Morning Money’s piece, “How gutting the CFPB clashes with affordability concerns,” suggests that the Trump administration’s efforts to shut down the Consumer Financial Protection Bureau contradicts the administration’s affordability goals. The argument is that the CFPB has tried to limit fees such as bank overdraft charges—a rule nixed by Congress—and such limits would save consumers money.
This thesis is, alas, sadly naive. Price regulation of financial services, chickens, gasoline, insurance, housing, or anything else does not solve affordability problems. Regulation might create the illusion that it has done so for a few people. But it also leads to shortages, loss of quality, higher prices elsewhere, and reduced competition and innovation.
The price of a good or a service is a function of two factors: the quantity supplied by sellers and consumers’ demand for the good or service. Demand is the quantity that consumers want to buy at a given price. More supply, same demand, and prices will tend lower. If the price falls and supply remains constant, demand will rise. If demand holds constant and supply falls, prices will rise (encouraging sellers to offer more supply). The graph below is a classic supply and demand curve, showing the relationship between the quantity supplied, price, and consumer demand.
What happens when government intervenes and forces prices lower? Supply will tend to fall short of consumer demand, even as sellers’ incentives to offer the good or service are reduced. Thus, price controls often lead to shortages.
Often? Not always? Behavior and markets are complex. Other pernicious outcomes are possible. Sellers might offer the same quantity of a price-regulated product but reduce the quality. Alternatively, a seller forced to sell a product at a lower price might raise the price of related goods or services to make up the loss. Or a combination—but none of it is good for consumers.
Forcing prices down will reduce competition and innovation too. Prices convey information about opportunities to potential sellers. High prices and healthy profit margins send a signal to entrepreneurs, letting them know when to enter the market and offer consumers an alternative. When prices are forced low, this will not happen.
Thus, the CFPB’s limit on overdraft fees would not have helped consumers. It might have saved people whose checks bounce some money in the short run at the expense of other consumers; however, overdraft fee caps would lead banks to reduce overdraft coverage and raise minimum account balances. As my colleague Nick Anthony has explained, other adventures in CFPB price regulation would have similar effects—reduced access to credit or low-priced services, hitting low-income consumers hardest. Meanwhile, state restrictions such as interest rate caps, which affect sources of funds other than overdraft services, make matters worse for cash-strapped consumers.
Price regulation of financial services creates, at best, an illusion of affordability while discouraging providers from making financial services accessible to those who need them most. Shutting down the CFPB, given its history of support for price regulation, would not conflict with policies that promote affordability.
What would promote affordability of financial services? Letting markets work free of paternalistic rules that restrict consumers’ choices, and letting prices signal opportunity to fintechs offering nontraditional business models. Competition, not price regulation, is still the best answer.