On Certification Instead of Regulation

What started as a “Ha, do you libertarians endorse this?” dare by Mike of Rortybomb has turned into a somewhat interesting discussion between him and Megan McArdle about to what extent it’s possible to protect people who are not good at understanding complex financial products (the elderly, or people who just aren’t good at understanding complicated service agreements) from being victimized by banks without in the process hurting the people you’re trying to help. This as the new credit card legislation is going into effect, trying to crack down on banks which raise interest rates quickly if you’re late paying, have hidden fees, or move due dates around (theoretically in an attempt to keep people from paying on time.)

Mike suggests that banks should be required to offer a “plain vanilla option” of products such as credit cards or checking accounts.

And that solution would be mandating financial services to provide Vanilla Option financial products. Boring, low-reward trap-fee products you’d probably have to pay a yearly fee for.

So much of our financial services are predicated on tricks and traps but also have a lot of benefits. You get free checking, but if you overdraft you lose more than you gained. Now with a vanilla option, you could pay more upfront to not take the risk of losing later. This is banking how it used to be, boring. And this is exactly the kind of product that people with weak cognition would want to have available. Someone approaching older age, but before getting there, could opt for the “extra boring” financial services package. People buy renter’s insurance; some might view a yearly-fee on their checking account or credit card as a “trap insurance.”

Megan doesn’t think the idea would be very successful:

It’s not a terrible idea, necessarily, but if it’s an actual option, I doubt it would accomplish much. Banks will find ways to steer you into the more lucrative product–unless, of course, you’re the sort of highly informed, financially disciplined consumer who doesn’t need a vanilla option, and is in fact better off in the current system.

The “plain vanilla” idea is somewhat with an idea I’ve kicked around at times in regards to health care, which is that perhaps one could achieve many of the good effects of regulation (while avoiding its pitfalls) via certification instead. The idea would be to have some sort of certification organ (either governmental or private, but something with sufficient credibility and reach to inspire confidence and get the message out) create some sort of standard guidelines for a product. If it was a health care plan, this would involve very clear and simple parameters for what was covered, copays, percent you pay, max out of pocket, etc. Perhaps there’s even be a standard disclosure form that everyone offering such a certified policy had to offer, which was only one or two pages long, and was formatted in a specific way so that you could easily compare different plans. There would not be a mandated price, or mandated copay, or a mandated max out of pocket — just a very clear disclosure format and coverage structure you had to follow.

Insurance companies could decide to offer a certified plan or not, but if they did, they could list their plans on the certifying agency’s website, brand their advertising with the certification, etc.

Now, the value in this would be that in products which have a reputation for being hideously complicated, and potentially biting you with a nasty surprise at some later date, customers would assign a value to a certification which allowed them to know the product they were buying met certain uniform standards. It might be that they could get non-certified coverage which worked just fine for them, and was cheaper, but part of what you’d be paying for would be the knowledge that you were getting a known quantity. If there was enough demand for this certainty, the prices on certified policies would actually be quite competitive since different companies would vie for the certified policy market. In coordination with this you would, of course, remove all the current regulation on what policies have to cover, as well as allowing interstate insurance purchasing. So you’d have the wild and crazy, totally free market, and you’d have the voluntarily certified market.

It seems to me that, if an institution with sufficient credibility created a set of certifications for complex, important products such as health insurance policies, and really marketed them, there would probably be a pretty decent market for the certified products. (If you were trying to solve the problem of people not being able to afford insurance you could also prove subsidies for those at certain income levels — perhaps making the subsidies only good on certified plans, or perhaps on any.) However, some people would, of course, still get themselves into trouble by getting uncertified plans which unbeknownst to them turned out to be have all sorts of nasty pitfalls. Just as there’s always a market for home study courses which can teach you how to become a millionaire, available on DVD for just ten easy payments of $49.95, it will inevitably be some of the hardest luck characters who are just sure that the policy costing only $129 per month for their entire family will be a great bargain. And unfortunately, if you want to preserve people’s freedom at all, you need to give them the chance to abuse it.

The problem with the idea of applying this kind of certification-as-regulation to products such as credit cards or checking accounts is, I think, that while a fairly large percentage of people in the individual insurance market might consider themselves sufficiently bewildered by insurance policies (and the danger of getting a policy that doesn’t really do a good job of covering you would be so great) very few people think that they aren’t equal to evaluating a credit card or checking account. Nor do they tend to imagine that the danger of selecting a bad one would be great. Sure, it might have nasty results for not paying on time your credit card on time, or for bouncing checks, but no one intends to bounce checks or pay late. You can always tell yourself that you won’t fall into these problems, and the rewards by comparison sound so great and so easily won.

So on credit cards and checking accounts, I tend to think that Megan is right: most people simply wouldn’t select a “plain vanilla” option. If checking accounts and credit cards were widely viewed in our culture as dangerous and tricky, people might opt for certified products. But although a few people might, I think most of the people who end of in the saddest straights would not.