The Consumer Financial Protection Bureau and the Quest for Consumer Comprehension (book chapter, April 2017) by Lauren Willis.
I found out about this new strand of work via ASIC. I really liked Willis’ debunking paper The Financial Education Fallacy (2011). Related to the paper I summarize below: Performance-Based Consumer Law (2015) and Performance-Based Remedies: Ordering Firms to Eradicate Their Own Fraud (2017). Perhaps I will dive deeper into one of those in another blog post.
To ensure that consumers understand financial products’ “costs, benefits, and risks,” the Consumer Financial Protection Bureau has been redesigning mandated disclosures, primarily through iterative lab testing. But no matter how well these disclosures perform in experiments, firms will run circles around the disclosures when studies end and marketing begins. To meet the challenge of the dynamic twenty-first-century consumer financial marketplace, the bureau should require firms to demonstrate that a good proportion of their customers understand key pertinent facts about the financial products they buy. Comprehension rules would induce firms to inform consumers and simplify products, tasks that firms are better equipped than the bureau to perform.
Demonstrating sufficient customer comprehension could be a precondition firms must meet before enforcing a term or charging a fee, or firms could be sanctioned (or rewarded) for low (or high) demonstrated comprehension levels. In effect, rather than prescriptively regulating the marketing and sales process with mandated disclosures or pursuing firms on an ad hoc ex post basis for unfair, deceptive, and abusive marketing and sales practices, the bureau would monitor firms and incentivize them to minimize customer confusion as the marketing and sales process unfolds over time.
- disclosures that do well in experimental conditions may not work in real-world conditions,
- firms are better situated than regulators to innovate to achieve consumer comprehension,
- valid, reliable consumer confusion audits are possible.
How might this form of regulation operate in practice?
- Measuring the quality of a valued outcome (comprehension) rather than of an input that is often pointless (mandated or pre-approved disclosure);
- Assessing actual customer comprehension in the field as conditions change over time, rather than imagining what the “reasonable consumer” would understand or testing consumers in the lab or in single-shot field experiments;
- Requiring firms to affirmatively and routinely demonstrate customer understanding, rather than relying on the bureau’s limited resources to examine firm performance ad hoc when problems arise;
- Giving firms the flexibility and responsibility to effectively inform their customers about key relevant costs, benefits and risks through whatever means the firms see fit, whether that be education or product simplification, rather than asking regulators to dictate how disclosures and products should be designed.
- By altering the design of the transaction (e.g. banks are adept at sabotaging overdraft disclosures, see When Nudges Fail: Slippery Defaults, Willis, 2013)
- Frame consumers’ thought processes long before consumers see a disclosure. Consumers may think they are unaffected, but advertising works (Wood and Poltrack 2015; Lewis and Reiley 2014).
- Physically divert attention from disclosures. AT&T designed the envelope, cover letter, and amended contract after extensive “antimarketing” market testing to ensure that most consumers would not open the envelope, or if they did open it, would not read beyond the cover letter (Ting v. AT&T, 319 F.3d 1126, 9th Cir. 2003)
- Take proactive steps to ferret out easy marks, vulnerable customers. Savvy firms might use inferred cognitive load, mood, or stress levels to sell consumers products at the very moment when mandated disclosures will be misinterpreted or ignored. Firms can even engage in real-time marketing through Internet and mobile devices to reach consumers at vulnerable moments (Digital Market Manipulation, Calo, 2014).
Comprehension rules & customer confusion audits
The very capacities that modern firms use to market products and defeat mandated disclosures enable them to attain better consumer comprehension more quickly and at a lower cost than regulators. The bureau can try to educate consumers, but nothing beats professional marketers when it comes to sending consumers a message.
- Fairness: the benchmarks would need to be high, perhaps as high as the approximately 85 percent benchmark implicitly used in false advertising cases
- Competition: the benchmarks might be lower, depending on the firm’s ability to differentiate informed from uninformed consumers.
- Prevent firms from undermining mandated disclosures: the benchmarks might be set at the comprehension levels the bureau can obtain in its disclosure testing.
- Increase consumer comprehension from where consumers stand now:
the benchmark might be set based on industrywide performance.
Benefits of Comprehension Rules
The effect of successful regulation through comprehension rules would be to bring transactions into closer alignment with consumer expectations.
The ultimate direct benefit of comprehension rules is increased consumer decisional autonomy; consumers would get what they think they are getting, not whatever hidden features firms can slip into the transaction.
Empowered choices free of confusion are only possible, and the market is only driven to efficiency, when consumers comprehend the transactions in which they engage.
Today we pretend that individual consumers use disclosures to drive market competition and make welfare-enhancing decisions, but we do not spend the resources needed to realize actual consumer understanding. As a result, consumers neither discipline the market nor consistently enhance their own welfare.