Consequences of Economic Downturn -- Part IV: Borrowing & personal responsibility
April 22, 2011
Martha A. Starr
Today’s topic is one on which Mark has much to say: personal responsibility. Looking back at the years before the financial crisis, a big question is why households were increasingly borrowing via ‘exotic’ mortgages and other high-cost methods, even though such borrowing was pushing their debt burdens towards all-time highs. Accumulating evidence from behavioral economics suggests they may not have understood what they were doing: because people’s financial choices seem to be very sensitive to how options are presented, perhaps lenders were tilting them into products that maximized their profits, but saddled consumers with exorbitant debt costs.
Enter U. Chicago scholars Cass Sunstein and Richard Thaler, who argue that a good way around this problem is to “nudge” consumers towards good decisions -- by making “good” choices the default option and “bad” choices available by special order only. Some view this idea as nicely balancing consumer protection and personal freedom. But if this idea of “libertarian paternalism” rubs you the wrong way, you’ll love Mark’s chapter in Consequences of Economic Downturn, which eloquently slams it on several accounts. For one, “nudging” assumes the government can effectively identify what’s best for consumers, despite great variations in their circumstances and the fact that government’s expectations for the future have no special claim to accuracy over those of consumers. For another, it ignores realities of government policy-making, whereby powerful institutions lobby Congress in favor of rules and regulations that best protect their interests. Finally, by taking responsibility for decision-making away from people, nudging actually cements any tendencies towards “cognitive flaws” they may have, and disregards fundamental concerns about building social environments that promote people’s agency, dignity and autonomy. {What do you say, Mark: Should Mr. Burns take the donuts out of the break room at the nuclear power plant?}
Deb Figart’s chapter takes a swing at a different proposed solution for curbing ‘imprudent’ borrowing: “financial literacy” programs, which have been rolled out by all sorts of government agencies, financial institutions, and nonprofits since the crisis. Most claim to aim to help consumers understand how to scrutinize financial products, identify those with low costs and risks that best meet their needs, and structure their spending, saving and borrowing patterns to minimize chances of financial distress. Yet as Deb points out, many do not actually focus on helping people become fully participating agents in control of their own economic and financial lives. Rather many aim to make them into orderly consumers, still taking for granted that the dominant work-and-spend lifestyle is the proper one and that ‘responsible’ use of borrowing products is fine. As with Mark’s view of ‘nudging’, Deb is skeptical as to whether these kinds of financial literacy programs actually respect people’s agency and enhance their capabilities. But whereas Mark thinks more can and should be expected of the individual, Deb objects to the assumption behind financial literacy programs that it’s up to the individual to make good financial decisions, avoid unscrupulous actors, attain financial security, etc., assuming that government and financial institutions do not also share responsibility for maintaining an orderly financial system that enables people to conduct their financial affairs without needing to constantly be on guard against risks of financial ruin. Thoughts, Mark?