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.

Family Vacation or Budget Deficit?

In the Wall Street Journal Demetria Gallegos writes about taking a vacation with her four daughters without her husband. She wrote about differences of opinion over affordability and location (Los Angeles and Disney), but appears to have skipped many other issues. Issues like control (did he have any input into planning?), frequency of their Los Angeles trips (is this the fifth trip there?), proximity to relatives (hers?), style (shopping and Disney trinkets vs. history and culture), trip efficiency ($ per day), and budget (was money saved for this trip, or is it coming from credit cards?). The responses tended to be polarized, with perhaps half of the commentators castigating the husband, and the others supporting him. Several were quite harsh, suggesting the wife divorce the husband.

One of the dangers of frugality is that other people attack it. It is difficult enough for some of us to refrain from spending money we shouldn't spend. When we do, we are being sensible. Ben Franklin would be proud. A penny saved is a penny earned. When other people attack that frugality, it is much easier to give in to the criticism and resume overspending.

Something more than "good parenting" was at stake in this article. Most of us know that a good shared experience can pay dividends for the family for many years. Time passes, and you cannot get it back. Children grow up, and if you don't seize the initiative to travel with them, you won't get that opportunity later. It evaporates.

What was missing from the article, though the author implied that her husband did understand all of that, was any discussion about whether this trip would be a memorable trip. It is possible that the husband calculated that circumstances would result in a poor "memory" payoff for the cost involved. Certainly those commentators eager to attack him gave no consideration at all to this payoff calculation.

The bigger issue is the people dynamics. It is possible to be sensible and do the right thing about your finances, to be great at getting high returns from both expenses and investments, and still someone will come along and berate you for reasons that are emotional. You were happy, but now they are doing all they can to make you believe that you were wrong for being happy.

I have to wonder about some of those commentators. Did they really have other motives in making those comments? An over-spender may be anxious to force others to also overspend, as a way of justifying their behavior. Or it may be simple competitiveness:  They want the husband to be as miserable and broke as they are. How dare he escape the vacation dilemma with money left over! Something tells me, however, that there is something even more sinister than that afoot.

Everything is an investment

The principal cause of recessions and depressions is lack of capital. Reduced capital stocks induce businesses and consumers to curtail their expenditures, in order to conserve their scarce stock of money.

What causes lack of capital? Poor return on investment is the primary culprit. During the preceding boom, consumers and business, and probably government as well, make what turn out to be poor investments. When capital and revenues are plentiful, people are less concerned with making the highest quality choices.

When I use the word "investment" here, I mean the allocation of any resource to any activity. We all think of stocks, bonds, money market funds, and real estate as investments, but what about time, purchases of durable goods, selections of educational topics, development of new skills? Home budgeting wisdom separates expenses from savings, but both come from the same income pool, and both have the capacity to return future gains.

Most expenses don't return cash, but they may return convenience, time, life satisfaction, and help you avoid costs. If you buy a reliable car instead of a flashy car, you may save thousands of dollars in maintenance over the life of the vehicle and spend dozens to hundreds of hours less time. Then again, if flashiness is supremely important, then buying a flashy car may return life satisfaction well in excess of any additional maintenance expense, or could induce you to extend your car maintenance skills, resulting in personal satisfaction and lower car repair bills.

If you don't think about which corn flakes to buy, you might buy the more expensive box, or the one with less quality per dollar. By not thinking, you lose money. When you don't pay attention, your resources go to the wrong place, and reinforce the wrong behavior in others.

These decisions get less consideration in boom times. If real estate is booming, people may worry less about what would happen if future prices fall than they otherwise would. The idea is that during bubbles the quality of many decisions about where to put capital may be reduced in quality. The result is a mis-allocation of resources, followed by substandard returns on those investments, further resulting in a reduced capital stock.

Hence, it isn't the lack of "animal spirits" that causes recessions, it the presence of "animal thinking" during the booms that causes capital to be allocated badly.

With this insight, the way out of a recession is clearer. Any policy or inducement for people to shortcut their thinking will make the capital deficit worse. Allowing people to sharpen the quality of their investments, to be frugal, insist on quality, and so on, directly adds to capital and immediately rewards those who are making the best efforts to allocate their capital.

Suppose burger chain A and burger chain B sell roughly equivalent value meals. Chain A sells theirs for $5.50. Chain B sells theirs for $4.00. If we assume that the psychological satisfaction of the two meals is roughly the same, the food has the same number of calories, the same quality, and same taste, then which chain is the better investment vehicle? Shareholders of Chain A might be better rewarded in the short term, but let's analyze what happens to society as a whole.

Say that Chain A "gets away with" selling its meals for $5.50. Over time, its employees might come to feel entitled to that $5.50. Or the price may reflect their higher costs, they may let costs rise because the price gives the company less impetus to cut their costs. In the long term, society gets fewer meals from Chain A for the same number of dollars.

Chain B, on the other hand, is generating more meals per dollar. Its customers have money left over, and their employees have succeeded at running the business on a leaner and meaner basis, which makes it more robust to economic shocks. In the long term, society gets more meals from Chain B for the same number of dollars.

In an economic boom, customers flush with extra cash may feel that they are able to show off their wealth by deliberating indulging in a meal from Chain A. Members of the opposite sex will be impressed: "Oh, he can afford the expensive burger! I want him to ask me out! Not that cheap Chain B guy!" Customers are then rewarding the less-efficient business, and making poor investment decisions because they get less for their dollars.

Society benefits from nurturing organizations that can produce and achieve more with fewer resources. Boom thinking, with conspicuous consumption, anti-frugality tendencies, and the success of even inefficient companies, is bad for the long term economy.

I hope that the point of the title of this posting is now clear. Even though a hamburger purchase may not feel like an investment, thousands of decisions to buy off the dollar menu are nevertheless the kind of capital allocation that sets the stage for long-term national economic growth.