With the most recent financial crisis still fresh on our minds and a double-dip recession looming, the U.S. has doubled down on its efforts to prevent the kind of practices that would lead to another crisis. Most notably, with the creation of a new government bureau--the CFPB (Consumer Financial Protection Bureau)--that has now taken over regulatory authority for consumer financial activity from the FTC, Federal Reserve, and the Department of Housing and Urban Development. While the timing of this initiative makes sense, it’s not yet clear how well it will work. The bureau’s primary goal is to protect and educate consumers and regulate bank and non-bank entities in order to prevent large-scale financial disasters, like the most recent mortgage crisis.
I believe that in order to accomplish this, the bureau must maintain a laser-like focus on bringing full transparency to the financial industry. But the definition of transparency that is often used can end up confusing the issue even more: Instead of simply making all numbers available, we need to make the numbers clear and understandable.
As someone leading a technology startup company that is helping Americans better manage and get out of debt, I’ve seen the effects of the most recent crisis firsthand. I’ve been following the progress of the CFPB closely in the hopes that it will be successful in its efforts to protect consumers. In fact, exactly one year ago, my cofounder and I had the opportunity to meet informally with the CFPB (before they had any real authority to take action) to discuss ways of getting better outcomes for consumers. We were very impressed by the caliber of the people we met there. They were optimistic, knowledgeable, and excited to make serious changes to the financial services industry as a whole. In short, they had the same goals in mind that we did when we started ReadyForZero.
Since then, after a controversial recess appointment by the President, the CFPB has added a new leader, Richard Cordray. Now the time has come for the bureau to take action, and there is a lot to do. Not to mention, as Mr. Cordray mentioned in his inaugural public address, “the stakes are high.”
But do we actually need the CFPB or any other regulatory body for that matter to protect us?
The short answer is: Yes, we do. The longer response has more to do with how things get done as opposed to if things should be done. Here’s why this is necessary: Financial products have gotten too complex for the average consumer (in some cases they are too complex for the experts, too). Budgeting and cash flow are hard enough for most American families (especially when there are no jobs). Add a dash of amortization, net present value, retirement, and finance fees and you have a challenge hard enough to stump most graduate students. But managing your money and debt obligations shouldn’t require advanced degrees or specialized knowledge.
Unfortunately, today’s confusion is in part because of product complexity but also because of the new regulatory landscape. New laws sometimes mean companies need to employ creative techniques, techniques which further confuse and frustrate customers. This has the unintended (we hope) side effect of getting them into more serious financial trouble. This, in turn, has a greater negative impact on our economy as a whole.
A simple example of what can happen when strict regulations meet the reality of financial services is the credit card informational table known as the Schumer Box. Named after Senator Schumer, the Box (example below) was designed to be placed on credit card agreements to highlight the key details, things like APR and payment terms, and make them understandable to all potential cardholders.
Similarly, the most recent CARD Act requires other bank disclosures that, for example, require showing customers the consequences of paying only the minimum payments.
Unfortunately, the Schumer Box is much easier to understand in theory than in practice. As you can see, even with something as simple as the Annual Percentage Rate, it’s hard to say exactly what’s going on, and the small print and confusing language of credit card agreements still appears in spades. What is the last day of the billing period? (An asterisk points you to the additional--small print--details.) Why is there an almost 10% difference in the possible standard APRs? (Another double asterisk points you to those details.) It wouldn’t be surprising if some financial experts still had trouble understanding what the consequences of this financial product were.
Within the context of the financial services industry, transparency doesn’t just mean making the “raw” information available, it means presenting the right information in a way that meets the needs of consumers. In the example above, it is obviously extremely valuable to have key information about your credit card in a digestible form, but it would be even more helpful if it included specific details about your account and financial situation. For example, it could include your actual monthly obligation, and how that might change if you took a cash advance or after it shifts to the standard APR. What is the cost of making a $100 charge at these rates? How much income do you need in order to support your current spending?
The best argument for increasing transparency is that it will ultimately lead to both more profits for financial institutions (in the long-term) and less frustrated customers (in the short-term) because people like you and me will be able to avoid getting involved with financial products that we don’t understand and ultimately defaulting, a problem that is currently costing financial institutions billions of dollars. In many ways, it’s no different than using credit history or behavioral data to determine whether someone is a good credit risk or not. If you can improve payment behavior by helping people understand the consequences of their financial decisions, you will get better outcomes for both individuals and the lenders.
Whether or not a bureau like the CFPB will be able to step up to these demands will depend on how well they understand consumer needs and financial behaviors. Transparency will be the key that helps unlock a healthier, more data-driven and profitable financial services industry.