Personal Finance is Broken—Can These Economists Fix It?

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About This Episode

My guests this week, economic professors John Campbell and Tarun Ramadorai, argue that the financial system itself is a powerful contributor to wealth inequality, and that there are ways to improve it. Their new book, Fixed: Why Personal Finance Is Broken and How to Make It Work for Everyone (out October 21), addresses how the bulk of our financial issues are downstream of poor structural design, not personal shortcomings—and what we can do about it.

• (00:00): Intro
• (04:00): 🏁 How our financial system allows the upper middle class to pull away from the lower middle class, even if they start in relatively similar places
• (26:55): 😈 Why financial firms aren’t incented to make better products, and how “competition” produces services that exploit the human tendency for bad decision making
• (41:42) 🏡 The unique products in the mortgage market that might actually be underutilized (like ARMs and reverse mortgages) 
• (57:50): 🍼 What John and Tarun would include in a “personal finance starter kit” for every adult (like a Finnish baby box, but for when you’re a baby adult in a predatory system)
• (01:08:50): 👊 Where the three of us disagreed about who should be providing said starter kit

RICH GIRL NATION IS HERE. GRAB YOUR COPY.

Our show is a production of Morning Brew and is produced by Henah Velez and Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is President of Morning Brew content and additional fact checking comes from Scott Wilson.

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Transcript

Tarun Ramadorai:

Over the last 20 to 50 years, there’s been an enormous growth of the middle class relative to other classes, which is to say, part of the wonderful story of the last 50 years is there’s been so much economic growth that people have been transported from near subsistence conditions to conditions where they have a little bit of money to spend. But that having a little bit of money to spend brings with it newfound vulnerability that needs to be managed using a modern financial system, and many of them are simply not equipped with the tools.

So one of the reasons that this is a universal problem is actually because of a good thing, which is that we’ve acquired enough income for us to be in the position where these kinds of issues matter. We just haven’t acquired the financial system we need to make our lives better, and that’s part of what our book is about.

Katie Gatti Tassin:

Welcome back to The Money with Katie Show. I’m Katie and I just read an advanced copy of a book called Fixed: Why Personal Finance is Broken and How to Make It Work for Everyone by John Y. Campbell and Tarun Ramadorai about the fact that the system is not producing bad outcomes by accident, but by design.

It’s structured into three parts. The problem or how the component parts of personal finance are fixed to benefit one group of people and disadvantage another. For example, consider the way that credit card rewards create an incentive structure of no interest. Short-term loans for those who are earning and spending in a manner to pay the cards off on time, generating points, miles and cash back in the process. That can be worth hundreds if not thousands of dollars per year, but is often subsidized at least in part by those who for whatever reason cannot take advantage of them, whether because they have low or unreliable income or otherwise not able to use credit responsibly.

Then it gets into the specifics what actually goes wrong for most people most of the time, and how do they find themselves in situations that are nearly impossible to claw their way out of? And finally, the solution practical midterm fixes for fixing our financial system so it works for the many and not the few. Now, the goal of any financial system they say should be to serve the interests of the general population and to preserve popular trust in institutions and a market economy, which is they say the best way to create widespread prosperity.

If you’re a regular listener to the show, you probably already know that my ears perked up a little bit when I read that because anytime someone says, oh, market economies, capitalism is the best way to create prosperity, I start slowly reaching for my copy of The Jakarta Method and gearing up for a long-winded discussion about how we actually need a durable attempt at well-designed redistributive policy in the United States.

But I think this book is intended to prescribe policy solutions that could be enacted almost immediately without totally overhauling the structure of American capitalism. We need researchers with influence and institutional capital who can advocate for these types of reforms to policy makers. So I am very excited to dig in with John and Tarun today.

Funnily enough, they outline the three most common responses that people seem to experience when they’re faced with this information for the first time, it felt a little bit like being told the stages of grief. I was like, yeah, that tracks. It ranges from outrage at the injustice to a general wariness that often translates into trying to become as educated as possible to a shrugging of the shoulders that well, okay, shit happens and there’s really nothing we can do about it. Does that sound familiar? I’m going to talk to John and Tarun today about what we can do about it.

Well, John, Tarun, welcome to The Money with Katie Show. Thank you for joining me today. In your book Fixed, you mount the argument that the financial system itself is a driver of wealth inequality, that it is structurally creating bad outcomes that are entirely separate from reasons like, well, some people’s families are just richer or some people just have higher paying jobs. Can you outline the thrust of that argument for me?

Tarun Ramadorai:

Sure. So I mean I think the thrust of the argument in the book is that if you look at lots of evidence from around the world, it seems that rich people earn higher returns on their investments. They pay lower rates on any borrowing or debt that they have, and they also tend to save more than poorer individuals. And so this can actually be a very powerful force that increases inequality. So if you were to start people off at a given level of inequality, we have an example in the book that we outline even small differences in the rates of return on investment, the rates of borrowing on debt, and the rates of saving can do things like double the rate of inequality or the level of inequality between a rich and a poor person over we pick a period of 20 years in the book in our example. And it turns out that these differentials can explain a very big amount in the real world of wealth inequality as well, not just in our hypothetical example. So there’s studies that have been done in Sweden showing that this contributes to almost all of the rise in inequality in Sweden, say, between in the early part of 2000s, India between larger and smaller investors, and also in the US: Up to a third of the inequality in the US could be explained by these sorts of differentials.

John Campbell:

The point is we’re not claiming that all inequality in wealth comes from the financial system, but we are claiming that the financial system is a powerful contributor. And it’s an area where we think we can do something about it, and that’s the purpose of our book is to persuade people that we don’t have to accept this, we can actually do something about it.

Katie Gatti Tassin:

There’s a couple things that you just noted. I definitely want to get into the lending piece on the income piece. I’d say in the work that I do, that’s something that has kind of become common knowledge, which is that rich people or rather people who have high incomes just save a lot more and if you’re just dumping a lot more into investments, it’s pretty clear that you’re going to end up with a lot more money later.

If you had to kind of assign proportionality there between the return differential between people who are maybe what we would consider to be upper class versus lower class, if we’re looking at the return on investment difference compared to just the sheer blunt force of having a higher income that allows you to meet all your consumption needs and then also save a lot of money, how do you divvy that up? How do you think about the respective responsibility there?

John Campbell:

I think Katie, what I would say there is that the very, very high savings rates that you’re referring to really apply at the very top of the income distribution. It is certainly true that extremely wealthy people save a lot and that does certainly contribute to the growth of massive fortunes compared to the rest of the population. I think where Tarun and I are mostly focused is on not so much on the extreme wealth at the top, but on the poor and middle class, the great bulk of the population. And we think that within that group, a lot of what helps the upper members of that group pull away from the lower members, if you like, is the return differences and cost differences that we are talking about.

