Arnold Kling  

Fraud, Preferences, and Paternalism

Social Darwinism vs. the Econo... Ray Fisman on Structural Unemp...

Don Boudreaux disagrees with my pro-CFPB post. He writes,

Because the transactions in question are voluntary and among adults, it isn't anyone else's business what transpires between A and C. Would Arnold applaud a DHS ban on the sale of Big Macs, for it's quite easy to construct an argument, very much like Arnold's above, for government to prevent unsophisticated people from buying food that those of us in the know know a sophisticated diner would not buy. I understand well and sincerely that one might draw out differences between the buying of Big Macs and the buying of credit-card payment-protection plans; the question would be just how compelling those differences turn out to be upon careful reflection. Why, for example, would government action on the Big Mac front be objectionable nanny-statism while government action on the credit-card front be applause-worthy government intervention?

Consider two actions.

1. B sells C a product that A does not like (say, cigarettes or jet-skis).

2. B sells C a product on the basis of fraud (say, snake oil).

One approach is to say that in both cases a third party should interfere via regulation. Another approach is to say that in neither case should there be third-party regulation--it's buyer beware all the way. But one also can try to differentiate between the two.

In the case of (1), my thought is that A has no right to impose his values on B and C.

In the case of (2), my thought is that if B goes unpunished, then we are headed for trouble. With no punishment, the upside for B is profit, and the downside for B is little or no loss. Since I want resources going into productive innovation rather than fraud, I think I have an interest in punishing B, even if I was not the victim.

The products in question fall somewhere in between (1) and (2), but in my view they are closer to (2). If I sold someone cigarettes or jet skis, I could easily say to myself, "I do not like what I am selling. But if I had the same preferences as my customers, I would buy them." With the Capital One credit card add-ons, I cannot say that.

So I think I have a test that would allow for some consumer protection without heading down a slippery slope toward paternalistic regulation. That test is, "Can you imagine a set of preferences that would make you want to buy this product?" If the answer is "no," then regulation is justified. However, if you can imagine a set of consumer preferences that would make you want the product, then regulation embodies paternalism and should be subject to libertarian opposition.

Incidentally, the CFPB's mortgage regulations, which I discussed in an update to my original post, do not meet this test. They do cross over into paternalism.

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CATEGORIES: Political Economy

COMMENTS (22 to date)
raja_r writes:
In the case of (2), my thought is that if B goes unpunished, then we are headed for trouble. With no punishment, the upside for B is profit, and the downside for B is little or no loss.

How is that different from (1)?

simon... writes:

Why apply this only to finance? Since you can't imagine set of preferences that would make you buy westboro baptist church's message, to hell with the First Amendment...

Also, how about Talib's "anti-fragility" argument? (a variation on moral hazard). Get rid of these relatively low cost streseers and you get the right environment for a big-time fraud that will go unnoticed until major damage is done.

simon... writes:

Apologies - "Nassim Taleb's", not "Talib's".

Sonic Charmer writes:

I can't tell whether I can imagine a set of preferences that would make one want to buy this product, since I haven't seen it described comprehensibly enough by the people applauding the CPFB's actions against it, who (since they're so against this product) surely must understand the details of it completely and why it's so bad, but just not want to share those details with the rest of us.

Aaron McNay writes:


I do not think that the test you developed would prevent the slippery slope toward paternalistic regulation that you give it. In your example, you mention cigarettes. I would imagine that many people could not imagine a set of preferences that would make them want to buy cigarettes. For them, and using the test you describe, banning cigarettes is a regulation that is justified as consumer protection. However, you describe the banning of cigarettes as one person imposing his values on others, a paternalistic action. Based on your test, it seems we are no better off in preventing a move down the slippery slope toward paternalistic actions than we were before.

