Friday, January 29, 2010
One of the things that I enjoy about NPR is the way they invariably locate the super-articulate over-educated dude who works in some low wage job and can therefore tell the public radio audience what life is like for the other half. So it was this morning when NPR interviewed a very thoughtful fellow who worked as a collections agent going after people who are in default on their consumer loans. He (sorry, forgot his name) was more interesting and less sanctimonious than is typical of such interviewees, but he did observe that many of these consumers simply do not understand what interest is, much less how to calculate it, estimate it, or comprehend the impact of compounding. What good are "annual percentage rate" truth-in-lending disclosures if the borrowers do not understand the cost of money at its most fundamental level?
Anyway, it occurred to me that I would support at least one incremental regulation of consumer credit. Rather than specifying the terms of such loans, reimposing usury laws, and other such substantive rules, perhaps we should simply require that any applicant for a consumer loan pass a simple online or paper test to prove that he or she understands what interest is and how it is calculated. A few multiple choice questions or short answers via a web site ought to do the job. It would simply be unlawful for a financial institution or consumer lending firm to extend credit to people who cannot pass the test. I suspect that simple requirement would would have prevented a fairly large percentage of the unwise consumer and mortgage loans that led to the present crisis.
Of course, some proportion of innumerate applicants would be driven to loan sharks, but that will happen (albeit less visibly) with any substantive regulation that lowers the effective rate of return on consumer lending.
Am I as wrong as I am ill-informed, or have I hit upon a subtle fusion of paternalism and market freedom? Release the hounds.
I think some types of consumer loans state not only the principal but also the total interest that will be paid over the term of the loan. Perhaps this practice can be increased as a way of educating the borrower about the consequence of an APR.
I am afraid that the economy would grind to a halt if understanding how to calculate compound interest were required even of most college graduates.
Perhaps I too am ill-informed, but I was under the impression that the credit card companies made most of their money from people that didn't understand the rules. If you disqualify the economically ignorant, won't that just cause added fees/interst for those with a sterling credit rating?
Hard for me to believe the credit card companies would willingly go along with this idea. I believe they rather like having a license to steal.
Such a law would not achieve the desired end goal for much the same reason we are in the current situation: Wanting to make profitable loans, the lenders administering the tests would simply find a way to ensure that applicants pass the test.
I don't see how to prevent this unless you are planning to set up a new industry or create another government agency.
Here's an idea, let's put a little more emphasis on practical math in our schools!
First, this reminds me that 10 years ago I was training the former president of a small credit union in a new line of work. He told me that back in the day, credit unions used to be able to make small, unsecured loans to members who needed a bit to tide them over until the next paycheck. Then the S & L crisis of the late 80s happened, with a new set of regulations which forbade the thrifts from making such loans.
As a result, the payday loan places took off because those folks couldn't borrow from their thrifts any longer. So, of course, the lawmakers got interested in regulating the payday loan business. Luckily, that was happening at the state level but the unintended consequences just kept rolling downhill (so to speak).
Second, I like the test idea. We should extend the concept to potential voters. That is, if you don't understand basic American civics then you don't get to vote. I'm thinking things like: how many branches of government? Who sets the tax law? Actually, the test given to naturalized citizens would be a good one - and not too much to ask, IMO.
Of course, if you think that's unworkable (and it may well be), how about a civics test that's a little more rigorous for Congressional candidates? In that case, we'd expect them to have read the Constitution and understand it.
Anon, such tests are tempting, but they have been overthrown because they are so easy to misuse.
If some such thing could be arranged, the Democratic Party would cease to exist as an important factor. They would lose half their voters. Libertarians would probably improve their numbers, though, as a goodly percentage of their folks would pass.