Cochrane on consumer financial protection

The John Cochrane shadow-blogging continues...

Cochrane has two posts up about consumer financial protection. The first is about the negative impacts of anti-usury laws:

Even a well-intentioned usury law has the unintended consequence that poorer, smaller, less well connected people find it harder to get credit.  And it benefits richer, well-connected incumbents, by keeping down the rates they pay, and by stifling upstarts' competition for their businesses... 

Here are just a few of the fun facts.

• Tighter usury laws led to less credit. People didn't easily get around them.

• Tighter usury laws led to slower growth. A one percentage point lower rate ceiling translates in to 4-6% less economic growth over the next decade. 

• Usury laws only affect the growth of small firms. Big firms do fine...

Now let's think about our massive financial regulation and consumer financial "protection." Let's guess who will end up benefiting...

This seems right to me (and Cochrane cites some research to back up these points). Anti-usury laws don't seem to have worked out too well in the past, either in terms of boosting economic performance or creating a more equitable society. Another downside of such laws, which Cochrane doesn't mention, is that anti-usury laws can lead to the proliferation of mafia loansharks.

The rationale for consumer financial protection in the U.S. - the main argument in favor of the Consumer Financial Protection Bureau - has always been that many modern financial products are too complex for consumers to understand (leading to either people being tricked, or markets breaking down because people fear being tricked). But high interest rates are not complex. They are very simple. People do not need government help to understand high interest rates. This means that the CPFB should ideally focus on complexity (and on behavioral effects that allow companies to repeatedly deceive consumers), not on the tightness of lending standards in general.

Cochrane's second post argues that since regulators are subject to behavioral biases, the CFPB will be no better at evaluating financial products than are the consumers that the agency is meant to protect:

Behavioral economics does not imply aristocratic paternalism. Behavioral economics, if you take it seriously, leads to a much more libertarian outlook. 

Which kinds of institutions are likely to lead to behavioral biases: highly competitve, free institutions that must adapt or fail? Or a government bureacracy, pestered by rent-seeking lobbyists, free to indulge in the Grand Theory of the Day, able to move the lives of millions on a whim and by definition immune from competition?  

Sure, the market will get it wrong. But behavioral economics, if you take it seriously,  predicts that the regulator (the regulatory committee) will get it far worse. For regulators, even those that went to the right schools, are just as human and "behavioral" as the rest of us, and they are placed in institutions that lack many protections against bad decisions. 

More generally, the case for free markets never was that markets always get it right. The case has always been based on the centuries of experience that governments get it far more wrong. 

This does not seem right to me. I don't think that behavioral theories apply to regulators in the same way that they apply to the people that the regulators are supposed to protect. 

For example, many behavioral theories rest on the idea that consumers are overconfident and exhibit considerable self-attribution bias. Regulators, when evaluating a financial product being sold by Company A to Consumer B, will presumably suffer from these same biases, but not in the same way. An overconfident consumer may say "Housing prices will always go up," even if a dispassionate analysis says that they won't. A regulator, by contrast, may be overconfident in general, but she won't be overconfident about the price of the consumer's house! 

So, just saying "regulators are people too" doesn't prove anything. The point of behavioral economics is not just to say that "people make mistakes"; it's to point out what kind of mistakes people make, and when.

(I should note that variants of this argument - "Governments make mistakes too!" - are extremely common among opponents of regulation. But just to say "Governments make mistakes, therefore we shouldn't rely on government for things" seems very wrong to me. We need to study what kind of mistakes governments make, and when. Otherwise we risk making the perfect the enemy of the good.)