English Professor writes:

Like the Sonic Charmer, I haven't seen the details of how the credit-card protection plans work. I too would like to know what makes these things "close to" fraud. I have read that companies like BestBuy make a large portion of their profits from extended warranties (a form of "protection plan"?) that they sell with appliances: if those are so profitable to companies, do they border on fraud? I also don't like the idea of letting government bureaucrats judge whether something is "closer to" fraud than to fair business practices. What does it mean for something to be "close to" fraud if it doesn't break any laws? Did anyone ever collect on the credit card protection? If they're selling a product that is structured in such a way that no one can ever collect on it, that is fraud and the company should be prosecuted. But if people sometimes collect, how is that fraud?

Sonic Charmer writes:

If the government is so good at identifying products/services whose max-imaginable-utility ($U) is so much less than their price ($X) as to approach fraud, how about this:

Instead of regulating-away such products, with prosecutions and investigations and all that expensive, time consuming, yet haphazard stuff, just undercut them. Empower some agency to offer the same product(s) at, say, U + (X-U)/2. (Since I think these are 'financial' products we're talking about, there should be no real problems of sourcing or raw materials.)

That agency should both reduce the cost to victims of 'fraud' directly, and (as long as material fraud exists) essentially be self-financing, since they would still be capturing some apparently free profit sitting out there (>=(X-U)/2).

The agency's 'open-market undercutting actions' would either bring all the X's down closer to their U's and 'arb away' those fraudulent products, and/or deter fraud altogether, but cheaply (=just the cost of the salaries for the crack team of fraud-undercutter analysts). In other words its own success would make it self-limiting.

There is the possibility that it would not succeed, would lose money, would need to have its funding increased, and so on. But I don't see that as a real objection to such an agency, since we're apparently assuming here that the typical government employee of such an agency is actually skilled at calculating U.

rpl writes:

You people are getting way too hung up on the word "imagine." Arnold clearly used the word in the philosophers' sense of "demonstrate the existence of a logically consistent example."

Thus, it is trivially easy to "imagine" (philosopher-style) a set of preferences that would lead someone to smoke cigarettes or support the Westboro Baptist Church, but it is not possible to "imagine" preferences that would lead someone to pay good money for a provably worthless cure for what ails them or to pay a dollar today in exchange for 50 cents tomorrow (without any additional compensation). To get someone to buy one of these products, you must first convince them that the product is something other than what it really is, which is pretty much exactly what we mean by "fraud."

Julien Couvreur writes:

I fail to see how your criteria relates to either (1) or (2).

I don't know much about the specific product in debate here. But if it is getting sold, then (1) seems plausible and obviously some preferences do lead people to buy it (demonstrated preference).
And if the customers were defrauded, then a third-party does not to have to get involved with coercion. Instead, the de-frauded customers should get compensation and make the fraud visible. If you want to help them spread the word, go for it.

The downside for (B) is punishment by people who were de-frauded and the abstention of business by the rest, not punishment by the rest of us.

Who is responsible for having bought the product?

rpl writes:
And if the customers were defrauded, then a third-party does not to have to get involved with coercion. Instead, the de-frauded customers should get compensation and make the fraud visible.
Huh? How, exactly, are the fraud victims supposed to "get compensation" without the assistance of the law?
Seth writes:

Your test is subject to personal preference bias. We have a hard time ever imagining sets of preferences that differ from our own, but that doesn't mean those preferences do not exist, it just means your imagination may not be very good.

The article I read says the actions were taken because of outright fraud.

That seems to be a reasonable test. If customers are paying for something they cannot benefit from or did not even agree to buy, that seems like a good test for gov't involvement. That seems to be exactly what I want gov't to do -- protect our freedom from the abuses of others.

However, the discussion about whether the actual products -- when sold to willing and qualified buyers -- are good are bad seems to be a red herring.

Matt C writes:

First, I'd like to agree with the idea that we do have organizations deliberately targeting the weaknesses of stupid and irresponsible people, in order to do business on terms that the organization knows perfectly well are net negative for most buyers. I think this is despicable.

