Cognition and Vanilla Options

Wow, I got a lot of excellent responses to my piece on weak cognition and the financial industry. After Andrew Sullivan referred to it as a litmus test, there were responses from E.D. Kain, Megan McArdle and Jason Kuznicki at CATO.

In case you are wondering, the credit card industry is in fact data-mining the hell out of you to learn how much they can get from you if you hit hard times, giving them a massive information asymmetry. Check out this New York Times magazine article, What Does Your Credit-Card Company Know About You?, for more specifics.

But on point, I would have gone ahead and written out the second half of that argument if I knew so many libertarians would have been reading it. From Megan Mcardle:

I’m not sure why this is supposed to be a hard question for libertarians. I mean, I might argue that preventing people from ripping off the marginally mentally impaired would, in practice, be too difficult. Crafting a rule that prevented companies from identifying people who are marginally impaired might well be impossible–I’m pretty sure that if I wanted to, I could devise subtler tests than “What day of the week is it?” And while the seniors lobby is probably in favor of not ripping off seniors, they’re resolutely against making it harder for seniors to do things like drive or get credit, which is the result that any sufficiently strong rule would probably have.

But it’s pretty much standard libertarian theory that you shouldn’t take advantage of people who do not have the cognitive ability to make contracts. Marginal cases are hard not because we think it’s okay, but because there is disagreement over what constitutes impairment, and the more forcefully you act to protect marginal cases, the more you start treating perfectly able-minded adults like children.

I agree with all of that except that it would be difficult to prevent. Not prevent fully, but prevent in large part. It’s a bad idea to set a single rule for these situations, because you’d be treating healthy, perhaps even risk-seeking, adults as if they were mentally ill. Is there anyway we can use markets to solve this problem?

Good Enough Vanilla Options

Guess what: we can! And that solution would be mandating financial services to provide Vanilla Option financial products. Boring, low-reward trap-fee products you’d probably have to pay a yearly fee for.

So much of our financial services are predicated on tricks and traps but also have a lot of benefits. You get free checking, but if you overdraft you lose more than you gained. Now with a vanilla option, you could pay more upfront to not take the risk of losing later. This is banking how it used to be, boring. And this is exactly the kind of product that people with weak cognition would want to have available. Someone approaching older age, but before getting there, could opt for the “extra boring” financial services package. People buy renter’s insurance; some might view a yearly-fee on their checking account or credit card as a “trap insurance.”

And not just them: Me too! And I’m a fairly smrt guy. And probably tons of you. Wired had a fascinating piece on the “Good Enough Revolution”, and I’m sure market research people at these financial services places are hearing a ton about how everyone would really just like a simpler product that they can worry less about, rewards be damned. Is “Good Enough” Financial Products better marketing than “Vanilla”?

If this solution is so market friendly, then why doesn’t it already exist? As this excellent paper, “Shrouded Attributes and Information Suppression in Competitive Markets” points out, (MR summary here) the market have a terrible time creating a vanilla option. Especially when confused or cash-constrained consumers subsidized sophisticated and rich consumers, there’s no incentive for the sophisticated to move. And a bank advertising something as being “trap-free” might be the product with the most traps in it, hidden deep within a terms of service that lawyers could read any such way. Having a credible stamp by the government saying “boring” is one way to cut through this double trap problem.

Casino Island

Here might be where I disagree with libertarians. Megan wonder if I am a paternalist. I’m not sure. Quick thought experiment: I’m the King of Rortybomb Island, and you want to open a casino on my island. I know many people will enjoy this, but many people won’t but won’t be able to prevent themselves from going to the casino, no matter how much they hate themselves in the morning. So what I propose is that you can open your casino, but you have to maintain a list of people who voluntarily want to never be allowed into the casino, no matter how much they beg when the time comes. The person can’t get off the list in a short period of time, it’s fairly binding.

We can also assume, reasonably, that people with a gambling addiction/problem are the most profitable to the casino, so there’s no way you and your casino backers would voluntarily, outside public pressure or government influence, create this list. So the government forces them to create it to get a business license.

I think that’s an awesome solution to the problem above. My question: is this paternalistic? Specifically, is this paternalistic towards consumers of gambling services? I don’t think so. In fact, I think the exact opposite: it makes markets more complete, and thus more efficient and reflective of information.

Back when the New Dealers were creating the idea of a regulatory state, post-NRA they came up with the idea that monopolies and big concentration of firms were ok and didn’t need busting or regulation as long as they didn’t harm consumers, and they determined that consumers weren’t harmed as long as prices were competitive. The problem is that they didn’t envision the idea that prices could be made lower upfront, making it look very competitive, by punching up the risk on the back-end. People with minor gambling problems want to be able to “buy” the option of never gambling being prevented from buying that hurts him as a consumer. People who don’t want the hassle and the risks of high-end financial services should be able to “buy” a generic product.

