Cohan Report: Do bank profits depend on consumer ignorance?
Banks are balking at President Barack Obama's plan to create a Consumer Financial Protection Agency (CFPA). They argue that the CFPA will raise costs to consumers. Even as they relish the chance to remain in business thanks to our government's $12.8 trillion to bail them out, they fear an agency that would force them to compete honestly for consumer finance business.
Not only do banks depend on taxpayers for their bailout, but 70 percent of overall economic growth springs from consumer spending. Yet banks are eager to keep biting the hand that feeds them their bonuses after they destroyed the global financial system -- by retaining the right to profit from consumer ignorance.
My conclusion is that banks are afraid to compete on the basis of providing an honest value to consumers -- their profits depend on luring consumers with low teaser rates into long-term loan contracts that bury profitable tricks in tiny-font legalese.
What will the CFPA do? It would set standards for traditional mortgages, and have the authority to demand that lenders offer those kinds of loans or give consumers the chance to opt out of riskier products.
It would also give the new agency the power to restrict or prohibit mortgages that come with hidden fees and steep penalties for borrowers who pay the loan off early. Best of all, the CFPA would create examiners who could go into specific institutions, issue subpoenas, analyze their practices, demand changes and seek penalties.
What we found in the sub-prime catastrophe was that not only were banks hiding the truth from consumers but they were paying big bonuses to mortgage brokers to put consumers in those riskier products. This means that another one of the positives of the CFPA -- educating consumers on financial matters -- will be crucial to helping protect consumers from banks.
Yet the CFPA has the potential to go even deeper to fix what ails the banking system. It needs to change the way bankers get paid. In the case of consumer finance, sales incentives -- such as yield spread premiums -- to push products that consumers can't afford and don't need ought to be wiped out.
Bankers are not in it to help people. They are motivated by money. And as long as the banker's bonus comes from tricking consumers into buying products laden with hidden fees and huge interest rate increases, that is exactly what banks will push.
If we really wish to fix consumer banking, we ought to change the way bankers get paid. They should earn more if they deal honestly with consumers and compete on the basis of offering the right product at the lowest price.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book isYou Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.