Thursday, September 5, 2013

UK's Financial Conduct Authority discovering transparency

Under the FDR Framework, governments are given the responsibility for ensuring that for each financial product or security market participants have access to all the useful, relevant information in an appropriate, timely manner so they can make a fully informed decision.

The UK's Financial Conduct Authority is learning what this means in the aftermath of the PPI mis-selling scandal.  As Yves Smith observed, no one on Wall Street is compensated for creating transparent, low margin products.  PPI was not an exception.

Phillip Inman points out in his Guardian column,

No amount of consumer education could undermine the efforts of high street banks desperate to sell PPI. It was a dangerous and fraudulent product that made fantastic profits for the banks. 
Try as they might, no single campaigner could block the marketing juggernaut designed to drive sales until more than half the working population had been sold one and the compensation bill topped £10bn. 
In the end it dawned on the government that only the regulator could fix the problem.
But the question is how could a regulator fix the problem of PPI or similar financial products or securities?
the Financial Conduct Authority (FCA), has .... enshrined a policy of "temporary product intervention" that means regulators step in when it becomes obvious financial companies are bamboozling their customers. 
Such bamboozling is happening now on packaged current accounts, which banks sell typically for £10 a month with phone and travel insurance bolted on. The accounts are sold despite many customers not needing the extra products or not being able to make a claim. Complaints are pouring in. 
Speculation abounds that the FCA is about to announce a temporary product intervention, or in common parlance a clampdown, on their sale. 
Temporary product intervention is an after the fact solution.  The idea being to end the sale of a financial product before too much damage has been done to customers.

This is a flawed role for regulators for the simple reason that it doesn't prevent financial customers from being taken advantage of in the first place.  Rather it lets Wall Street/The City take advantage of their customers and hopes to end the most egregious practices.
There was a hint in the aftermath of the banking crash that regulators would go further and examine each and every new financial product for its potential to cause harm, but that was dropped.
In the US, the Consumer Financial Protection Bureau has been given the role of examining each and every new financial product for its potential to cause harm.

There are two problems with this solution.  First, Wall Street is very good at devising products that don't appear harmful but are actually toxic (see sub-prime loans).  Second, it takes away from consumers the responsibility for losses and therefore the incentive to assess if a financial product or security is right for them.

The solution that was adopted in the 1930s under the FDR Framework was to make the government responsible for ensuring the transparency of each product before it could be sold.

This means for every financial product or security all the useful and relevant information about the product or security must be disclose to the buyer before they make a purchase decision and they must have enough time to independently assess this information before making a purchase decision.

So the question becomes what is useful and relevant information.  An example of useful and relevant information when insurance is sold is what it takes to actually trigger the insurance.

Of course, if financial firms had to disclose this information, it is likely to end up in a newspaper with a financial expert explaining why nobody should buy the product because they are being ripped off.
Instead we have a system that hopes to stop bad dealing before too many customers become victims. 
As a compromise it is not the worst outcome. 
Actually, it is a compromise that doesn't need to be made.

The government just has to perform on its responsibility to ensure transparency.
However, it ignores the more fundamental point that the financial services industry is pathological in its pursuit of profit. As a result, most financial products are over-complicated and over-priced. 
As Yves Smith observed, financial products are designed to be opaque (over-complicated) and high margin (over-priced) because this is how bankers are compensated.
There are some competitive arenas like house insurance, but mostly our savings, investments and mortgage interest payments leach into the pockets of countless City folk. 
Five years after the crash, they have somehow clung to their bonuses and commissions, trail fees and termly payouts. 
Politicians, fearful that any move against the industry will depress profits, have rarely intervened. Ultimately they believe one of the UK's biggest taxpayers could wither away.
Bankers have clung to their lofty pay because politicians have adopted policies to let them retain their pay and regulators have failed in their responsibility to ensure transparency.
The OECD appears to be equally accepting of the finance industry's dominance. And just as the food industry blames individuals for getting fat, so the financial services industry is allowed to re-establish caveat emptor. 
After all, an "educated" consumer is one they can blame for their own misfortune.
Caveat emptor is part of the FDR Framework.  At the end of the day, bank customers have a responsibility for the results of the financial products they purchase.

With transparency, customers have the ability to do their homework and say no.
Yet when most people in the City fail to understand products sold in other parts of financial services industry, what chance do ordinary consumers have? 
The government hasn't just not upheld their responsibility with regards to ensuring transparency for consumer financial products, but also institutional products as well.  A classic example of this failure to ensure transparency are the opaque, toxic structured finance securities.
The OECD should attack the profiteering by financial services firms and demand simpler products, while dodgy products are regulated out of the system. 
Yes, there should be a demand for simpler products.

The way to assure these simpler products exists is by requiring transparency of all products.  Transparency reveals which products are dodgy and makes it easier for bank customers to avoid any exposure to these products. 

1 comment:

Bankers Bane said...

From the point of view of an ordinary customer, it's difficult to see that the FCA will achieve anything worthwhile. The banks remain a law unto themselves