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Fringe Banking and Financial Distress: Argument and Critique

posted by Katie Porter

Today at The Conglomerate Blog, there is an online workshop of former Credit Slips guestblogger Jim Hawkins' paper, Regulating at the Fringe: Reexamining the Relationship between Fringe Banking and Financial Distress. Jim shared some of his thoughts on what he claims is the "dubious" relationship between fringe banking and financial distress in some of his Credit Slips posts.

I found Jim's paper to be provocative and I've posted a critique of his approach at The Comglomerate as one of their invited commenters. I think Jim's definition of financial distress as too many dollars of debt is unduly narrow and that it is only by using that definition can be claim to debunk the relationship between fringe banking and financial distress--primarily by arguing that because these are small dollar loans they can't really be much of a problem. I also think Jim tends to overstate the extent to which the Bureau of Consumer Financial Protection was justified by concern about financial distress. I think its primary focus is on correcting malfunctions in markets caused by misinformation or deception. Jim himself seems open to intervention in fringe banking on that basis, as he concludes his paper by exploring rationales other than financial distress might support regulation. Check out The Conglomerate blog to join the conversation about this topic and to see the thoughts of other invited commentators: David Zaring, Larry Garvin, and Todd Zwyicki.


I enjoyed reading that blog, thank you. I think there is a lot of merit in each of the perspectives. Regarding your comment, I thought the phrase "social norms" was too vague and encourage you to be more precise. In my view, it is appropriate to ban indebtedness that is only incurred in extremis because someone who has gotten to that point is, imo, not realistically capable of getting out on their own and just needs to be directed toward bankruptcy where they can get relief from their debts and a fresh start. For example, when I read Professor Zywicki's comment and saw the statement that a study showed that when payday lending was curbed in Georgia, chapter 7 filings rose, I thought "yes, that's the point - debt relief as opposed to further indebtedness".

So in a sense I agree with Professor Hawkins' thesis that this stuff does not cause financial distress but I agree with you and the others who said that is beside the point, it's only used by those in financial distress and it's quite suboptimal for the people in that state compred to the benefits of chapter 7 at least for honest debtors. However, I disagree with your proposed remedy of more disclosure oriented regulation as I think it is well proven that disclosure based regulation is ineffective and we need to have stronger, simpler, clearer credit regulation than that, that limits indebtedness to begin with.

I'm glad you enjoyed the Conglomerate discussion. It's a good forum for general business law issues.

I do not think I advanced disclosure as a "proposed remedy." I think I pointed out that the Bureau of Consumer Financial Protection is premised on market disfunction, based at least in part on misinformation. While disclosure could be offered as a remedy to information problems, substantive regulation could also mandate products with simpler terms or the Bureau could rate products on their clarity, etc. My point was primarily that the legislation establishing the Bureau does not seem to focus on prevention of financial distress as its major goal but rather on ideas about lack of understanding, fraud, deception, etc.

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