Katie Gatti Tassin:

That makes sense. I can see that. I appreciate that distinction.

Tarun Ramadorai:

The thing to sort of keep in mind is, yes, there’s lots of reasons why poor people might be deterred from saving. I mean, to give you just one example, if you have a social network where people are constantly coming to you for money because they’re short of it, then this kind of discourages you from saving because obviously this is a powerful disincentive. If you think that the reason that you’re saving is for sort of helping other people when a rainy day turns up, then this kind of creates problems overall. So in that sense, structurally there’s also an issue of the way that poverty creates further poverty or just entrenches poverty in some sense. But as John correctly points out, the returns and the debt are really important pieces of this, especially within the middle class.

Katie Gatti Tassin:

So let’s get into that. Let’s get into the return on investment, the lending. One example in the book of how this happens is a chart that shows how wealthy people tend to get lower interest rates on the money that they borrow. They can borrow money much more easily and cheaply. And when I’m saying wealthy, now moving forward, I suppose we should clarify that I’m speaking more about this upper tranche of the middle class than your Jeff Bezos is, and that they tend to get higher returns on their investments than maybe lower middle class people. I could see someone reading that or hearing that now and going, well, that’s just how lending works because lower risk people who tend to be richer, have more assets, have more collateral, what have you—they just get access to cheaper money and nothing you can do about that. How do you respond to that?

Tarun Ramadorai:

It’s certainly true that having more assets and more collateral actually makes borrowing cheaper and it’s certainly the case that this is something that contributes, but there are many other reasons why people who are relatively well off borrow cheaper that have little to do with those kinds of preexisting wealth differentials.

Lemme give you sort of two or three examples of that. One is shopping. This is sort of a simple thing. It sounds like a very simple thing, but it turns out that shopping first of all requires knowing what’s out there and then being able to discriminate between the stuff that’s high cost and the stuff that’s low cost many times, because there are embedded fees and embedded costs in some of these products. And it turns out that there’s plenty of academic work out there and other work as well that sort of shows that the poorer and less educated they tend to go hand in hand are generally not as good as shopping as those who are slightly better off and those differentials can actually be very material.

Here’s another one which might be helpful as well, which is bargaining power. Just to give you a very simple example, suppose you’re shopping for an auto loan, you’re going to buy a car, and then there’s a financing scheme that’s put on the table. Well, there’s plenty of evidence that shows that when the auto dealer knows that they’re in the presence of someone who doesn’t feel very comfortable with these sorts of bargaining situations, women and minorities, people who are in a position of less power in society, that they’re going to be offered deals that are not as good, and sometimes they’re just embarrassed about something on the table and saying, look, I’m entitled to something a bit better than this, and those things can also contribute. So those are two simple examples of how debt can be cheaper for the wealthy than for the poor, relatively wealthy. I agree with you that we’re not talking about the Jeff Bezoses, if that’s the right plural for Bezos.

Katie:

Bezi.

John Campbell:

There are going to be differences that are inevitable, because setting up a bank account, running a bank account for the bank incurs a fixed cost that’s independent really of the size of the account. So to cover their costs, they’re going to have to charge a higher proportional fee on the smaller accounts. This higher proportional cost of small ticket size items is just, it’s really inevitable. It’s almost like the fact that if you go to Costco and buy an enormous bag of something, you get a lower price than if you buy a little amount.

So there is an inevitable part of this, but there’s also a lot else that we can address because some of the same forces that Tarun was talking about on the borrowing side also apply on the investing side. Shopping around index funds for example should be really, really cheap. But actually it turns out there’s a lot of rip-off index funds out there that are essentially the same product with a substantially higher fee, and if you don’t know how to shop for an index fund, you easily could be taken advantage of.

There’s also the fact that poorer people often don’t know about risk taking and the reward for risk taking, the tendency to put your retirement savings fund into a bank account or a money market fund, and take no risk. We and others would argue that’s a big mistake and that lowers the standard of living you can expect to get in retirement. So beyond the fixed costs, there are these other forces that disadvantage poorer people, and we argue in the book that these are important and furthermore that we can do something about these.

Katie Gatti Tassin:

I guess I should note when we’re saying shopping, we are specifically referring to shopping for financial products. So shopping, to the examples we’ve used already,  for the auto loan or the index fund, not going out and buying a new top.

It also feels important to me to sort of draw this connection explicitly here because as I was reading and reading about return on investment, I’m imagining some of this data about who in the US own stocks who are shareholders that yes, the majority of the US population owns some stocks, but the majority of the wealth itself, it’s something like, I don’t know, the top 10% own 90% of the stock market. So when I’m thinking about those, what those returns on investment are, what those dividends are…If you are a shareholder and your ownership stake in something is becoming more valuable or you are receiving dividends, the money that you’re receiving represents money that is not being paid to that labor force in the form of wages and the labor force is probably made up of lower and middle class people. So in that respect, as I was reading, I was like, man, it’s kind of like they’re losing out twice.

John Campbell:

Well, I guess we think that there’s nothing inherently wrong with capital income that savers deserve a reward. We’d like to see greater equality in the reward that savers receive, and we’d like saving to be made easier for ordinary people.

But Katie, your point about shopping and people being reluctant to shop, yes, we do mean shop for financial products and we feel this ourselves. We’re economists, right? But I don’t enjoy shopping for financial products. That’s just human nature for all of us, but we think it could be made easier and less painful.

Katie Gatti Tassin:

We’ll get right back to this conversation after a quick break.

So I want to talk a little bit about the financial diaries. This was new to me. I had not heard of this before. It sounds like quite a human look at how real people relate to money. So this was a 2012 to 2013 study that looked at people in New York, Ohio, Kentucky, Mississippi, and California with below-median incomes and very high income variability. Can you tell us a little bit more about what they found in studying those groups?

John Campbell:

Yes, and just to frame it right, they picked people with below-median incomes, but they didn’t deliberately select people with high income variability. Instead, what they found is that the people that they were talking to and interviewing who had low income, they discovered that they also had very high income variability.

So as a sort of intuitive, easy to grasp measure of that, they defined a spike or a dip in income as income that’s more than 25% above or below the average in a particular month, and they found that the typical families they were talking to had two spikes and two dips every year. The same kind of spikes in dips or volatility shows up in their spending, and there’s a mix of reasons, and by talking to the families, they could get a sense of that. Sometimes it’s belt tightening because you are short of income this month. Sometimes it’s an unexpected emergency, medical, or your car breaks down, Sometimes it’s a celebration, your daughter gets married. Or it’s catching up with bills because you fell behind and now you get a little money and you catch up.

