Richard Thaler on the value of disclosure in financial regulation

In financial markets, where evidence of irrationality has been abundant lately, (Thaler) says he would increase regulations, but very carefully. There’s no evidence, (Thaler) said, that regulators could actually determine appropriate leverage for specific investments, for example, and “heavy-handed regulation” could shut down financial markets and weaken the economy further.

“The trick is to try and figure out a way of forcing these firms to disclose more of what they’re doing without giving away so much that they can no longer make a living,” he said. Such information would help individuals decide whether to invest in the funds, and would help regulators assess overall risk imposed on the financial system and the economy. In addition, he said, disclosure itself often has a salutary effect on behavior because people tend to be mindful of the opinions of others.

Thaler calls Sunstein the “Nudger in Chief.” Read the full piece in the New York Times.

Should home mortgages come with a label?

Over at the CL&P Blog, Jeff Sovern has more thoughts on nudges in mortgage agreements. (Earlier post is here.)

Suppose after stating the monthly payments, and especially the maximum payments under an adjustable mortgage, what would happen if the disclosure statement explicitly asked “Are you sure you can make these payments on time?  If you can’t, you may lost your home.” Or is that going from a nudge to an annoying nag–and if so, would that be bad? The late payment fee is already required to be in the “Federal Box” set of disclosures, and so won’t be far away from the statement of when payments are due, but the regulations could be amended to require that it be right next to the notice of when payments are due, just as with the credit card statement.

Before diving into the effects of one sentence’s construction or placement on a page, it’s worth stepping back for a minute. The point of Sovern’s comments, and other like them, is that clearer disclosure in the mortgage industry would be better. More disclosure would be nice too. More disclosure is one common refrain among mortgage industry reformers. And let’s not savage the government too much. Disclosure is an concept it has looked into. The question is what does better disclosure look like? To put the question another way: Should a mortgage, like a refrigerator, a car or even a box of cereal, come with a label? Is a label the best form of disclosure – as opposed to an Excel-style spreadsheet or a brief executive summary? The FTC has considered a hybrid of these two approaches already. See here for the prototype.

To Nudge blog readers: What information would you put on a mortgage label? How would you design it? Is the interest rate amount and structure the most important information? Perhaps conflicts of interest between broker and other parties?

Assorted links

1) Enforced transparency isn’t just a tenet of good governance types. It is a solution for behavioralists grappling with the problems of information asymmetry and how best to get crucial information to the right parties. While Jon Danielsson and Casper de Vries apply this insight to credit markets, it could follow for politics too. (Hat tip: Mostly Economics)

2) Behavioral economic consensus on how fiscal policy? A psychologist thinks the tax cuts in the stimulus should be doled out in small increments rather than one lump sum as previous tax cuts have been.

3) Food and behavioral economics. A video filmed at Cornell. Runs about an hour.

4) TheStreet.com warns not to let the endowment effect keep you from selling losing stocks.

Roundtable on libertarian paternalism to be held in Washington D.C. later this month

America’s Future Foundation, an think tank comprised of libertarian and conservative members, is sponsoring a panel discussion of Nudge in Washington D.C. on February 18th at 6:30 p.m. Cost: Free for organization members, $5 for non-members.

Many view Libertarian Paternalism as oxymoronic. Despite the name, can this idea offer a “third way” and improve our decision making processes in a beneficial way?  Or, is Libertarian Paternalism another way for “choice architects” to manipulate individuals into behaving in ways they view as correct and beneficial, while restricting our individual ability to choose?  Understanding the policy implications of this idea is especially relevant as Cass Sunstein was recently tapped to head the White House Office of Information and Regulatory Affairs in the Obama Administration.

The full slate of panelists will be announced soon. More information about the event can be found here.

Addendum: An audio tape of the event is here.

A reader critiques casino self-ban policies

Reader Joanne Fendell astutely points out some weaknesses of casino self-ban policies and offers possible improvements.

