Bankruptcy

Fringe Banking, Financial Distress, and the Consumer Financial Protection Agency

By Jim Hawkins

I'd like to say thanks again for the chance to share some thoughts at Credit Slips.  I've really enjoyed the comments.  I wanted to end with a post about a current issue before Congress. 

One reason it is important to know what financial distress means and to understand the relationship between fringe banking and financial distress is that policy makers consistently use financial distress to justify intervention into fringe markets.  Because financial distress creates externalities, it is a powerful tool to justify regulation.

A speech President Obama made late last year arguing for the Consumer Financial Protection Agency (still working its way through Congress) is a good example of how this works.  To make the case for the CFPA regulating payday lending, the President gave the example of a women who'd taken out a payday loan.  He linked the product to wide-spread financial distress: "Abuses like these don't just jeopardize the financial well-being of individual Americans?they can threaten the stability of the entire economy."  As I have argued, I think this claim is really hard to make out.  Financial distress might justify the CFPA regulating credit cards or mortgages, but I don't think it justifies regulating on the fringe.

Relying on a link between fringe banking and financial distress distracts from the other persuasive arguments for creating the CFPA.  And, in other contexts, it leads to regulation aimed at solving the wrong problems.  People using fringe banking need protection, but we need to rethink regulation aimed at preventing financial distress because it solves a problem that I don't think exists. 

Full post as published by Credit Slips on February 28, 2010 (boomark / email).