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Financial stupidity

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Tuesday, May 15, 2007

At BusinessWeek‘s website is this debate between economists Nouriel Roubini and Tyler Cowen about what, if anything, should be done about predatory lending. The debate hinges on whether it’s okay for firms to exploit the financial ignorance of a populace—whether it’s okay to base your business model on other people’s stupidity. In general, this seems bad to me, because it gives people a vested interest in the stupidity of others, which ultimately disserves society as a whole. the predatory lenders profit at the expense of the general well-being of society, assuming society profits from having smart people in it who understand how to make economic exchange more efficient and are more capable of watching out for their own interests. This is essentially what Roubini is arguing when he suggests unrest and misery in subprime credit markets can spill over and present us all with a recession. The ignorance of borrowers and the cupidity of lenders don’t merely affect those involved in the exploitative arrangements, but they have macro effects.


The case for predatory lending is that, well, they are better than loan sharks, to whom bad credit risks would have to turn for their needs. But this doesn’t address the real problem, which is how unscrupulous lenders use deceptive practices to put borrowers in debt traps. Borrowers fail to understand the ramifications of the loans they agree to and aren’t aware of alternatives. To Cowen, this is a matter of choices: some individuals choose to be ignorant (it costs more in time and effort than it is worth to them—financial stupidity is valuable), and choose bad loans, and we shouldn’t force them to do otherwise and trample on their right to make bad decisions. (Alas, freedom means freedom to fail.) Writes Cowen: “Government cannot protect us from every possible form of our own stupidity, and it’s often counter-productive for it to try.” The thing is, deception can make almost any of us look stupid after the fact; the line between deception and opportunity is hard to draw. Is hiding fees deceptive or just good business sense? The emotional pressures and desperation involved in emergency borrowing are sure to cloud judgment and invite lenders to cut corners or make misleading promises that may not be deceptive on paper but are surely deceptive in practice, in the moment. The definition of what constitutes deception can be especially nebulous, making it far from a simple proposition to restrict government’s role to be “to ensure transparency of terms and protect against fraud” as Cowen recommends.

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