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Thursday, May 13, 2010

Shiller: How Nutritious Are Your Investments?

Robert Shiller hopes that regulatory reform will include the requirement that financial products have "a standardized disclosure label analogous to the nutritional labels on foods":

How Nutritious Are Your Investments?, by Robert J. Shiller, Commentary, Project Syndicate: Those labels that you see on packaged foods listing their ingredients and nutritional values had their beginnings in an international scandal and in the efforts by governments to deal constructively with the public outrage that followed.
The scandal erupted with the publication in 1906 of Upton Sinclair’s novel The Jungle... The public response to the book’s description of unsanitary conditions in the industry was so strong that the United States Congress enacted the Pure Food and Drug Act – the first law to require labeling of contents on food packages – the very same year. ...
These labels are undoubtedly useful to consumers, but it is unlikely that many manufacturers, if given the choice, would have introduced them on their own.
That is how regulatory progress is often made. The history of legislative reform is ... long periods of time during which public apathy prevents any progress, interrupted by scandals that suddenly make progress possible. Entrenched interests ... resist change with all of their lobbying efforts, but public outrage is too strong for them to win.
We have to hope that the same kind of outcome will emerge from the financial scandals that have produced public outrage analogous to that directed at the food industries in Upton Sinclair’s day. As was the case then, public outrage today is at a level that might well overwhelm the lobbying efforts of entrenched interests. ...
For today we need laws that will require purveyors of financial products to provide the essential information that consumers need. ...[I]nvestment products like mutual funds should include a standardized disclosure label analogous to the nutritional labels on foods. The structure of the label should be developed by a committee of academics, regulators, and industry executives with the objective of promoting informed comparison among consumers of investment products. ...
The ... standardized disclosure should give the consumer an understandable measure of long-term risk. ... Not all investors will be able to interpret even ... simple measures of the outlook for an investment. But neither are all consumers of food able to interpret the quantities of nutrients that are shown on nutritional labels. These facts should be there to allow those people who will look at them to do so, and to encourage them to spread the information...
The standardized disclosure label should not, however, include past returns on investments. This is because most investors overreact to past returns... Moreover,... when an advertisement for an investment product does report a prior average return, it should also include a statement of the uncertainty associated with that return. ...
Including such information on financial products would give an enormous boost to the efficiency and efficacy of our financial products in serving customers’ needs. The only reason that such labeling has not yet been required is the same reason that nutritional labels were not required long ago on foods. Public outcry at a time of scandal forced progressive change then; we should hope that it does so now.

I don't think it's on the financial reform agenda, though there was talk of providing "plain vanilla" options for some financial products awhile back to help with this problem. But that got dropped due to opposition from the financial industry.

Is there a good reason not to do this? I couldn't think of one. There is a small cost to the banks to develop the labels, but if it's a standard form that shouldn't be too costly, particularly relative to the potential benefit to consumers from overcoming the informational market failure.

    Posted by on Thursday, May 13, 2010 at 12:33 PM in Economics, Financial System, Market Failure | Permalink  Comments (29)


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