The problem that comes out very clearly from this study is that most people have very little money available to get through the periods of low income or to cover the emergency spending needs. In the study, they found that the median level of savings, that’s to say the middle of the distribution of savings is only $55, and yet when you talk to people, they say, well, to comfortably manage our budgets over the course of the year, we need $5,000. That’s almost a hundred times more people express the desire for income stability, which is very natural, very human, but that’s hard for many people to achieve in this economy. The mystery of course then is why can’t people save a little more so that they could live more comfortably with the income risk that they’re exposed to?

Tarun Ramadorai:

One of the other things I should just point out is that while the financial diaries focuses on families in America, these problems are widespread. I mean, there are billions of people around the globe and many of them have circumstances that are, they’re not in the richest countries in the world, and so this is a very much a universal problem, and we sort of try and demonstrate that in the book.

You see this of course in developed countries, the US, the UK, Germany, but you also see this in plenty of developing countries around the world, India, Thailand, South Africa, China as well. So this is very much a universal problem that people are not saving very much. They’re faced with very adverse shocks which come from life circumstances, and we need to find a way to protect them from these things.

Katie Gatti Tassin:

What do you think the common denominator is? Because these are all very different countries, very different cultures, very different levels of overall wealth. If we’re looking at gross domestic product, why do you think we see this pattern over and over again kind of no matter where we look?

Tarun Ramadorai:

I can sort of point to two things. The first is income variability is actually very high. So the first thing I will say about that is that plenty of shocks are going to come along. Expenditure shocks are very, very common, and we’ve known about that for a while. It’s just that the risk management mechanisms that we have available to deal with those kinds of income shocks are just not very good. So people don’t really enjoy purchasing insurance. We were talking about shopping, but it’s even worse when you’re asked to shop for something like insurance.

Katie Gatti Tassin:

Yeah, that’s miserable. Nobody wants to do that.

Tarun Ramadorai:

Because you’re told in the best case scenario, you give us money and nothing comes back to you because there’s no bad shocks, and it’s very hard to sell a product like that because it’s like saying, you give us money and if nothing goes wrong, which is the best case scenario, you just lose all the money you get.

John Campbell:

There’s a basic psychological struggle with saving and struggle with temptation. It’s always more fun and easier to spend your money than to save it. That’s just a fundamental feature of human psychology, and I think we all as human beings need help with that. We need to be trained. We need products that make it easy. We need a culture that supports saving. So that’s one thing.

The second thing is that we are now living in an environment where there are these formal financial institutions that offer us products, which in the case we’re talking about might be savings accounts, and many people find those daunting. There’s paperwork, there’s terminology that they don’t understand. It feels off-putting and daunting, and this is why people are so reluctant to shop for financial products.

If you have a higher education, you get an advantage, you get more comfortable with this. It just feels more natural to walk into a bank, fill out a form and so forth. But for many people it’s not natural and it’s not easy, and that combined with the temptation to just give up and spend your money creates problems.

This is all even more true in countries like India where a huge number of people have recently emerged from a traditional world of living in the village and saving collectively by storing agricultural produce—they’ve moved to a new world of middle class life in a city where again, they have to deal with formal financial parts, but people aren’t used to it yet. So that just makes it more difficult.

Tarun Ramadorai:

One of the things that we say in the very first chapter of the book is that over the last 20 to 50 years, there’s been a enormous growth of the middle class relative to other classes, which is to say, part of the wonderful story of the last 50 years is there’s been so much economic growth that people have been transported from near subsistence conditions to conditions where they have a little bit of money to spend, but that having a little bit of money to spend brings with it newfound vulnerability that needs to be managed using a modern financial system, and many of them are simply not equipped with the tools. So one of the reasons that this is a universal problem is actually because of a good thing, which is that we’ve acquired enough income for us to be in the position where these kinds of issues matter. We just haven’t acquired the financial system we need to make our lives better, and that’s part of what our book is about.

Katie Gatti Tassin:

I want to check that my understanding here is correct: that the middle class globally has grown, intercountry international inequality has shrunk, but that intra-country inequality has grown. So when I look at the data for the United States in the 21st century, it does appear that since the 1970s, the middle class has gotten smaller because more people have moved into the lower or upper classes, but that globally, we’re kind of telling a different story here, and I think that assuming that is true, that feels like a sort of important nuance and I’m not sure what that insight would tell us, but I wanted to check that with you.

Tarun Ramadorai:

I think that’s right, that the global middle class is now far bigger than it ever was. It is also true that intra-country inequality has increased simultaneously.

Katie Gatti Tassin:

It’s so fascinating.

Tarun Ramadorai:

It absolutely is. I think one way of thinking about our book is that there’s plenty of good books about the very poorest about development economics, and that’s extremely important. There’s also books that are catering to people who are looking to make their millions into billions. I mean, for lack of a better way of thinking about it, it’s just that there’s a large and increasingly large underserved middle class population that desperately needs the financial system to work for them, and that’s what our book is pitched at. It’s pitched for those people.

Katie Gatti Tassin:

Yeah, I mean your book to me—let me, I guess, give you a little bit of background on why I was drawn to it and why I wanted to talk to you both, because I’ve written a personal finance book. I know how this game works, and most of the personal finance books somewhat by necessity kind of just say, hey, here’s how you personally navigate this, but I appreciated that yours said, well, yeah, you need to know how to navigate it. And also there are some structural things here that could change, that would make that navigation much less daunting and a little bit less unnecessarily difficult for the regular person. The system should work for the regular person, not against them. You brought up human nature and no objections there. It certainly is more fun to spend than save. I mean, hell yeah, brother, I’m with you.

One of the key tenets of your approach is this recognition that humans’ financial behavior is both intermittent and emotional and that financial products are largely designed to exacerbate and exploit those mistakes that we are as humans naturally going to make rather than course correct them. And that this brings questionable benefits, high costs, unnecessary complexity. You argue that, and here I’m quoting, “The exploitation of market power is pervasive in the financial industry that companies compete for customers in a wasteful rent seeking fashion.” And I think someone with a cursory understanding of how markets are supposed to work would go, well, wait a minute, isn’t a market economy supposed to produce competition? These are all private companies that are competing for our business, so why aren’t financial firms making better products?