I believe that the use of self-exclusion can be quite useful for gamblers, but it doesn’t reach out to enough people. I live in Maryland. If I want to be self-excluded from Delaware Park, my nearest “gambling opportunity”, I have to register for the self-exclusion list in Dover, some 40 miles farther away. Similarly, I would have to travel to Casino Gaming Commission in Atlantic City or Trenton to be self-excluded from casinos in New Jersey. Both of these states require the prospective member of the self-exclusion list to sign up during normal business hours. The options are consistent from state to state: self-exclusion for one year, five years, or life. If the “life” option is taken, you can never be removed from the self-exclusion list.

Self-exclusion does not automatically expire upon the completion of the self-exclusion period. It is necessary for gamblers to petition to be removed from the list.

Pennsylvania took a positive step in their self-exclusion program by letting people sign up for self-exclusion at the casinos anytime. Unfortunately, this is not explained well on the web site of the Pennsylvania Gaming Control Board, and the prospective member of the list will believe that they have to go to Harrisburg to sign up for self-exclusion. Pennsylvania has more self-excluded gamblers, about 700, after a year than New Jersey has after at least 20 years of the self-exclusion program, about 550. There is likely to be some overlap in the people on the lists.

There are unintended consequences to self-exclusion. Harrah’s casinos reserve the right to ban gamblers from all of their properties nationwide, not just the gaming floor, so sign up for one self-exclusion list, and you’ve signed up for self-exclusion everywhere that Harrah’s has a business presence. They won’t even let you stay at the property.

This can be inconvenient for business travel, if you need to attend a conferences that is held at a casino. There should be a way to petition for a week-long parole that lets you stay at the hotel, with the ban on gambling still in effect.

The virtue of self-exclusion can be seen in a saying of Oscar Wilde’s: “I can resist anything but temptation.” By signing up for self-exclusion, you are volunteering to be arrested. Most casinos treat violation of the self-exclusion ban as trespassing, so you may be escorted from the property of arrested. This may be why New Jersey and Delaware require the sign-up to be done at a non-casino site.

There is an easy way to fix this problem. Have a phone number at the casino that the person who wants to be removed from the list can call for an appointment.

Has Nudge unintentionally led to airline marketing scams?

We sure hope not. Ian Ayres and and Jonathan Macey see an opt-out scam where airlines and flight aggregation sites like Orbitz set the default rule for flight insurance (typically between $10-$15). They wonder if Nudge is to blame? Say it ain’t so. Nudging, as we have tried to show in the book, can be used by shrewd manipulators.

In their recent best-selling book Nudge, Cass Sunstein and Richard Thaler show that default setting can be a powerful force for the social good. But default setting can also be a powerful force for mischief if controlled by those with ill intent.

We wonder whether the fact that opt outs were only recently introduced in the travel industry — and only after Nudge was published — is merely coincidental. Perhaps the insights in the book provided valuable, if unscrupulous, tips to the marketers who help design websites for the travel agency.

As lawyers and economists, we would have predicted that reputational sanctions would have kept Orbitz from engaging in these sorts of shenanigans. Experience, however, is proving us wrong.

Addendum: Ok, we know these scams were around long before Nudge and will be long after. Be on the lookout – and let us know about them! The Geary Behaviour Centre points to a nice 2006 FT article (pre-Nudge) by Eric Johnson and Daniel Goldstein about the power of defaults.

Paralyzed by choice down under

In Australia, superannuation is a long-term savings and investment vehicle that, like the 401(k) in the U.S., provides tax-advantaged retirement benefits for individuals. Since summer 2005, a overwhelming majority of Australian workers have been able to choose an investment fund through superannuation. (Prior to 2005, fund selection was largely made by a trustee of some kind.) With more than 200 fund options to choose from, investors have been overwhelmed. (Just think how overwhelmed they would have been if they had lived in Sweden where a privatized version of social security yielded almost 800 fund options!) In a new report on the policy, the Australia Institute levels some harsh criticism.

