There was a story this morning on the cover of the New York Times about the mortgage industry fighting back against new regulations coming down the pike from the Federal Reserve. The Fed wants to require lenders to do things like make sure people taking out subprime loans can afford them, and clearly disclose fees instead of rolling them into interest payments.
That reminded me of a conversation I had a couple weeks ago with Richard Thaler, a behavioral economist at the University of Chicago, who recently wrote a book with legal scholar Cass Sunstein. The book is called Nudge and it has a very interesting thesis: that by paying attention to pitfalls in human psychology, policy makers can silently guide people to make better decisions.
One part of the book that many reviewers have been ignoring argues that in trying to better regulate the mortgage industry, policy makers should overhaul disclosure requirements, since, in the words of the authors, the Truth in Lending Act “is now hopelessly inadequate.” It was nice to require everyone to report interest rates as APRs, but with all the bells and whistles of modern mortgages, that’s not cutting it anymore.
What Thaler and Sunstein propose is a system they dub RECAP, for Record, Evaluate, and Compare Alternative Prices. RECAP would work for all sorts of products with complex pricing schemes. The first example they give explains how it would work for cell phones:
The government would not regulate how much issuers could charge for services, but it would regulate their disclosure practices. The central goal would be to inform customers of every kind of fee that currently exists. This would not be done by printing a long unintelligible document in fine print. Instead, issuers would be required to make public their fee schedule in spreadsheetlike format that would include all relevant formulas. Suppose you are in Toronto and your cell phone rings. How much is it going to cost you to answer it? What if you download some email? All these prices would be embedded in the formulas. This is the price disclosure part of the regulation.
The usage disclosure requirement would be that once a year, issuers would have to send their customers a complete listing of all the ways they had used the phone and all the fees that had been incurred. This report would be sent two ways, by mail and, more important, electronically. The electronic version would also be stored and downloadable on a secure Web site.
Producing the RECAP reports would cost cell phone carriers very little, but the reports would be extremely useful for customers who want to compare the pricing plans of cell phone providers, especially after they had received their first annual statement. Private Web sites similar to existing travel sites would emerge to allow an easy way to compare services. With just a few quick clicks, a shopper would easily be able to import her usage from the past year and find out how much various carriers would have charged, given her usage patterns.
For mortgages, lenders would be required to provide a spreadsheet, too. It would break down the cost of a mortgage into two categories—fees and interest—and it would also, importantly, provide a digital interface for third party vendors to come along and sell comparison services. Similar to what Morningstar does for mutual funds. With downloadable data, third parties could create systems to flex the assumptions behind a mortgage (how much interest rates will go up; the year you go to sell your house), and then help you make a better decision about which sort of loan to pick. There could also be some sort of worst-case scenario feature. That would have been handy.