Tarun Ramadorai:

Just to try to explain our characterization of intermittent and emotional, the way that we think about this is there’s a huge hassle factor. Financial decisions are stressful as we’ve already discussed. Shopping for financial products is not as much fun as shopping for sneakers, and I’m a finance professor.

And we have a tendency to procrastinate when things are unpleasant, but then when we finally get around to it, these decisions become emotional because when you wake up, you have a big rather than a small problem, you have a stressful ice stakes decision that’s facing you. And then in those circumstances, the best of us is ill-equipped to make the decisions appropriately and therefore we’re emotional about making the decisions.

Now to your point about why is it that competition is not working well under these circumstances, I think a simple way to say that is firms out there are responding to your actual demands, which are intermittent and emotional rather than the correct demands that you should be making if you’re managing your financial situation properly.

So firms are just going to respond to the incentives that they’re faced with and what they’re faced with is intermittent and emotional decision makers. So what are they going to do? They’re going to design products that cater for intermittent and emotional decision makers, and if they capitalize on the mistakes that people make, that’s fine. Profits or profits. There’s no pictures on the dollar bills that you get about where you got them from. Ultimately that’s how it’s going to operate. And so what that means is they can raise prices. They don’t have to worry about competition because people are not going to switch out of their products. Firms are going to spend on loyalty rather than on product innovation. So I mean there’s a number of different features here that pervert competition from where we think it should be.

John Campbell:

If people are shopping on the basis of price, let’s say, or objective quality, then indeed competition will deliver. It will tend to drive prices down and quality up. The problem is if people pick their financial products on some other basis, well firms will compete on that basis.

Now, let me give you a little example. I live in Lexington, Massachusetts. It’s a suburb of Boston and like many smaller towns in this country, sort of suburban towns, the downtown is absolutely full of bank branches which are empty. Essentially they have tele-machines, maybe they have one person sitting there kind of twiddling their thumbs. There’s very little business goes on in these bank branches, yet they fill up the downtown and my neighbors complain about how come we have all these banks? We want more cafes or shops? Well, why is that? It’s because people actually pick banks in part on the sense of comfort that there’s a real institution there that has a physical presence, and even though they’re never going to use the branch, they pick the bank because it has a branch. And so of course banks will compete by building branches.

Now that’s true in this country. In some other countries, the population has shifted its attitude. So in the UK for example, this is much less true because there’s a small number of big banks and people don’t choose the banks on the basis of branch presence, but it’s just that competition works in a way that’s driven in part by the way in which people shop. And if people are not shopping in a smart price sensitive way, you won’t get good price competition in the book at the end, we talk about the need to des designing standardized products that are easy to shop for on the basis of price,

And our goal really is to make financial shopping as easy as walking into a pharmacy and knowing that you need some and you go to the shelf and you see the brand Advil, you can always buy that if you like the brand, but right next to it is the pharmacy generic version, and you can look at the ingredients, you can see they’re the same. You can look at the price it’s stated in a comparable way, and that’s the kind of shopping that is relatively easy and that we think could be facilitated in the financial industry.

Katie Gatti Tassin:

This conversation about the demands that consumers are actually making, compared to how they would or should be behaving in an optimal world where everybody is raised on Dave Ramsey courses, is the research that I think I read about it for the first time in your book that the introduction of the buy now pay later services at checkout isn’t just changing how people are paying, but it’s actually changing how much they’re spending in retail’s total share of overall consumption. That was really fascinating to me because I’m sitting there thinking about it and I’m like, man, we’re kind of just glorified like rats with the lever. It’s like they put something in front of us to buy more sneakers and we’re like, great, thanks, I’ll take it. And it struck me how, for lack of a better word, how easily manipulatable our behavior in the financial realm is.

John Campbell:

Yes. And your example gets to the fact that we think that one of the things that would improve people’s financial lives is making small dollar credit more readily available, but we have to be very careful not to do that in a way that just encourages impulse spending so that people get more into the hole and more in debt and end up in fact worse than before.

Tarun Ramadorai:

Another really important aspect of financial products is post-shopping management and firms are also very interested in understanding if you mismanage your product after it’s purchased, then that also has implications.

Let me give you an example of this. We often have teaser rate contracts. You’re probably familiar with these on cell phones, on cable TV plans, but we have them all the time in finance as well. We have them in mortgages for example, where in the United Kingdom you could get an adjustable rate mortgage. You can also get one in the us, which after a couple of years of a very low teaser rate suddenly goes on to a very high standard variable rate. And unless you pay careful attention to the timing of when that happens, you’re essentially going to be paying, you’re on the hook for paying a very, very high rate over the life of the loan unless you are religious about switching the contract as soon as it comes to the end of the teaser rate period.

Now, what does this mean? It means that firms are incentivized to attract everybody into the product by having the lowest possible teaser rate. All the savvy people switch out into the next teaser rate product as soon as the period elapses. And all the sleepy people who also happen to be generally lower income, less educated and so on and so forth, more time starved are going to be ending up paying the high rates. And so this is a weird sort of system where in some sense, if you’re a savvy shopper, you’re being paid by the sleepy shoppers because you’re just failing to manage. And so this is perverse because the poor are paying the rich and that doesn’t work very well.

John Campbell:

This is so important, Katie. What the competition does is some of the revenue that the sleepy people deliver to the product providers, the mortgage lenders or credit card providers for that matter, this is very big in credit card in this country, alright, some of that revenue is offered upfront in the form of lower costs, but at the end of the day, savvy people win and the less savvy people lose. It’s everywhere.

Once you start seeing it, it’s everywhere. It’s present in fixed rate mortgages where rates are lower on refinancable fixed rate mortgages because there are plenty of people who don’t refinance when the code should. So we get lower mortgage rates upfront, that’s great, I know how to refinance, I’m a winner, Tarun’s a winner, you are a winner, but the people who don’t understand the product are the losers. It should be very troubling that there’s this transfer from the less savvy to the more savvy people.

Same thing with products like life insurance. It happens there. So credit cards, life insurance, even bank accounts with overdraft fees, banks can offer cheap checking accounts for all of us on the back of the overdraft fees. One reason to simplify things is to try to eliminate these cross subsidies by making the products easier to use. And in a world where engineers are working on self-driving cars and where you can see Waymo cars on the streets of San Francisco and Phoenix, you can take a taxi ride without a driver. We should be working on self-driving financial products that don’t require such a careful management and therefore don’t build in this cross subsidy from those who mess up to those who know how to manage the product.

Tarun Ramadorai:

I mean especially because we know that the population of people who mess up is highly correlated with the population of people that we don’t want to exploit. That is to say the ones who can’t afford it are the ones who are paying.

