Redesigning Regulation: A Case Study from the Consumer Credit Market

The consumer credit market is broken. Businesses have learned to exploit customers' systematic cognitive errors, selling complex credit products that are loaded with tricks and traps. Because customers cannot see or understand complete credit terms until it is too late, the market no longer operates to achieve competitive efficiency. Instead, creditors engage in a race to the bottom, boosting profits by offering ever-riskier products that families are poorly equipped to handle. The consequences are serious: Americans are sinking deeper in debt each year, and defaults, foreclosures and bankruptcies are on the rise. The regulatory framework that once controlled consumer credit is now in tatters. From colonial times until 1979, state-based usury laws were the central feature of consumer protection. In 1979, a Supreme Court interpretation of ambiguous language in a national banking law effectively ended state usury laws. Congress could easily have reversed the opinion by clarifying the language, but it turned away while this critical consumer protection vanished. By the 1990s, product innovation from payday lending to universal default to creative mortgage financing took root largely outside the purview of any regulatory body. Truth-in-Lending laws, which were designed to supplement usury protection, failed to keep pace with market changes. The Federal Reserve, the Office of the Controller of the Currency, the Office of Thrift Supervision, and other federal and state agencies regulate various financial institutions, but the mission of these regulators is aimed squarely at protecting the banks and the stability of the overall financial system, with scant attention to consumer protection.