A Financial Product Regulatory Board is a Bad Idea

The other day it was announced that Obama was investigating starting a regulatory commission for financial products that would ensure that they were “safe” for consumers – basically a financial version of the FDA.

From WaPo:

The Obama administration is actively discussing the creation of a regulatory commission that would have broad authority to protect consumers who use financial products as varied as mortgages, credit cards and mutual funds, according to several sources familiar with the matter.

The proposed commission would be one of the administration’s most significant steps yet to overhaul the financial regulatory system. It would also be one of its first proposals to address causes of the financial crisis such as predatory mortgage lending.Plans for a new body remain fluid, but it could be granted broad powers to make sure the terms and marketing of a wide range of loans and other financial products are in the interests of ordinary consumers, sources said.

This is a bad idea, and I’ll tell you why.

Financial products are different than any other product.  They are not drugs.   They can’t be tested on small subgroups of people for safety.  There is only one test and that is the market at a given period of time.   Since rarely, if ever, do you see the same market twice, even a longstanding product can’t be ensured to be “safe” or “good” for consumers, and time only increases the chance that something crazy will happen.

Terms for financial products may seem good, and while at the onset some terms are definitely better than others, there are no terms that protect the consumer from market risk, moral hazard, and many of the other elements of markets that are timeless and not going anywhere any time soon.  Saying that the government can protect the consumer from this is naive and will almost always end up in disappointment.

Moreover, I believe there is a dangerous unintended consequences lurking here.  What happens when something goes wrong?  Now that the government has given this product its “seal of approval” surely it stands behind such a thing.   This is going to force the government’s hand towards bailing out the consumer of the product should a loss occur, or something go wrong.  Furthermore, like the FDIC, it allows the issuer of the product to hide behind the veil of the government regulatory board not its own desire to build a good, clean business and reputation.  This will almost certainly end badly – especially when Government and the financial companies are already kind of cozy.

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  1. alephblog

    Well said. Add in that different people have different needs. What might be appropriate for one person might be inappropriate for another. Also, what might be an appropriate product at one point, can be inappropriate at another point in time.

  2. zerobeta

    Great points there. Another unintended consequence could be the fact that people won’t make as much as they could make. With a focus on less risk and lower “fees”, managers of these “approved” products may earn their keep by structuring complex products that pay them outsized fees in the form of lower returns. On paper they may be safe and low fees but very low return for the risk that’s being taken.




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