Sunday, January 29, 2012

US vs. UK: Crack Down on Bad Behavior or Just Ban the Products?

Over the last week, both the U.S. and the U.K. have moved to protect consumers of financial services. In his State of the Union address on January 24, 2012, President Obama highlighted the appointment of Richard Cordray as the new head of the Financial Consumer Protection Bureau. However the U.S. President went further and announced the creation of a new Financial Crimes Unit, consisting of federal prosecutors and leading state attorneys general with the mandate to “expand our investigations into the abusive lending and packaging of risky mortgages that led to the housing crisis." 

The special unit has no fewer than five co-chairs. They are:
  1. Eric Schneiderman, Attorney General of New York State,
  2. John Walsh, Attorney General of the District of Colorado,
  3. Robert Khuzami, Director of Enforcement for the Securities and Exchange Commission,
  4. Tony West, Assistant Attorney General for the Civil Division of the US Department of Justice and
  5. Lanny Breuer, Assistant Attorney General for the Criminal Division of the Department of Justice.

Not all analysts welcomed the move, citing concerns over the Financial Fraud Task Force. Despite – or perhaps because of -- representatives from more than 20 federal agencies and 94 U.S. attorneys offices, in two years the Financial Fraud Task Force resulted in no major successes. Among the banks that had wrongfully foreclosed upon homeowners, not one of the CEOs was held accountable for their actions.

Safe and Fair Finance Blog takes a different view. Much has changed since 2009. President Obama and other politicians have come to recognize that the 2008 financial crisis was also a crisis of fairness. It showed that ordinary people – those who work two or three jobs just to pay the bills – have little chance of winning a battle with financial institutions. It showed that ordinary consumers are befuddled by confusing financial products and smooth-talking sales personnel. It showed the unfairness of the current financial system.  Safe and Fair Finance Blog therefore welcomes the creation of a special unit with strong teeth and encourages the five co-chairs to do all necessary to improve the fairness of U.S. financial system.

Change is also afoot in the United Kingdom. As noted in his interview last week with the Financial Times, the head of the new investor protection and markets watchdog, Martin Wheatley, explained that the 2008 crisis changed the way financial regulators think about consumers of financial services. Mr. Wheatley noted that in the past the regulators had thought of consumers as homines economici. The regulators relied on game theory and assumed that all agents (a.k.a. consumers) would behave rationally and use optimal reason. No longer. The new approach is to allow the Financial Conduct Authority to “step into their [consumers'] footprints.”

Mr. Wheatley points out that, “Faced with complex decisions or too much information, they [consumers] default…They hide behind credit rating agencies or behind the promises that are given to them by the salesperson.” The decision then is to allow the new financial conduct regulator to explicitly ban – or at least limit the sale of – financial products that could harm consumers.

Now we need to wait and see.  Is the U.S. approach of cracking down on bad behavior effective? Or would it be better to follow the U.K. and simply ban the sale of harmful financial products, as if they were toasters? Keep posted for updates.

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