It’s been said before, but it’s worth reiterating. During the heady years of the credit and housing bubble, financial innovation seemed harmless, exciting, even lucrative. Wall Street experimented with new and increasingly intricate ways to bundle together mortgages, slice them, repackage them, rate them risk-less, and sell them into the secondary market. American consumers scooped up these products too. There were fancy mortgages, each with a different permutation, no money down, no proof of employment needed, the now infamous liar loans. Credit products, like shiny plastic credit cards came with no-fees, countless rewards, and tricky, ever fluctuating terms. What happened in the labs, in the back offices of Wall Street, and the front offices of real-estate agents seemed harmless enough. All these great new financial products available for use, re-use and sale.
Of course, now that the financial crisis has decimated the U.S. economy, we are chastened. We have learned, at least for the interim that these financial products can be dangerous, can rob people of homes, can trigger countless job loss, can hurt, and cause a lot more than red ink. That’s why, Daniel Carpenter, director of the Center for American Political studies and professor at Harvard is spearheading a Financial Product Safety Commission. The idea is relatively simple and takes a page from the FDA’s drug approval process. The Commission, currently being batted around Congress would be staffed by regulators who must evaluate and approve any new financial product—whether it be mortgage or low-interest credit card—before those products hit mass market.
Part of the Commission’s goal would be to provide clear guidelines and information for consumers before they take on a mortgage, credit card or car loan. Just last month, lawmakers passed a bill that helps eliminate many of the unfair and deceptive credit-card billing practices. The Safety Commission would build upon this foundation, working to eliminate tricks, and embedded fees that pose serious financial risk for consumers.
Although the parameters of the Commission are still being hashed out, Carpenter recommends employing much of the lessons learned from the Federal Drug Administration’s new drug approval process. “The Commission would create useful information to help decide whether a product should enter the market,” says Carpenter. “Once it hits the market, the product would reflect both safety and efficiency.”
In order to get that efficiency and safety, the Commission would have to experiment with various regulatory structures. Carpenter gives an example of how it might work. He instructs skeptics to imagine that a bank wants to introduce a new kind of adjustable rate mortgage. Before the bank can sell and license them, the bank might have to get regulatory approval from the Commission that would subject the product to rigorous analysis and review. An alternative might be to allow the bank to offer an adjustable rate mortgage and then evaluate the mortgage after the end of two years.
While on its face, the commission sounds like a great idea, it’s less obvious than with drug approval, what the effects of a financial product will be. Even a great credit card, with low-interest rates, and no onerous fees could be used recklessly and prove dangerous if a consumer racks up huge amounts of debt. Also, it’s questionable whether financial product safety could really emerge without a cap on predatory lending interest rates. Is a standard mortgage safer than an adjustable rate mortgage for instance, or does it simply depend on the underwriting?
I’d love to think that a regulatory body could scan all financial products for tricks and traps, but I question whether it’s possible to implement or whether the solution to financial safety lies in more money devoted to financial literacy so that each American can evaluate financial products without an often sluggish Washington doing it for them.