The fact that fewer than ten per cent of workers actively choose a fund should not come as a surprise. Indeed, as little as four per cent of workers switch super funds each year and around half of this is ‘passive’ choice due to job change or fund closure. Because participation is compulsory, a great many fund members, and particularly those a long way from retirement, do not take a keen interest in their super. Being automatically enrolled in a retirement savings system is not conducive to active consumer decision-making.

Choice of Fund has also been largely unsuccessful in lowering the number of multiple accounts, one of the most serious problems for superannuation policy-makers. In fact, the number of accounts per employee has actually increased, suggesting that choice has not ‘empowered’ consumers to take even the most basic action to improve their superannuation arrangements. Three years on, the failure to promote consumer-centred competition has resulted in considerable waste across the super system. Average fees levied by fund managers have not fallen, remaining at around 1.25 per cent of funds under management (equating to around one per cent of GDP), and significant fee and performance variations persist between not-for-profit funds and for-profit (retail) funds. Moreover, it is estimated that Australians pay around $2.4 billion a year in commissions on superannuation assets, including $862 million on their compulsory superannuation contributions. Financial outcomes for workers can vary considerably depending on the fund that their employer nominates as the default fund.

Read the full paper for six design principles for a default rule, including a somewhat controversial argument that default options should “focus especially on the needs of people who are a long way from retirement, or whose accumulated benefits are relatively modest,” because of the poor decisions that people make in situations where the effects are not felt until well into the future. Because of the complexity of investment decisions, and the number of amatuers among all age groups, the default rule should be issue No. 1 for a choice architect regardless of whether the employee is 23 or 63.

Promoting friendly competition to cut back on energy

The New York Times reports on a favorite nudge of ours from California: Giving people information about their energy consumption and how it compares with their neighbors’ in order to cut back on energy use – and printing smiley faces and frowning faces on customer’s bills to emphasize the message. By subtly shaming or applauding individuals, the nudge taps “into a time-honored American passion: keeping up with the neighbors,” the Times writes.

Interestingly (albeit perhaps not surprisingly), one positive development from this nudge is the encouragement of spontaneous, small-scale action by groups. As designed, the nudge is entirely focused on individuals or individual families. Each household receives a bill, providing information about its energy habits, plus the habits of the energy of an average household, or one especially green household. But by piquing curiosity about the behavior of others, groups are likely to spontaneously form to take advantage of the information they’ve been given.

Competition among homeowners is still rare, but is becoming more widespread. In Massachusetts, the BrainShift Foundation, a nonprofit that uses games to raise environmental awareness, recruited towns to compete in a reality series, called “Energy Smackdown,” which is shown on a local cable station.

At the start of this year’s season, 10 families from Cambridge, Medford and Arlington formed teams and competed against one another in conservation categories that included waste, heating fuel, electricity and food. Patty Nolan, 51, who lives in Cambridge with her husband and two children, agreed to participate because, she said, although family members thought of themselves as “environmentally conscious,” they knew they could be doing more.

Promoting friendly competition is fast becoming a recognized strategy for designing a nudge. Looking to the future, smart choice architects may be able to take this kind of individually delivered information, and use it to promote or strengthen broader social norms.

Urinals part VIII

Monica Hamburg sends over another goodie. Bring on the bathroom graffiti. Poetry, at least in Japan, can cut down on toilet paper usage.

A study by the research center Japan Toilet Labo showed that it can make a big difference – cutting down paper use by 20%. Written poetically, the posters send messages like: “That paper will meet you only for a moment,” “Fold the paper over and over and over again,” and “Love the toilet.”

Researchers said that toilet paper usage has been increasing in Japan as of late, and they hypothesize it’s because it’s free – people scrimp when they’re at home. So they’re pushing to have 1,000 posters put in public stalls to encourage people to cut down on how much toilet paper the use as one more small step to save the planet.