Katie Gatti Tassin:

Totally. On the note of making these things simpler and easier and less designed explicitly to exploit and extract from people who are most vulnerable… You point to and talk about how a standardized means of sharing financial disclosures and information upfront rather than pages of terms and conditions and legalese that nobody can read and understand is a necessary change. Can you give us a couple examples of what that might look like already? Areas where we’ve already seen progress here and where you think it would go the farthest?

Tarun Ramadorai:

The classic example of this is the Schumer box where the details of credit payments and what an APR means, an annual percentage rate, on a credit card are clearly outlined on the front of any offer that they send out to you. Now, you can still obfuscate with that because obviously you can put the Schumer box in sort of brown paper envelope and sort of in a tiny little bit in a tiny little corner. Well, you have all of the marketing stuff that is sort of in floridly colored type, but nevertheless, I mean it’s still something that sort of tells you upfront what this costs. I mean we feel like this is important. I mean those kinds of disclosures can be helpful.

As you probably recall, we don’t think that’s the full story. There’s plenty of other stuff that we think we should be doing, but we think that fees should be first of all specified in dollar terms rather than in percentage rates because people are just much, much, they find it far more intuitive to see what the dollar number is going to be for a particular size of loan, for example.

And so anytime there’s a debt contract of any type that you get into, we believe that that should be the case in the mortgage market. You should know exactly what you’re on the hook for. What is the total interest paid? What’s the initial monthly payment? There’s lots of basic details that need to be shared upfront in a standardized fashion.

This is the other point. So standardized machine readable disclosures should absolutely be part of what’s going on. I’ll give you an example. I did some policy work in India where I chaired a committee and for years committee after committee looking at household finance has been asking for insurance claims, statistics to be displayed in a machine readable format that is uniform across insurance companies. Now, this is a simple thing that tells you when I pay for an insurance contract, what is the likelihood of me getting paid back if something really terrible happens? What’s been the history of this company paying out on the specific product that I’m about to purchase?

And unless you have those things in a very standardized form, in an easy way to compare, it’s very hard for me to figure out whether company A or company B is the right one for me to pick. And if we can’t have that, then competition isn’t working the way it should.

John Campbell:

This is about quality disclosures, even when people are shopping for financial products on the basis of price. Let’s suppose they’re buying home insurance. Huge issue in this country where home insurance is becoming very expensive in states like Florida, which are very exposed to natural disasters. So the risk is that what happens is that low-quality insurance companies come in and they offer cheaper products that are cheaper because in the event of a disaster, their payout rate is they delay and deny and people may not be aware of that. Obviously people are going to have to make some tradeoff between quality and price, and there’s also going to be regulation involved. But for people to shop intelligently, they need to be able to see some objective measures of quality.

Katie Gatti Tassin:

I want to actually dig a little bit deeper into the housing piece of this because we’ve now, we’ve kind of talked about home insurance, we’ve talked about these teaser rate mortgages, that there is a possibility or there is a world that you could see wherein when you take out a mortgage product or when you’re shopping for a mortgage product, these lenders are required to actually outline things like, okay, what is going to be the total cost of this loan over the time that you are paying it off? What is the total interest paid? What is the expected highest monthly payment that you’re going to have?

It seems to me that much of the challenge with housing as I see it in the United States, which is the only housing market that I really know anything about is structural. However, there are a couple products that you all talk about in the book that I had an underwhelming appreciation for and definitely did not understand very clearly, and I think that that’s common.

So I want to talk about a couple of those starting with the structural side of things. You all talk about how the rules of our mortgage market are actually exacerbating the housing crisis, and I think anyone who has a 2.75% mortgage is going to be like, oh, yep, that’s me. Because this lock in effect creates what is ultimately an unnecessary and arbitrary gridlock. Can you tell me a little bit about how our mortgage lending system is creating this gridlock and maybe how other countries have handled this differently?

Tarun Ramadorai:

Suppose you take a 30-year fixed rate mortgage in the US. You have a rate that does allow you to refinance at any point. So in that sense, it looks like theoretically this is wonderful, but imagine someone who took a mortgage in the US a few years ago when the rate was a little under 3% and the rate’s now gone up to 6.8%. It’s over double, right? And so if you were to refinance your mortgage, you’d have to get into a much, much higher rate.

Now what does that mean? It means that if you get a great job opportunity that forces you to move to a different city and sell your house and then take on a new mortgage, you might be very reluctant to do that because now there’s an additional disincentive to take that wonderful job offer because of the fact that you’re going to give up your super cheap mortgage and you’re going to have to pay a massive cost for it.

And so in that sense, this is what we call lock-in. Now, how have other countries dealt with this? There are two features that are both pretty important features. One is portability, which is it’s possible in some other countries to take your 3% deal with you, of course subject to a reassessment of the collateral that you buy in the new place, which is whatever the house is that you purchased. But in that sense, you can take that deal across, you can port it across, hence the term portability, and that can be very helpful.

The other possibility is that a mortgage could be assumable, which is to say someone who’s purchasing your house might be able to assume the mortgage at the 3% rate, and because they’re getting this nice mortgage that is priced much lower than the currently prevailing market rate on mortgages, they’d be willing to pay over the odds for your house. And so therefore there’s no problem because in that sense, there’s some transfer of resources that’s happening between the two individuals that allow you to do that now.

So those are two good features, right? I mean, the other one of course is maybe you should be allowed to refinance your mortgage either at face value, which is the original rate at which you bought it or at market value. And so this is the Danish mortgage system where you’re allowed to do that, and that’s another possibility. So there’s lots of design features that allow you to do this if you want to.

John Campbell:

This gets to some of the structural aspects of financial system design that go beyond just sort of making it easier for an individual to manage their affairs and get more into sort of how does the whole economy work? How does the housing market work? And we think there too intelligent, thoughtful design can make a big difference.

Katie Gatti Tassin:

We will get right back to it after a quick break.

So I want to talk for a second about a couple tactical things that I learned reading this. You write about three different groups of buyers who would actually benefit from ARMs or an adjustable rate mortgage as opposed to the 15 or 30 year fixed product in the United States, which is very popular and unique. I didn’t realize that there was anyone for whom these adjustable rate mortgages made sense, and I think it’s because of all the baggage that they assumed after the Great Financial Crisis that I just kind of wrote them off in my brain is like, okay, you never do that. You always go with the fixed. You don’t roll the dice.

But you talk about these three groups: people who are moving before the rate is going to go up, someone who is stretched thin but who reasonably anticipates they will have a higher income imminently (that one makes me a little nervous, but I can see the use case), and then wealthy people with substantial assets. That last one I don’t know that I’m connecting the dots on. I don’t know that I see the benefit there. So can you kind of talk me through these different use cases?

