Q&A with credit card and debt expert Amelia Warren Tyagi
Unsafe toasters aren't allowed on market, but unsafe credit cards are
Why aren't credit card contracts tested for product safety just like toasters?
That's exactly the sort of fundamental common sense that unites Elizabeth Warren, the Harvard Law professor who chairs the Congressional panel overseeing the $700 billion economic bailout, with her daughter Amelia Warren Tyagi, a Wharton School alumnus, co-founder of Business Talent Group and co-author with her mother of "The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke."
Amelia Warren Tyagi
To rectify this obvious-in-retrospect gap in our consumer defense, Warren and Tyagi propose creating a Financial Product Safety Commission modeled after the Consumer Product Safety Commission. Its purpose: To require financial institutions to reveal the true cost of their products, from credit cards to mortgages, in language consumers can easily understand. Their proposal was recently singled out as a Breakthrough Business Idea for 2009 by the Harvard Business Review.
We caught up with Tyagi at her Santa Monica office to discuss credit card offers, predatory lenders ... and toast.
CreditCards.com: Let's start with this mysterious connection between credit cards and toasters. What gives?
Amelia Warren Tyagi: Here's the thing -- no one can sell you a toaster that burns down your house the minute you plug it in, right? No one can sell you a toaster that advertises that it will also wash your laundry. You can't buy a toaster that says $29 on the box and you get it home and they actually charged you $48 for it. We assume that things that are sold to consumers are going to meet basic safety guidelines because, with the exception of financial products, they do meet basic safety guidelines. Nobody understands that you can buy a financial product that in fact does have a one-in-five chance of sending you into bankruptcy. And that's if you 're using it correctly!
CreditCards.com: It's strange that the concept of a Financial Product Safety Commission hasn't been raised before.
Tyagi: Well, it is. From a regulatory standpoint, America treats financial products as contracts, not as products. This made a certain amount of sense when it was a little community bank negotiating a loan with a local business, where the two parties could sit down and hash it out. But today, when the typical loan is between a $1 trillion bank and you or your neighbor, it's a little bit absurd.
Back then, the banker was in the business of making you a loan that you would pay back. That's how they made their money, that you paid them back on time. Today's banks are in a fundamentally different business. Credit card companies are not in the business of having you pay them back on time; they make their profits by having you pay them late, and in partial payments. Their most profitable customers are those who are in trouble.
CreditCards.com: When did responsible lending start to jump the tracks?
Tyagi: In the 1970s, the states played a very strong role in financial regulation. Then a series of Supreme Court rulings and changes in law severely diminished the ability of the states to regulate. And since no one stepped in to fill the vacuum, credit card lenders and banks were really left largely unregulated. That resulted in a lot of innovation, and some of that benefited consumers, but along with that, a lot of tricks and traps were developed that made money by tricking people into products that they didn't understand. And without any regulatory oversight, there was nobody looking out for the consumer to help an unsophisticated consumer navigate.
CreditCards.com: This all occurred at a time when most Americans had never purchased anything on credit, with the exception of their house and car.
Tyagi: Right. Before the all-purpose credit card, the typical American seldom dealt with debt, and when they did, they had to go into the bank in person, they had to bring a stack of paperwork with them. It was a very formal and somewhat intimidating process and people had to think long and hard before taking on debt.
Now, all of a sudden, by signing your name to a piece of paper, you could carry around debt in your wallet! There are certain advantages to it, but we unleashed a very dangerous new product without any safeguards. Many people didn't understand how dangerous it was, and they didn't understand that there weren't any safeguards.
We're accustomed to having safeguards in everything else we buy, but we've come to overlook it for credit cards. Somehow, someone can market a credit card to you that says in big letters that it's a 6 percent interest rate, and you really can't figure out, unless you read all 30 pages of fine print, that in fact it's a 28 percent interest rate.
CreditCards.com: Issuers insist that they're not intentionally trying to mislead consumers.
Tyagi: Oh, I think there is a lot of evidence that they try to obfuscate. I don't think there is any evidence that they're regulating themselves, and I think there is a lot of evidence that they're not regulating themselves. No one would tolerate this in any other industry. We wouldn't tolerate a lawnmower manufacturer that makes all of its profits by tricking customers into buying a lawnmower that doesn't really cut grass. Or a homebuilder who builds all their homes out of plywood so that they wash away in the first rain. We just don't tolerate that. It's not allowed.
