Friday, September 24, 2010

Let the buyer beware

THE term Caveat Emptor is a Latin phrase used in economics, which means "let the buyer beware'. The reasoning behind this philosophy is that the ultimate protection for market transactions is the responsibility of the buyer. This I think is the real essence of the protection in market economies, as one can never truly provide legislation to protect the buyer against every possible infraction by sellers.

Last Monday I was a presenter at a regional conference on banking and credit put on by Consumers International in Barbados, and funded by the IDB. I think it was a very productive seminar, with much discussion on some of the issues that consumers face, and ultimately some of the challenges that lead to market failures. The conference delegates discussed ways to improve consumer protection in relation to the predatory banking practices in the Caribbean.


Banking practices
Ironically the day after the conference ended the Business Observer published an article titled "Jamaican banking region's worst". At first glance it would seem that the World Bank report was saying that Jamaica's banks were the worst in a group of bad banks, but when one reads further it actually shows that Jamaicans embrace banks less than other territories in the region. It showed that Jamaica had the lowest penetration of loans and deposits per 1,000 adult population count.

This is so although there are many branches of the various commercial banks scattered across Jamaica. I believe that there are explanations such as the greater use of instruments through securities dealers and the tendency for many to engage in community-based banking, referred to as "partner".

Whatever the reason, however, one thing that cannot be discounted is the fact that the Jamaican banks are predatory in their pricing towards consumers. Since they are no longer able to make money from the easy pickings of GOJ securities, they have now turned on the hapless consumer who is charged for even thinking of making a withdrawal, or deposit, or even thinking. Such is the nature of Jamaica, where, as a docile bunch of people we allow politicians, banks, and everyone to step all over us in the name of harmony. I would much rather say we dont want to stand out from the crowd.

In other progressive countries, such as the US we all aspire to reach, consumers are a belligerent bunch of people who understand the real meaning of the term Caveat Emptor. So whether it is their politicians, banks, or retailers they give them a piece of their mind when they feel shafted. And in those progressive countries they are supported by the media, rather than wallowing in the alleged misdeeds of others at the drop of a hat.

The fact is that the only way for true market economy development and growth is through consumer development. The problem in the region is that we have a tendency to regulate everything in the name of protecting our poor citizens, who cannot do a job of protecting themselves as the slave mentality still permeates the society. So we must ensure that everything government touches is biased towards welfare, that is, giving a man a fish rather than teaching him to fish.

So for example, education is always a favourite topic for politicians who profess that no one has to pay for education (even if it's just $10,000 or $20,000 per year) but they don't say where the funding will come from.

Here is another example of over-regulation: at the end of the mid-90s financial crisis in Jamaica, regulations were introduced to prevent the recurrence of the events leading to the crisis . In my own view, we went too far and had too much regulation, because we had to protect the naivety of the Jamaican population. The result, I believe, is that the over-regulation stifled capital innovation and development and may have contributed, in this way, to the rise of the Ponzi culture.

Market progress
One may argue that at least our financial system was not impacted negatively by the recent crisis, but then again we did not benefit from the growth before the crisis, and it is a well known fact that markets never move in a straight line as market progress is always tainted with pullbacks, or corrections. But always in the end the net effect is progress. This is the nature of the market economy, that market players overreach, and by doing so create bubbles along the way and there is consequently always pullback.

The irony is that the extent of the recent global financial crisis was caused by the regulators: contrary to the belief that it was the fault of the banks, the crisis (bubble) actually started in the Bill Clinton era, where the rules at Fannie Mae and Freddie Mac were relaxed to allow for the toxic mortgage-backed securities to seem like gold. To support the home expansion, Alan Greenspan reduced interest rates to 1 per cent, and to put the icing on the cake the rating agencies gave these toxic securities AAA rating. All the banks were doing was packaging the securities endorsed by the Federal Government and the ratings agencies. But such is the nature of the short-term memory of people where they will always only remember the last bad act, rather than the millions of good ones before.

Similarly in Jamaica, it was the fiscal policy of high interest rates that led to the financial crisis we faced. The fact is that banks are nothing more than market players trying to sell a product — money — and they will always seek the highest price if the market allows it. The call therefore to crucify the banks (for doing a market function) with regulations is nothing more than an emotional response which has never truly had any long-term benefit. I am the first to admit that the bank's pricing policies are predatory, but the best ways to improve markets are (1) through competition; (2) information; and (3) consumer education.

Any other way will only lead to short-term relief, which simply distorts the market and will lead to another bubble. The bank charges survey that was done by the CAC is one example of what is needed to reduce the charges by the banks, as faced with consumer pressure they were forced to revise down their fees. If we want to see market development then we must give the CAC more resources and regulatory authority over consumer-related issues.

So the emotional arguments about the need to place strict regulations on banks will be nothing more than a futile long-term effort. It seems, however, that human beings are prone to continue making the same mistakes over and over again, as the tendency is always for politicians the world over to play to the cries from the loudest mouth rather than rational reason. I guess politicians are also only market players catering to the demands of their constituents. This is why economic and social progress is always greater in societies with a more educated and aware population, as they know what is best in the long term and place pressure on politicians to represent their ideas.

So it is clear to me that despite the ranting of many who believe banks, politicians, etc. should be muzzled with regulations, if we pursue that path - as a globe - we will only be setting ourselves up for the next round of market failure. And with the efficiency of globalisation, the next one will be worse than what was just experienced. In fact the US is trying to fix the problem with the same policies that caused the problem. So in the end the only true protection against economic and social failure is Caveat Emptor.

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