The price of these services may be very competitive; the market for buying a level of risk in your financial services is not. People in the United States need financial services, and if people are willing to pay an annual fee to not worry about getting nailed on every little, last, fee, and that product isn’t provided by the market in order to push consumers into more damaging forms of services, that’s a form of hurting consumers. And that’s when a government reaction is needed.

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17 Responses to Cognition and Vanilla Options

  1. Morph366 says:

    Maybe I haven’t read deeply enough on your notion of cognition but I wonder how you distinguish between those with “weak cognition” and those with “cognitive dissonance”. I suspect many who should be on the casino black list would fall into the second category and not voluntarily add their names to the list.
    Even libertarians are prone to self deception, perhaps more so than most. But I wouldn’t know because I’m a cognitive nihilist (at least I think so)

  2. pebird says:

    Actually, I think the irrevocable list idea is very paternalistic – it sounds like something a crazy father would do, asserting a quasi-voluntary rule that turns into a justification for limiting freedom.

    What the rule actually does is provide limited protection in exchange for an admission of personal weakness. The individual submits to an authority who is assumed to know the individual’s “true” interests. It is extremely paternalistic.

    The funny thing is that if someone is perceptive enough to know they shouldn’t be in a casino, they really don’t need such a list in the first place. It only serves those that are ambivalent about their ability to resist temptation. Some might sign up but many would defer until they realized so much harm they would need a different kind of help.

    We can also be assured that many who sign up would change their mind and protest about their freedom being restricted. If the authorities refused to relent the public would never sign up.

    The list would soon have a image similar to the TSA. The anti-regulatory interests would have a field day.

    The notion that we can make non-contractual decisions then change them based on new data is something we grant as an individual right.

    Instead the list should be designed as a positive contributor to individual freedom – a list of people signing up to demand vanilla products that they can freely decide to purchase. If the financial industry does not respond (and it has not), this demonstrates a market failure and the government then has the responsibility to regulate and restrict industry freedom to ensure individual freedom.

  3. Dennis Mennis says:

    Really, all this paternalism is pathetic. If people screw up, too bad. If people who are retarded do, too bad. If people aren’t smart enough to not get ripped off, too bad. If people get lied to by someone who sells them something, and that something doesn’t work, or they lie, and it causes financial or physical harm, too bad. They should learn a lesson! The marketplace will receive its signals and adjust!!

    Really, personal ruin is a small price to pay for the valuable signals an individual would be returning to the marketplace. There is no such thing as externalities, they are gifts….they merely exist for you to bounce the signals back into the marketplace. And then private sector firms will adjust. They always do. They don’t need to be compelled. They are not flawed. Do your duty. Send the signals back to the marketplace and stop complaining and coercing. It’s your role as a human.

    Libertarianism forever!

    • Allan says:

      Dennis Mennis, you sound like someone who makes his living ripping people off!

      It’s nice that you cloak selfishness and exploitative behavior in a your “the market is god” theory, but I, for one, don’t wish to view my “duty” and “role as a human” as sending signals to the all-holy market!

      I have better things to do with my freedom than fulfill your market-imposed duty; for example, I can fight like hell against exploitative cretins who pray on the weak for personal gain.

      I urge you to try out “personal ruin” for yourself as the “small price” you pay to send valuable signals to the market.

      If you post your real name and address, I will make sure that you send valuable signals to the market every week by sending people to you to rip you off in the cleverest ways they can think of. Sure, they will lie, cheat, deceive, connive and extort, but, hey, those market signals are so valuable, and making money is such a sure sign of virtue, that if that’s what it takes, so be it.

      What’s pathetic is claiming that anti-fraud measures to prevent the weak from getting ripped off by the unscrupulous is nothing but paternalism. In most places, we simply call it justice.

      • Dennis Mennis says:

        I apologize, what I wrote was pure sarcasm. Sometimes, I get too wrapped up in the role, if you know what I mean.

  4. Charles Gervasi says:

    I have libertarian leanings, so I don’t like the sound of a gov’t-endorsed vanilla option. The current market, though, is not working, so I would support your plan.

    I wonder if it were enacted, how many consumers who would benefit from a vanilla option would select that option. I suspect if these unsophisticated people would be driven to tricky products and not the gov’t-certified vanilla ones.

    I suspect the credit card marketed as “No Hassle” is a market response to this desire for non-tricky products. I do not know whether their product lives up to the “No Hassle” claim.

    I agree with your position that financial companies have gone over the line when it comes to trickiness. A contract requires meeting of the minds, so it’s clearly a problem if a huge segment of banking customers do not understand the agreements they’re entering. A vanilla option would be a good thing.

  5. Pingback: The vanilla option | The League of Ordinary Gentlemen

  6. Marc says:

    Have you ever bought a big ticket item that included dealing with salesman? The last one was my car. The first place I went to, when the time came to discuss the price, the sales guy gave me number and followed it by something like ‘You must know that is a good price, you’re a smart guy, you’ve shopped around, you’ve checked the internet’.