John Campbell:

Absolutely. Very happy to do that, and I think your reaction to the arms is quite common in this country. There’s a tremendous attachment among Americans generally to the 30-year fixed rate mortgage, and I certainly agree that it’s a useful and important product, but it’s not the best thing for everyone. You also mentioned the financial crisis and the sort of bad wrap that adjustables got after the crisis.

I would like to emphasize that in fact, when we look back at it, the people with adjustable rate mortgages actually did rather well because when the rates reset, the overall level of interest rates had fallen a lot. So in years, like 2010, 2011, people whose adjustables reset then found themselves paying much lower rates, so it worked out fine for them in the end.

Katie Gatti Tassin:

Fascinating.

John Campbell:

Now you asked the question, who are the three groups who can benefit from an app? So the first group is fairly obvious. If I’m going to move fairly soon and I know I’m going to move fairly soon, really the only thing that matters is what’s the rate? Now, if I can get a lower rate for say the next two or three years, and I know I’m going to move in two or three years, just take the lowest rate.

Another way to put it is the fixed rate mortgage gives you an option that’s potentially valuable, which is to refinance if rates fall, but you are only going to exercise that option over time if you stick around to use it. And if you know you’re not sticking around, you won’t be able to use it. You shouldn’t buy a feature that you won’t ever use. It’s sort of like saying if you buy a car and you’re going to sell it after three years and get a new one, don’t buy an extended warranty that covers the car for six years because you’re not going to use it. That’s throwing money away.

So that’s the first group. The second group is if you’re trying to buy your first home, and let’s suppose you’re in a career where your income’s going to rise pretty fast. You might be, let’s say you might’ve been in medical school, but now you’re going into private practice. You don’t have a lot of money yet, but you expect that you’re going to make a good living as a doctor in private practice and you need your first home. The key thing is to get the lowest rate to qualify for the biggest mortgage because you want to buy a big house that’s going to be suitable for you in the future, and it makes sense to try to finance it cheaply. Now, if rates go up in the future, yeah, there may be a cost, but by that point the money will be rolling in and you’ll be able to handle it. So that’s the second group.

Now, the third group is wealthy people with assets, and we do actually see that these people often do use adjustables. So in this country, among jumbo mortgages, the really big ones that go along big houses, big expensive houses, there are more adjustables in that jumbo category. And the people with these big houses typically have a lot of assets. In fact, they could sell some of those assets and pay off the mortgage or at least pay it now substantially. Why don’t they do that? Well, actually, these are people who want to use leverage to make risky investments. They want to have a portfolio of stocks and bonds because they think those stocks and bonds are going to deliver high returns. They can tolerate the risk and they want to borrow cheaply to do this. Well, what’s the cheapest borrowing for an individual, even a wealthy individual? Well, it’s borrow against the value of your house. That’s the best collateral. So you’re going to use a mortgage not really to be able to afford the house. You could afford the house anyway, but to be able to have more money invested in the financial markets and the cheapest form of mortgage typically is an adjustable rate.

Now, for people like this, if rates go way up and the mortgage becomes expensive, they can always sell some assets, delever, and pay off the mortgage. So they’re not so worried about being trapped in a high rate mortgage and having to pay that interest because they have the ability to pay it off if they need to. And so it can be a good financial strategy that people appear to use. And we see this both in the US and in some other countries. We’ve looked at this in Denmark and we see the same behavior there.

Katie Gatti Tassin:

Wow, little hot tip there. I didn’t realize that. I also learned that in your book, I learned this that you should only refinance after the mortgage rate drops by more than 1.5%. I was like, huh, okay. That’s a good little threshold to keep in mind. You also bring up the reverse mortgage product for folks in old age who maybe cashflow poor, but have a lot of home equity, which immediately made me think of every listener who has ever written in to ask, how do I help my parents who are in this precise position? Can you tell me a little bit about why reverse mortgages are actually a pretty well designed product for this group?

John Campbell:

It is a common problem that you have a senior, an older person who’s living in a big house with the mortgage paid off, it was the family home, so they have a lot of value tied up in this house and also involves paying high property taxes. They don’t want to move, but they may be short of cash to finance their consumption in retirement. The obvious answer is to say, let’s get money out of that house. Now, you could do that by downsizing, move to a smaller home or an apartment or maybe a senior community, but many seniors don’t want to do that. They want to stay in the house.

Well, can you borrow against the house? Yes, you can. And the way a reverse mortgage works is that you borrow against the home. That’s why it’s a mortgage, but you actually aren’t making payments to repay the mortgage. You instead are taking money out. You can take it out all at once. So you can take it out gradually in the form of an income, a pension payment if you like. And then what’s happening is the debt on the house is building up over time. You’re not paying it down over time. It is in fact building up over time. However, nothing is payable until the older person either does decide to move or passes away, at which point the house will be sold and the proceeds can be used to pay off the loan. Now, an important point is that if the loan is more than the house fetches, well that’s the bank’s problem. That’s the reverse mortgage lender’s problem. The heirs are not on the hook, and that’s a very valuable feature.

Now, people are sometimes wary of these products because they are complicated and there are high marketing costs for the reverse mortgage lenders because they have to reach seniors who are particularly suspicious of new things, slow to catch on. It can be difficult to market these products. So they are inherently expensive because of the marketing, and in some cases you may be offered a rip-off reverse mortgage, so you have to be careful, but there are good reverse mortgages out there, and it really can solve a very meaningful financial problem.

Many municipalities, including the one where I live, Lexington, mass, allows seniors to defer property taxes. And that is a form of reverse mortgage because you are building up a debt of unpaid property taxes, but the debt is not payable until you sell the house or pass away. And the key point is the interest rate on that is tied to the municipal borrowing rate. So it’s actually very low rate credit, and I would strongly recommend, even if your listeners with parents in this situation are not ready to go all the way and take out a reverse mortgage, the first move should be to defer property taxes, and that’s cheap credit and can often relieve a retirement financing problem.

Katie Gatti Tassin:

Fascinating. To summarize, when the person passes away or sells the house, the house is sold to pay back that loan and if it’s more than the loan, so if it has appreciated beyond what they owe, the estate gets to pocket the difference. And if it’s less, the estate doesn’t owe anything else. So it’s kind of a win-win situation.

