A while back, I described the “illusion of inclusion” – what happens when financial products reach under-served consumers or investors largely due to terms that advantage the provider instead of the customer, advertising that a product has vital protections such as FDIC insurance, little of the customer-servicing capacity needed to prevent undue loss, or the vulnerable are otherwise persuaded to take a chance that’s just too good to be even close to true. The events this week show that some policymakers are taking notice, but the notice is so limited and the risks so large that much more is required before still more of the financially fragile are put at even greater risk.
First, Senate Banking Chairman Brown called on the CFPB to investigate not just one nonbank claiming to be a bank even as it summarily closed consumer accounts, but also for a review of all nonbanks now outside the reach of critical consumer-protection safeguards. Second, state securities enforcers struck out at BlockFi, a crypto company opening what purports to be savings accounts paying a 7.5 percent rate of interest on crypto assets. All of the “depositors” and “investors in these “bank” accounts think that the new provider will beat all the old, tired, low-rate offers, as are Robinhood’s customers. Very few of them can, though, afford to take a real risk – Robinhood’s investors aren’t merry men; they instead have a median investment of only $240 with this fun firm.
The problem here isn’t just a few rogue actors. There will always be marginal providers – indeed even some big and perhaps also regulated ones – who do ill in the name of innovation. If that’s all that were happening now, then stepping up the pace of enforcement would ensure that bad actors are ensnared and, if needed, rules can eventually be wrought if enforcement doesn’t suffice.
However, this wait-and-see, piecemeal approach belies hard truths and even harder experience. One might say that, if only a small sliver of consumers or investors is harmed, then ex ante enforcement might well seem sufficient given the putative efficiency and inclusion benefits of wide-open innovation. But harm to small market segments still means loss to many, if not also thousands, of vulnerable households. To each of them, that’s a high price to pay even if a pittance of enforcement remuneration eventually trickles their way.
Almost forty percent of Americans have less than $400 on hand against the unexpected. Thus, loss of even a little money to ill-behaved financial providers puts all too many at grave, long-term risk even for losses some might well think negligible.
Further, consumers bewitched by the promise of a higher return at a time of negative ones across the regulated sector don’t deserve their fate at the hands of the unscrupulous. They are desperate for the yield vital to even a hope of a little wealth accumulation. They thus more often than not fail to understand the risks they run when marketing is seductive and product agreements are impenetrable to all but the lawyers who wrote them. The more financial companies are able to advantage themselves via information asymmetry, not product value-add, the riskier grows the financial system as a whole. Been there, seen that, don’t need to do it again.
Once, we trusted auto manufacturers to bring out the latest, most original cars inspired by the spirit of innovation and the demands of an efficient market. Starting in the 1970s with the infamous Pinto expose, we learned that trusting safety and soundness to the marketplace put too many innocent lives at too much risk. Only some kids died in these crashes, but some was rightly seen as too many. We thus mandated where gas tanks are located, that cars must have seat belts and airbags and over time also that each car must have protections seen and unseen to protect even the driver who wants to take risks so others do not suffer needlessly thereby.
Highways also have guardrails to keep all cars where they belong, not just those which for some reason or another seem most prone to go off the road. Despite all these rules, we have automobile innovation, lots of it.
In the absence of like-kind rules for like-kind activities, we are designing a financial system full of Ford Pintos on roads with higher and higher guard rails thanks to bigger and bigger bailouts. This means more crashes that kill more people even though the roads stay clear for emergency vehicles. Surely, we can build in some seatbelts now to protect the innocent later on.