The One Thing that CFPB Must Do

The Consumer Financial Protection Bureau (CFPB) was created in 2011 to, according to the US Treasury Department, "promote fairness and transparency for mortgages, credit cards, and other consumer financial products and services." If you look at the underlying motivation for the CFPB's creation, however, its origin lies in the perceived deception of consumers by financial companies. Finance is really psychology, and the most successful finance companies understand the psychological pitfalls that consumer don't. Consumers make the same mistakes over and over, and the CFPB now exists in the hopes of preventing finance companies from allowing consumers to fall into those traps.

A great example of this is use of credit cards. Because there is no physically representative counter involved, spending money with a credit card tends to be too easy; there is no feedback, such as a diminished weight in your pocket, or thinness of your wallet, that would signal to you that you might be spending too much money. Even relatively sophisticated consumers spend more money when they use a credit card instead of cash. This is exactly the kind of "trick" that consumers fall prey to every day.

So if the CFPB exists to help consumers avoid such tricks, then they really need to go after retail pricing. For decades retailers have discovered that they can sell more products if they mark the price down by a penny or two. Instead of charging two dollars, they charge $1.99, and sales magically rise. Although you might argue that sales rise because the customer is getting a one penny discount, most of the rest of us would think you were pretty stupid to buy that line. No. Instead, when a product is priced at $1.99, a huge majority of consumers think, on some level, that it costs one dollar, not two dollars, even though simple third-grade math tells you that you really ought to round it up to two dollars.

The proof is in the prevalence of the practice. When JCPenney recently decided to price goods "honestly" in whole dollar amounts, investment analysts roundly criticized their new strategy as naive. Perhaps 99% of all retailers use this pricing strategy.

Clearly, using prices based on nines (.99, .98, .97, .95) works, and it is tricky. It is a psychological trick designed to make consumers think that things cost less than they do, and as a result, consumers overspend.

The CFPB is starting in the wrong place. They really need to be out there setting rules for pricing of retail goods. The rule to be imposed is simple:  Goods must be priced so that when rounded to the nearest five percent, there is no change in the price. With this formula in play, items could cost $1.90 or $2.00, but not in between. No consumer is going to lose any sleep over the difference. The retailer, faces a much tougher choice. If they price at $1.90, they keep most of the "trick", but at a loss of 9 cents (4.5%) on every sale. Or they can post the "honest price" of $2.00, and stop tricking the customer into spending money they don't really have.