I want to note this particularly because a lot of libertarians take the attitude that consent is all that matters. Just because you have found a legal way to take advantage of weak people does not mean you are not a scumbag for doing it. Getting deep into this would go way beyond a blog comment though.

That said, I think it quite difficult to say "this product is effectively fradulent because *only* a stupid or grossly irresponsible person would buy it". Take payday loans. Sometimes the lenders are just exploiting people who are dumb or who have the maturity of children or both. But sometimes they are providing an extremely valuable service to people who need ready cash *today* and for whatever reason can't get it any other way.

> That test is, "Can you imagine a set of preferences that would make you want to buy this product?"

For almost any product that is not 100% fraud, I think I could do this. I don't know the details of the credit card protection plan, but I bet there is a scenario where I would choose to buy it.

I don't have a good answer. I don't like weak people to be exploited, but I am also highly doubtful that a push for more paternalism from our authorities than we already have is the right answer.

Jacoby writes:

Arnold Kling:

Good post. I went over to Don Boudreaux's blog post and I saw he stated this rhetorical question:

But does the cost to C of his or her naiveté justify G forcing A to fund B’s efforts to protect C?

I thought it was a very interesting question; I rarely hear questions like it. What would be your answer if it wasn't rhetorical?


Hasdrubal writes:

By "'Can you imagine a set of preferences that would make you want to buy this product?'" do you mean "Can I model a rational actor with these preferences?" Or do you mean you can empathize with a person who has those preferences?

The former probably prevents a slippery slope but can be very limiting on the regulator. (Even more restrictive if you allow for some behavioral economic fallacies under the rubric of bounded rationality.) The latter is no protection at all against a slippery slope and very likely to change as norms change.

Floccina writes:

I always say to this sort of thing, that Government seems very bad at prosecuting fraud and in fact disinterested in doing so. Until they get rid of all the obvious fraud that is what they should focus on.

James writes:

I find it difficult to have an opinion on this without having more details on what misleading and deceptive tactics were used.

On one of my (former) credit cards the area just below where an address change would be listed included a line for a signature. The signature was not related to the address change, but instead would enroll the cardholder in one of these lost jobs/disability payment schemes.

It is very easy to see how someone on the left side of the bell curve (or anyone who was in a hurry) would make the mistake and sign up for the unwanted service, when they made an address change.

I decided to register my disapproval with the company's tactics by closing my account.

D. F. Linton writes:

I never thought that a failure of imagination constituted a definitive proof of nonexistence...

Chris Koresko writes:

I saw a post recently that claimed the stock-market losses to Ford and Firestone resulting from the blowout-and-rollover accidents a decade ago were much larger than the fines imposed on those companies by the government.

That suggests it's possible that the most effective way to discourage deceptive practices among consumer credit companies may be a press release that names the offenders and describes the offense.

Of course, it doesn't need to be a government agency doing that. Consumer Reports?

MingoV writes:

Many people make unwise decisions. I admit to making some myself. But, I strongly object to the government taking money from me to fund inefficient bureaucratic efforts to protect people from their unwise decisions. (Does this attitude make me a Social Darwinist?)

John David Galt writes:

Kling's test is the same one that has traditionally led to bans of drugs, alcohol, and prostitution: "If I can't imagine myself ever wanting a product or service, it shouldn't be allowed."

The denial of consumer sovereignty is self-evident.

If a legitimate fraud case exists, then some member of group B should be willing to act as the plaintiff and sue A. Unless the product or service in question kills the people who buy it, there is no good reason for us or the courts to accept any assertion by third parties that A has defrauded B. Therefore the third parties who would so assert should continue not to have standing to sue.

Luther writes:

John David Galt & Boudreaux are onto the right line of questioning: shouldn't one of the alleged "victims" bring a suit against the company for "fraud"... including a class action? Further, and more importantly, how do the CFPB goons have legal, much less moral, authority to be judge, jury & executioner?

Luther writes:

One more thought... what about a rabbit's foot? Is that fraud? Is there value in placebos?

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