I have a feeling that my listeners are probably kicking me under the table right now going ask them why one and a half percent is the threshold for refinancing. I think we probably have a lot of folks that have purchased homes in the last couple of years who are now like, wait, why 1.5%? Why should I wait that long? What about 0.5%? So can you speak to that a little bit too, and then I’d love to move on and we can talk about some of the solutions that you all recommend in the book.

John Campbell:

Sure. It’s basically that there are costs involved in refinancing the mortgage. You have to pay a new set of mortgage origination costs, and there’s even costs that you really shouldn’t have to pay or title insurance often have to be paid again, and these can really add up and get into the thousands of dollars. So you have to trade off the cost against the benefit, and it’s also influenced by the fact that interest rates are bouncing around. So if you wait a little longer, you might be able to do even better. You’re not going to be able to refinance all the time because of these fixed costs. So you have to pick your moment really carefully.

But one of the points we make in the book is that actually choosing that threshold point exactly is very tricky. 1.5% may be a good rough rule of thumb, but it’s going to depend on how big the mortgage is, how likely you think you are to move all kinds of things that make it a very tricky decision. And this is one of the points we make in the book is this is too hard even for PhD economists to figure out, easily loan the ordinary person, and we ought to make all of this kind of thing a lot easier. So one product that would do that would be an automatically refinancing mortgage, which will simply down where the rate will ratchet down at certain threshold points, and that would save a lot of hassle and confusion if we could introduce a self-driving mortgage or a self-refinancing mortgage,

Katie Gatti Tassin:

Right. Yeah. If you’re going to move in a couple years, you’re not going to spend all those origination fees to refinance something that it doesn’t really matter if the rate is lower, you’re not going to live there long enough to—yeah, I see what you’re saying.

John Campbell:

Exactly.

Katie Gatti Tassin:

Let’s start talking through how you see the way forward a lot here that I find very fascinating, and there’s one thing that I wanted to dig a little deeper into. You two express a skepticism within the book, and I think within this conversation too, rightfully that, oh, well, technology will fix it. We just need better FinTech and everything is going to be great. Saying something to the effect of, well, we have to fix the fundamental economics of the personal finance system before we start introducing more technology to it.

And one example of the little micro interventions that became popular in the 2010s was this idea of a nudge or, hey, we can make these little small tweaks that are going to hopefully make people make better decisions. So something like automatic enrollment in a 401(k) is kind of the quintessential example of this. You two are arguing for more of a shove and you conclude the book with a recommendation for what you call the personal finance starter kit.

When I was reading this, it reminded me a little bit of the Finnish baby box, that box that the government gives to new parents to get them started. But this is for when you’re like a baby adult in a predatory financial system instead. So you talk about how all the products it contains should be simple, they should be cheap, safe, easy to use. So we’re talking about things like mandatory transaction and savings accounts with the ability to automatically have things like tax refunds or bonuses deposited into savings. Short-term uninsured credit, which you spoke to a little bit earlier. Income driven student loans where any unpaid amount is forgiven after 20, 25 years. Fixed rate starter kit mortgages that do not require refinancing when rates decline. So we’re kind of touching on things that we’ve already discussed as potential solutions earlier in this conversation. Diversified investment portfolio, basic insurance, retirement savings match for all citizens to help encourage participation.

So in my mind I’m thinking, okay, so maybe we’re actually kind of decoupling this so much from the variability of really good employers who are giving you great matches. Those people are doing well. People who don’t even have the option to participate in a 401(k) plan are at a structural disadvantage. If you can, can you give me a sense for why you chose this particular bundle of products and the implementation of, okay, how would something like this work? What is the—I don’t want to say enforcement mechanism—but how does this sort of bundle get delivered to the masses as something that’s just sort of standard in society?

Tarun Ramadorai:

First, just to outline why we feel this is the right solution. I think you alluded earlier to the fact that there’s lots and lots of personal finance books out there that are kind of like how-to guides to help you navigate through system. And our contention is that while that’s great and it’s a great market and so on and so forth, the people that the how-to guides have mainly enriched are the authors of the how-to guides. So we sort of feel a little bit like there’s an—

Katie:

Amen. Living proof of that one. Kidding.

Tarun:

But I think one of the things that, jokes apart, I think the reason that we’re saying this is because I think we’ve all agreed during the course of this conversation that the financial system is super complicated for a huge set of people around the world who are newly entering financial systems and as you correctly point out maybe adults in predatory financial systems.

So what’s the right solution for this? I think we feel like the right solution for this is a structural solution to the problem, which is to say maybe we can actually do something to redesign the financial system to work better for the ordinary person who is entering that system. That is to say a more muscular intervention as you point out a shove. Now why do we think that that’s the right solution? So first of all, let’s sort of take nudges. We think nudges are fine. I mean there’s lots of interesting things that you can do with nudges. Why have nudges been so popular? It’s because they feel like they’re trying to do something without really being kind of in your face about

Katie Gatti Tassin:

The libertarian playbook.

Tarun Ramadorai:

There’s a sort of libertarian paternalism aspect to this. There’s a kind of softly, softly everything is going to move in the right direction if you just use the path of least resistance. Now the problem with that is that if you actually look at a lot of the evidence that’s emerging about nudges, there’s a couple of problems with the way that they have gone in practice.

The first is sometimes they just don’t work very well. Suggestions in particular or so the way you kind of couch something or phrase it doesn’t seem to make a huge difference to people’s actual decisions. That’s kind of the first problem.

The second problem is when they do work, they sometimes have unintended consequences. And so the default contribution on retirement savings, well, how do you pick it? Should it be 3%? Should it be 4%, 5%, 6%? What should it be? If it’s going to be really sticky, then that number matters a lot. That number may not be the right number for everybody and it might actually disincentivize good behavior because people just say, oh, well there’s a nudge operating, there’s a default contribution rate, and then they kind of fall asleep afterwards and then maybe you sort of end up making people even more sleepy than they were at the beginning. And so nothing really happens as a result.

Another problem is if you set the contribution rate too high, maybe people just forget about the fact that 6% or 8% or whatever it is has been deducted every month and then get into debt. There’s actually increasing research that shows that people are completely oblivious to what the contribution rate is. And in some cases when it’s set high, they’re doing weird things in other parts of their household balance sheet to kind of offset the effect of something that is kind of imperceptible to them, which is the nudge.

So for all of these reasons, we feel like they have their limits, they’re beneficial. There’s many things that could come from them, but we sort of feel like they’re not the right approach where we think this more muscular approach is required. Now we have a distinction in the starter kit that we are proposing between things that we believe should be mandatory for financial firms to offer people and other things that are mandatory for people to choose. So that is to say there are some things that we believe are so important that absolutely everyone ought to have them. And so at some point in their lives, they should be forced to choose these things such as a basic insurance product.

