oh yeah, this is going to be my rate for the next 30 years.' Now you know there's a problem, because that's not true.

So I think that's the direction that behavioral economics is going in policy — find these pockets where we have pretty solid empirical evidence that there's a problem, and then constructing policy remedies around the evidence.

You alluded to an argument that some conservative critics of behavioral economics have made, that this is just sort of a way to put a veneer of academic responsibility on paternalism. Do you think that's a real danger, or is it kind of a caricature of what's going on?
I think it's a real danger. I'll give you two very extreme examples. When you look at drug behavior for diabetics, that has really large consequences, when diabetics fail to take their medication. Like 100,000 limbs are lost every year because people aren't taking their meds. This is a pill with very few side effects. I mean, it's just a no-brainer.

Drinking sugary sodas? Now, that's a much harder case to make. Because soda provides some utility, and there's no doubt it has some health costs. It's easy to imagine somebody looking at that tradeoff and saying, "Fine, I'm going to live a little bit less in my life. But I love the utility. I want to drink it."

Somewhere what ends up happening is: the same principle tries to be applied to the soda case. You can see it already happening, and I think it's a legitimate concern. I think that what's a mistake is saying that because we have that legitimate concern, we shouldn't do anything.