CreditCards.com: How would a Financial Product Safety Commission change things?
Tyagi: The advantage of a Financial Product Safety Commission is that it's a very nimble model. To the extent that we've done any regulation in financial products, it has been very piecemeal regulation targeting specific practices. For example, there are some good laws against discrimination based on certain categories, and there are some good laws about disclosure. But Congress hasn't passed a serious new set of regulations since the early 1980s, and a bank can change its financial products overnight.
It's just not realistic to expect lawmakers to keep up with the latest new trick. Just imagine if the last time anyone passed any safety rules about telephones was in the 1980s. We wouldn't have a single law addressing cell phones or BlackBerries or anything else. But the Consumer Product Safety Commission has done a very good job of encouraging innovation and competition while still making sure that there are basic safety rules in place.
CreditCards.com: What's wrong with the current regulators?
Tyagi: The current system is deeply challenged by two facts. The first is, financial institutions don't all have to play by the same regulatory rules. For example, mortgage lenders have entirely different sets of regulations depending on how they're incorporated. You can get into a terrible game of regulatory three-card monte, which means that regulatory agencies are very reluctant to push too hard, lest the banks they regulate simply reincorporate as a different kind of entity.
The other very serious flaw in the system is that many of the major regulatory agencies, such as the Federal Reserve, the Office of Currency Comptroller and the Office of Thrift Supervision, are chartered first and foremost to protect banks, not consumers. It's very difficult for them to try to serve two masters. If banks come to them and say, "Gee, having fair and clear terms will reduce our profitability," what are they supposed to do about that? I think we need somebody clearly looking out for the consumer.
CreditCards.com: You propose that such a commission might actually test-drive some of these products. How would that work?
Tyagi: That's an interesting question. I think one of the important roles a Financial Product Safety Commission would play would just be to gather data and information. Today, we all know that an incredible number of mortgages are going into foreclosure, but we really have very little information about which kinds of mortgages, which particular clauses lead to foreclosure, which groups in the population are most susceptible. That kind of information could help policymakers make very sensible choices about policies and rules about products.
If Consumer Reports decides to review toasters, they can probably test six or eight toasters and would cover most of the marketplace. But one bank can have 500 different credit card products, and they all have clauses that say we can change this product with 14 days notice by sending you a note in the mail. What are you going to do with that?
CreditCards.com: Would the commission be primarily a watchdog group, or would it work together with the financial industry more in an advisory capacity?
Tyagi: I think a little of both. The commission has to have some teeth, so there needs to be an ability to eliminate really egregious behavior. At the same time, I believe that good financial institutions that are doing the right thing will want to cooperate and want to shut down the bad practices, because they don't want to compete with that and it makes the whole industry look bad. A lot of mortgage lenders have said that they found it very difficult to compete with the really aggressive, deceptive brokers that were in the marketplace. They would have preferred to compete on a level playing field.
CreditCards.com: But you're not looking to meddle in pricing, correct?
Tyagi: Absolutely not. It's not about price fixing, any more than the Consumer Product Safety Commission is about price fixing. They don't say toasters need to cost $42. They do say you can't advertise one price and then charge another price, or you can't sell a product and let someone take it home and then, six months later, say oops, you actually owe us another $50 for the product.
CreditCards.com: Could such a commission become reality considering that the financial institutions pay $100 million annually to lobbyists to protect their autonomy?
Tyagi: I would say that if ever there was a moment for dramatically rethinking financial regulation, now is the moment. I can't imagine more appetite than there is right now. If this doesn't show that the way we've been regulating is a massive failure, I don't know what does.
CreditCards.com: Yes. It's as if all of our toasters went bad on the same day.
Tyagi: (Laughs) Yes -- the day the toast stood still!
CreditCards.com: You mother Elizabeth Warren is in a position to strongly advocate for a Financial Product Safety Commission. Is there a sense that there might be an openness to this?
Tyagi: I do think this is a unique window for it. In fact, Sen. Dick Durbin has proposed it in the Senate. So I do think there is going to be some interesting traction on it with the new administration. If we had had sensible mortgage rules in the past decade, the whole mortgage meltdown might have gone a little differently.
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