The SEC Should Act on Fee Disclosure Regulations for Financial ServicesMay 21, 2008
One clear lesson rising from the ashes of the sub-prime mortgage mess is that it is difficult to change the rules of the game once all interested parties think they know them. The Bush Administration’s narrowly focused bailout of some borrowers has been widely criticized as catering to business interests at the expense of cash-strapped homeowners. The government’s unfortunate task in these kinds of situations is to decide who loses money, homeowners or the multitude of businesses and individual investors that knowingly or unknowingly hold low-quality mortgage-backed securities.
It is easy to be sympathetic to affected homeowners. In many cases, even if one could argue that they should have understood the implications of the variable rate and other exotic mortgages they were signing, they clearly did not. And it is difficult to blame them. Mortgage financing is about as clear as mud to the average family looking to purchase a home. This lack of transparency leads to poor decision-making. Poor decision-making leads to public angst and the aftermath of government bailouts. Much like the Enron-era accounting scandals, it is too late to save some people from financial distress. But we can look closely at the harsh lessons of this crisis with an eye toward creating reasonable protections for people who enter the increasingly complex market for financial services. Are there other sectors of the financial markets that suffer from the same staggering opaqueness as the mortgage market? You bet.
Most people have almost no idea how much money they are being charged by the mutual funds contained within their company-sponsored retirement plans. The regulations governing mutual funds, set by the U.S. Securities and Exchange Commission, foster this ignorance. The General Accounting Office has recommended changing disclosure laws to require investment management companies to tell investors how much, in dollars, they are being charged. Under pressure from financial industry lobbyists, that information has not been revealed. The result is tepid price competition in the mutual fund industry, and a slow but steady drain on the retirement savings of millions of Americans — even though most are completely unaware of it.
The market for annuities, a popular product among those preparing to retire, can also be very confusing. Its mystery is shrouded by complicated insurance speak that may be well intentioned but is not accessible to most retirees. Some retirees fork over a substantial proportion of their life savings to these products, sold on the merit of apparent safety, without understanding the risks macroeconomic events can pose. For example, the holder of a simple fixed-payout life annuity could see the real earning power of his or her steady monthly payments plummet if inflation suddenly lurched upward and remained at that higher level for a few years. If the problem were widespread would there be calls for some kind of government bailout? Who could doubt it?
Mutual funds and annuities are just examples of perfectly good investment products sold by many well-intentioned companies that, due to woefully inadequate disclosure laws, can be abused by some institutions that market them. The creativity and flexibility of our financial markets have outstripped the creativity and flexibility of those charged with ensuring that consumers and investors who make reasonably diligent efforts to understand the products and services they are being offered can do so.
We need bold reform in financial disclosure regulation. The costs of the financial products and services many Americans purchase should be made absolutely apparent, even to those without any financial background whatsoever. It would increase individuals’ ability to understand these marketplaces, to shop around, and ultimately encourage healthy competition in both price and service quality. Perhaps more importantly, it would lead some people whose bewilderment about financial matters keeps them from entering financial markets that might be beneficial to them to enter those markets. Commercial law requires price transparency when we go, for example, to the grocery store to purchase a gallon of milk. The stakes in financial markets are much higher than they are at the grocery store, and yet financial institutions aren’t required to divulge their prices to you. Americans of all economic strata are being asked to shoulder an increasing portion of the burden of their own economic well-being in retirement. And most of us are not going about the task very effectively. The seeds of a future government bailout should be obvious. Government regulatory agencies need to learn the lessons of the subprime lending crisis and act now to stem the rampant disparity between what we know and what we ought to know before we enter the ubiquitous financial marketplaces. The hard-earned savings of many Americans depend on it.