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The End of the Vanilla Option, and More Bad News for Consumers

The watering down of the proposal for a new consumer financial protection agency continues, with the latest victim the end of vanilla option. Treasury Secretary Timothy Geithner announced at a hearing of the House Financial Services Committee this week that the option was being dropped. Via Felix Salmon, Mike Konczal at Rortybomb explains why this matters.

First some background: The vanilla option means a consumer gets presented with the most basic financial product first, then can choose to add on or buy into something more complex. With the vanilla option, a borrower would first be offered a standard, 30-year fixed loan. If the borrower wanted something more exotic, like an adjustable rate mortgage with a balloon payment, he or she would deliberately choose to go that route. The idea is to avoid all the confusion that surrounds some financial products, from add-on insurance on credit cards and checking accounts to mortgages so complicated the borrower isn’t entirely sure of the terms of his own loan.

From Rortybomb:

I was at a dinner party with some friends a few weeks ago, and the topic of credit cards came up. One friend talked about how she had just realized she had been paying for “credit card insurance.” What is that? If she died, her balance would be paid off. She is a 24 year old law student, who doesn’t carry a balance and has no dependents – it didn’t seem like it was a great value for her. She had to jump through some paperwork to get it turned off, and ultimately did, but for a few months there her credit card company was earning fees off something their customers didn’t want.

The funny and sad part is that we all had these stories (what are yours?). I had “unemployment insurance” on my checking account, where I’d get like two months salary if I was laid off – or something, the terms seemed so off for what I wanted (I was 22), I also shut it off after a few months of paying fees for it. The table was a collection of very well educated people who work in new economy jobs and lead upper-middle class with no families, so we could chuckle at the fact that the companies that provide us financial services were able to “get us” for maybe a couple hundred bucks, and felt a pang of sadness and guilt about what that difference would mean if we lived paycheck to paycheck. The question we asked ourselves was, what do you do about it?

The answer is obvious: you create a baseline, a vanilla option, and then let consumers decide what extra options they want to have in addition to it. Credit card insurance and unemployment insurance is probably valuable for someone, and that person would be excited to pay extra fees to have it. As Daniel Davies famously said, good ideas do not need lots of lies told about them in order to gain public acceptance. A corollary for innovation would be that you shouldn’t need to trick people into signing up for something that is genuinely innovative. Nobody was tricked into the internet.

Despite that obvious answer, the vanilla option seems to have bitten the dust – and it really didn’t have to end this way:

I don’t think it was ever explained very well by anyone in the administration, and perhaps I should have done a better job trying to explain how it is less adversarial than it looked on first examination. It is adversarial to the current way things are done, with massive profits coming from providing services consumers don’t want; and it is my fear that those profits contribute so much to the “safety and soundness” of large banks, the Fed’s first responsibility, that the Fed will have zero interest in breaking this terrible equilibrium financial services have gotten themselves into.

R.I.P., vanilla option. One more win for the banks, and another defeat for consumers.

Be sure to check the fine print on all your credit card and banking statements. No one else will be looking out for you.

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