August 13, 2008
The following article, "Disclosure Is the Best Kind of Credit Regulation," co-written by Harvard Law School Professor Cass Sunstein '78 and University of Chicago Professor Richard Thaler, was published in the Wall Street Journal on August 13, 2008.
The Federal Reserve Board recently issued proposed amendments to Regulation Z, which governs Truth in Lending. According to the Fed, the amendments "are intended to improve the effectiveness of the disclosures consumers receive in connection with credit card accounts and other revolving credit plans by ensuring that information is provided in a timely manner and in a form that is readily understandable."
The Fed's interest in this problem should be applauded, especially in light of the consumer credit crisis. Improved transparency, rather than draconian regulation, is the best response to the current situation. However, the Fed can substantially improve its proposal by requiring credit issuers to disclose relevant information electronically in a standardized, machine-readable format. In one simple stroke, new disclosure requirements would dramatically improve the current situation.
Here is how the process could work for credit cards. Once a year, credit card issuers would be required to make available to users two secure electronic files. The first would be essentially a spreadsheet that listed all the ways in which a customer can be charged. For example, the spreadsheet might reveal that if a payment is received late, the customer is charged a fee and the interest rate is raised by 200 basis points. The disclosure would also reveal how much customers are charged for transactions in foreign currencies. The second file would be a list of all the actions the customer made in the past year that incurred a charge.
To be sure, most consumers would not read these files in any detail. Instead we anticipate that new third-party Web sites would compete for the business of distilling the information in the files. The Web sites would serve three purposes. First, they would translate the information into plain English. Second, they would explain to consumers how they could save money by changing their behavior. And third, they would point consumers to alternative providers that, given their past behavior, would provide a better deal.
None of these functions is being adequately provided now, and for one simple reason: The precise details of the terms being offered are not easily available. A useful analogy is the case of Morningstar and other firms that track and evaluate mutual funds. Their activities are possible only because the government requires mutual funds to disclose their holdings. By comparison, no similar services exist for hedge funds, because the information on their holdings is unavailable.
For now, electronic disclosure should be viewed as a supplement to the new rules the Fed is proposing. In the long run, this disclosure requirement might eliminate the need for future changes in rules. Everyone, including the Fed, is well aware that in banning activities that have caused justified ire in some quarters, the regulator is playing a game of whack-a-mole. If some method of making money is eliminated, lenders will find a new way in the near future. Merely by making market pricing more transparent, better disclosure can make consumers better shoppers, enabling them to be their own regulators.
The same concept should be widely adopted as the 21st century's first-line approach to consumer regulation. At least in general, the government should not decide which pricing practices are permitted; it should simply require suppliers to make their pricing observable.
Continue reading "Disclosure Is the Best Kind of Credit Regulation."
Messrs. Thaler and Sunstein, professors at the University of Chicago Graduate School of Business and Harvard Law School respectively, are the authors of "Nudge: Improving Decisions about Health, Wealth and Happiness" (Yale University Press, 2008).