    Now, how many going to say ‘no, I don’t’ after that?

    The sales guy was using not so subtle psychological pressure on me. And it probably worked well for most people in my demographic, 35 yo male.

    Any good sales guy is going to know more about psychology, than an average psychologist. Stuff like you bring up has been going for eons. It will go on for eons. You have found nothing new.

    And a new government regulations won’t end it.

    Grow up.

  7. Sandrew says:

    I see no sound libertarian objection on grounds of paternalism. The Opt-In Gaming Blacklist idea is not paternalistic to the consumer, except insofar as it enables future-self paternalism. I find it hard to imagine a libertarian idealist railing against such forms of freely exercised self-restricting behavior. It’d be like a libertarian arguing that the right to get a vasectomy somehow infringes on the future self’s right to freely choose to reproduce.

    However, I can imagine an objection to this scheme (libertarian or otherwise) on the grounds that the enforcement costs might likely outweigh the scheme’s effectiveness. For fun, try to design an efficient enforcement regime.

  8. Hans says:

    As a smoker, I would put my name on a government-regulated list that would prevent me from buying cigarettes. I would be happy to sign this contract for a term of one month, one year, or however long the period needed to get me off cigarettes.

    Naturally, tobacco companies and cigarette vendors have no incentive to create such a list, at least not without charging me a fee equal to what I would spend on cigarettes in a lifetime, appropriately discounted. Which would be good for my health but not for my wallet. In this case, government intervention, forcing companies and vendors to offer such a contract and deny cigarettes to people on the list, would absolutely not interfere with my libertarian leanings.

    Of course, I’m counting on my smoking friends to quickly tire of me constantly bumming cigarettes off of them.

  9. Sandrew says:

    I spoke to a libertarian friend and posed him the Opt-in Blacklist scheme. He didn’t care for it. I asked him some questions to try to pinpoint why (paraphrased):

    Me: Do you think that casinos are just in profiting from people with gambling problems?
    Libertarian: Kind of.
    M: OK then. So is there such a thing, in your view, as taking advantage of someone?
    L: Yeah.
    M: So there’s something about a gambling addiction that makes it somehow different from other impaired mental states (e.g. dementia, retardation, chemical dependence). Certain people may be off-limits, but gambling addicts are fair game. Is that right?
    L: They’re not really addicted in the way that, say, a drug addict is chemically dependent. It’s not the government’s place to meddle with a gambler’s poor choices. Even if the government isn’t imposing anything, but simply trying to give tools to the gamblers to help themselves resist temptation (i.e. an enforceable opt-in blacklist), that’s still not cool. It’s not the role of government. The costs of such a government scheme (enforcement, bureaucracy, etc.) would be unfairly foisted upon non-gamblers.

    Now, this libertarian may not be representative. But I wouldn’t be surprised if many people share his skepticism about the pathology of gambling addiction, and that these people generally oppose government intervention of this kind.

  10. Not the Mike You're Looking For says:

    How about this for a libertarian solution–get the government out of the debt enforcement business! We can tell the banks that if they want to offer their complex products, they can, but such agreements will not be enforceable through the courts, the bankruptcy process, or any other government-sponsored mechanism. Furthermore, lenders must abide by laws against trespass (defined broadly to include any unwanted communication via a telephone number or email address owned by the debtor), invasion of privacy, and libel (which will apply to any inaccuracy made in a statement to a third party, such as a credit reporting agency, that could disadvantage the subject of said statement). Finally, we will not allow the owners of lending firms to benefit from any special privileges, such as limited liability, that might protect them against lawsuits or criminal charges brought for violations of those rights.

    I’ve probably left some gaping hole somewhere, but I hope I’ve gotten my point across: If we’re not going to allow the government to protect anyone from the consequences of their own bad judgment, let’s not be selective in our application of the rule.

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  12. clawback says:

    No need for a thought experiment. Missouri has for many years had a program that functions pretty much as you describe.

    http://www.mgc.dps.mo.gov/prob_gambling/pg_vep.htm

  13. Jake says:

    The Missouri program appears to have been completely captured by the gambling addiction treatment industry and the casinos themselves. The page describing it is actually fairly depressing.

    Rather than allowing a problem gambler to ban himself from casinos, the casino has to stop sending him junk mail and not allow him to join their player loyalty clubs or cash checks in their casino. In exchange, if he wins more than $1200 the casino can have him arrested for tresspassing, and are trying to change the rules so they don’t have to pay him his winnings, either.

    “Free to play, just not free to win” is not doing anyone any favors.

    • clawback says:

      The Missouri program was actually effective up until recently because the state had a “loss limit,” the enforcement of which required the casinos to register everyone on entry, during which customers’ names could also be matched against the program’s database. The loss limit was removed and the casinos no longer registers gamblers’ names, if I’m not mistaken. So enforcement of the program is now less effective.

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