New Forms of Credit Disclosures?

Economist Richard Thaler and law professor Cass Sunstein ran an article in the Wall Street Journal suggesting policy makers re-look at consumer disclosures for credit products (and even cell phones). The authors mostly promoted themes from their new book "Nudge: Improving Decisions about Health, Wealth and Happiness." But in general they have a good point -- too often disclosures and consumer information strategies are dismissed. Would better disclosures have avoided the current subprime mortgage default problem? Surely not. But at least at the margin some consumers would have had more information.

I have some research in process showing that states requiring a signed "YOU MAY LOSE YOUR HOME" statement on disclosure forms for very high cost loans reduces the probability a consumer will go through with a loan offer from a lender. The effect is not large, but not zero either.

Thaler and Sunstein wrote "the Fed can substantially improve its proposal by requiring credit issuers to disclose relevant information electronically in a standardized, machine-readable format. In one simple stroke, new disclosure requirements would dramatically improve the current situation."

The key to their solution is that 3rd party providers will create a market to supply consumers with easy to read reports and recommended actions--much like investment tracking firms like Morningstar do in the mutual fund market.

They argue "electronic disclosure will merely supplement the current written disclosure requirements...the electronic disclosure we are advocating would make it much easier for nonprofit groups to help the poor make better choices because they could have all the information they need right on a computer."

Would it work? It is hard to say for certain, but at least this suggests technology can enhance paper and pen information disclosures. Before deciding consumer disclosures are a failure, policy makers ought to explore how disclosures--many of which are regulated by a hodgepodge of agencies and using forms dating back to the 70s--can be modernized and refined to better impact consumer behavior.

I agree with Thaler and Sunstein when they wrote"Some politicians have clamored for banning some types of mortgages, especially in the subprime market, but low-income or high-risk borrowers are often the ones that can particularly benefit from financial innovation." Product bans such as they fear are probably unlikely to happen, and in fact the private market has shut down most risky lending on its own. It seems likely these products will return, however. It may take a few years but $1000 downpayments, low credit scores and high debt to income ratios will be common again in the mortgage market before long. In the meantime, exploring better ways to communicate the terms, costs and risks of products to consumers should be a high priority. The Federal Reserve Board and FTC have some research efforts under way on the wording of disclosures, but more testing of innovations such as Thaler and Sunstein discuss has merit.

See the full op-ed at:

http://online.wsj.com/services/article/S B121858695060335079-search.html