Consumer Protection Can Lead to Moral Hazard

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Barack Obama proclaimed March 7th-March 13th to be the National Consumer Protection Week. Supporting the creation of an independent Consumer Financial Protection Agency, Obama said:

“[…] our Government must do more to stand up for consumers. From excessive bank account overdraft fees to abusive mortgage lending practices, our broken financial system produces profits at the expense of American families.”

Do we really need the government to “do more” considering that it plans to do more of what helped create the current financial crisis?

Mark Calabria of the Cato Institute believes that “as designed, it [i.e. the Consumer Protection Agency] would increase the likelihood of future crises rather than reduce them.” Arguing that the intention is to expand government reach over non-banks financial products, Calabria calls for a repeal of government efforts to push risky lending and easy credit.

At a recent Loyola Economics Club meeting, Dr. George Selgin pointed out that we spend considerable time deciding which technology to buy, but when it comes to choosing a bank for our savings we often look only at the interest rate. As uninformed depositors, consumers unwittingly contributed to the current financial crisis.

Consumer indifference in the area of banks is encouraged by the overly protective safety net of insured deposits guaranteed by the government. As editor of RealClearMarkets John Tammy explains, “because our savings are over-insured, we don’t stop to consider the activities or the health of the institutions we bank with.”

Tammy believes that if the FDIC were to be abolished, the private sector would have the incentive to step in and insure deposits; a private form of insurer would emerge. It is likely that markets would provide greater and more effective oversight of the activities of insured banks, leading to more careful investing from consumers. Tammy continues:

“If savers were faced with the possibility of losing their savings altogether, it’s near certain that just as they diversify their stock holdings as a form of wealth protection, so would they diversify their bank deposits.”

The over-insured depositor is a moral hazard to our economy. The current administration has to realize that consumer protection does not necessarily improve the US financial system. It is time to revisit the federal deposit insurance program and introduce reforms that will allow free markets to incentivize responsible behavior.

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