Posner Questions Behavioral Economists and Proposed Credit Regulator

A proposed credit regulator that would encourage consumers to opt for “plain vanilla” financial products leaves a bad taste in the mouth of federal appeals judge Richard Posner.

The judge writes in a Wall Street Journal editorial that the proposed law, the Consumer Financial Protection Agency Act of 2009, would create a new agency that regulates consumer financial products. One provision requires the agency to design standard financial products, such as mortgages and credit cards, that must be offered to consumers. Sellers of the products would have a safe harbor from lawsuits.

Posner, of the Chicago-based 7th U.S. Circuit Court of Appeals, questions whether it’s a good idea to discourage consumer choice. For example, the agency could outlaw adjustable rate mortgages or prepayment penalties on mortgages. But an informed consumer might prefer the lower interest rates that come with such products, he writes. “Is the choice among such alternatives really beyond the cognitive competence of the average home buyer? Is three minutes the limit of his attention span?”

Posner says the idea for the new regulator is influenced by behavioral economics, “which teaches that people, even when fully informed, often screw up because of various cognitive limitation.”

But Posner wonders if cognitive limitations also plague some behavioral economists. He notes that one leading researcher has long called for investment in all-stock portfolios—advice that would have been devastating if followed before the economic downturn.

“Behavioral economists are right to point to the limitations of human cognition,” Posner says. “But if they have the same cognitive limitations as consumers, should they be designing systems of consumer protection?”