Credit Cards: Is Enhanced Disclosure Enough?

Public outcry about practices like universal default has led to several legislative and regulatory proposals.  A first-cut analysis distinguishes between proposals advocating enhanced disclosure and proposals that seek legal intervention beyond disclosure, including the outright ban of certain practices.  The disclosure side is led by the FRB who recently proposed an overhaul of Reg Z, which specifies disclosure mandates for credit card issuers.  The OCC also supports disclosure regulation.  On the other side, bills introduced in the House (by Rep. Keith Ellison) and in the Senate (by Sen. Jon Tester), seek to ban universal default, and other bills seek to ban various fees and practices.

Disclosure regulation has its advantages.  During his testimony before a subcommittee of the House Committee on Financial Services, Comptroller Dugan said, “Effective disclosure can have three fundamental benefits for consumers: first, informed consumer choice; second, enhanced issuer competition to provide consumers the terms they want; and third, greater transparency that will hold the most aggressive credit card practices up to the glare of public scrutiny and criticism, making issuers think long and hard about the costs of such practices before implementing them.”  (OCC News Release, "Comptroller of the Currency Calls for Better Credit Card Disclosures," June 7, 2007).

Let's consider these benefits of disclosure.  The basic goal of disclosure is to facilitate informed choice. Informed consumer choice is surely a good thing, and disclosure can facilitate informed choice.  But to facilitate informed choice disclosure must inform.  Much disclosure does not inform.  Even rational consumers will not become informed, if becoming informed is too costly.  And imperfectly rational consumers might not become informed even if it is cost-effective to become informed.  The challenge is to design simple disclosure mandates that require little time and effort to digest.  On this regulatory design metric many current Reg. Z disclosures do not score very high (although some, e.g., Schumer Box disclosures, score higher).  The FRB is aware of the challenge of designing effective disclosure mandates, and it uses focus groups and interviews to test the efficacy of existing and proposed disclosures.  Let's hope that this process will produce effective disclosure regulation.

Next consider the benefit of enhanced competition.  This benefit of disclosure depends on the ability of disclosure to facilitate informed choice.  In particular, competition will give consumers the terms they want only if consumers are informed.  But the power of competition is constrained by the limits of informed choice.  If disclosure makes a certain term, say the APR, salient to consumers, competition will indeed focus on this term, and consumers will get low interest rates, which is surely what they want.  But there are many other terms.  And it is very difficult, if not impossible, to make them all salient through disclosure.  As a result, lower interest rates might be accompanied by higher fees, which is something consumers do not want.

This suggests a fundamental tension: the credit card product is complex.  It is very difficult to convey all of this complexity to consumers.  This implies a tradeoff: A disclosure approach would leave at least some consumers imperfectly informed about some aspects of the complex product.  The competing approach is to reduce complexity by banning certain fees and practices.  But this approach also entails a cost.  To the extent that complexity has an economic rationale, and is not intended to exploit consumers, reduced complexity hurts consumers.

Comments

[John Pottow]

Insightful post. As is often the case, we might turn to distributive considerations to assess such trade-offs.