Okay, so to give you an example, catastrophe insurance is becoming ever more important because of the climate crisis that we’re facing at this point in time. If you don’t have insurance, it imposes terrible negative externalities on other people and therefore because these become liabilities that the taxpayer is eventually on the hook for. And so what should you do? You should force people to choose this product. If they’re being forced to choose a product, then the product should be standardized. Very, very simple, completely plain vanilla, easy to compare across different service providers.

And so in some sense we view this if you’re going to have a lot of people operating on a financial system, then the government’s job is to set the guardrails around which the financial system can innovate. And so the guardrails can be a template about what is permissible, how things should be specified, what are the design features, no unnecessary features and so on and so forth. So lots of different products of this type. A retirement savings match is sort of another kind of classic example of this where you can choose this. It’s mandatory to choose at the point at which you do that. Student loans for education.

John Campbell:

In general, we’re very cautious about price regulation. We don’t want to tell the financial industry you must offer products with these fees.

Katie Gatti Tassin:

Why is that? I’m just curious.

John Campbell:

It’s because we are aware of the fact that products are expensive to provide with small tickets just inherently expensive. And there’s a risk that if you regulate prices and set them too low, you actually make products unavailable to the poorest people. That’s one point. And we believe actually that the force of competition can lower prices effectively if these problems that we’ve been discussing with corrupted competition can be solved.

However, I do want to say there are cases where we think that some price regulation is warranted, and here’s an example. We talked earlier about very expensive rip-off index funds. Now we believe that retirement accounts should be made as universally available in this country as possible. At the present we have a very messy system. IRAs, 401(k)s, Traditional, Roth, a confusing menu of choices. Many people who work for small businesses or who are self-employed can only use IRAs. Those are very hard to shop for. The contribution limits are low, so we believe the system needs to be cleaned up and within that system, the government is offering you a tax break on your savings because retirement savings is important. And given that tax break, we feel that it’s appropriate to have some rules that the starter kit should involve index funds that go into these retirement accounts and that some price regulation to squeeze out rip-off index funds from the marketplace would be appropriate in that context.

But I do want to emphasize that we’re not talking about a sort of generalized regime of price controls everywhere. We’re not talking about government provision of most financial products. What we’re trying to do is get capitalist competition in the financial industry to work properly as opposed to the corrupted type of competition that we see today.

Tarun Ramadorai:

If I can just add one other example of a place where we think price regulation is appropriate. I mean there are some junk fees out there that we think should absolutely be eliminated. Bank overdraft fees are sort of a good example of this. There was this practice that you’ve probably heard of where banks would reorder transactions during the day to push people into an overdraft if a credit comes into the account and then there are three debits. If the bank has liberty to push the three debits in first so that you go over the limit totally, then you kind of incur the overdraft fee and only then does the credit get recorded. This is a sort of pretty terrible approach and in some sense you’re incentivizing that kind of behavior by allowing banks to charge a big overdraft fee.

So in some sense, getting rid of those fees hopefully eliminates the incentive to engage in such bad behavior. So certainly there are examples where we feel like that kind of muscular regulation is warranted. That having been said, we think that sunlight is a very important disinfectant that competition should be allowed to flourish. And so there should be guardrails around that competition.

Katie Gatti Tassin:

The nudge listener, the libertarian listener is like, I don’t want government in any of this and that’s why I’m not a fan. I am of the opposite mind where I’m like, I would actually probably go further. So on the note of the government subsidizing or advertising these products, I do feel a little wary about that because it reminds me of the private public partnerships that created the student loan bubble where you have a government subsidizing something that a private for-profit company is then going to sell to you that you are required to buy.

And so I think for me, when I’m thinking through the implementation here, which I love the solution, I’m nodding my head aggressively and agreeing with many of these recommendations. And I also want to talk about the idea that it’s a foregone conclusion that important financial services could not be publicly owned and provided in this country.

I just want to thought exercise our way through that because I think you state that generally government monopoly services are slow, they’re inefficient, they’re subject to political pressure. I think in some cases that’s absolutely true. I would say that it wouldn’t necessarily have to be, I worry that we rely way too much in the United States on what Suzanne Mettler has called the submerged state or this system of invisible programs of tax credits, indirect subsidies, incentives that regular people probably don’t even understand or notice. It’s not necessarily affecting their behavior because they’re not aware of them. I think we’re seeing this actually quite distinctly in the US right now with Medicaid cuts and I’ve seen people on the news like, well, I don’t care if Medicaid goes away. I have health first. And it’s like, yeah, that’s what Medicaid is called. In your state, you are on Medicaid and you don’t realize it.

So anyway, tax breaks, as we know, they disproportionately benefit higher income people by the very nature of our progressive tax system. And in the book, there are a couple good examples I think of public programs working really well. So like Australia and the UK’s student lending services, which are public, that works well and they’re income driven by default. I’m sure you’re familiar with how Singapore has solved housing. They have a housing and development board that originates those loans. And so all that to say, I don’t think the fact that those areas of US governance are currently subpar means that they would necessarily have to be, and I want to know what would it look like to expand our scope of solutions here to think a little bit bigger about whether we necessarily have to accept the presence of private profit and private gain when it comes to financing things that every single person needs. Education, housing, pension income.

You could, you see a world wherein there is a public option for some of these things where you’re not necessarily outlawing private industry and finance, but you’re doing the USPS thing where it’s like, yeah, you have UPS and FedEx, you can use them. You also have USPS, you have this public option that’s going to drive down costs.

John Campbell:

So I’m sympathetic to some of what you’re saying, and you didn’t even mention, in the US, the Social Security Administration, which actually is a very good example of a very big and important financial product that provides defined benefit pension income to pretty much the entire US senior population and does so very efficiently and at very low cost. And the recent attempt by DOGE to come in and uncover all times of fraud and abuse was a fiasco because really the program works extremely efficiently.

But what I would say is that it’s going to depend on two things. One is how standardized the product is. So social security is a kind of old time, pretty simple product designed in the thirties, widely understood, very standardized, newer and more complicated things. The record is much worse. We mention in the book government IT programs, which failed disastrously when the Obama administration, there was the initial rollout of the healthcare exchanges where the software was very glitchy.

More recently, there was a big problem with student loans, the update of the software for student loans in the UK. You mentioned the post office in the UK, the British post office has just had a massive scandal involving faulty accounting software, which caused prosecutions of innocent post office franchise holders, multiple people committed suicide over this. It’s a huge, huge scandal. So I would say that big IT projects, doing new things are much harder to get right.

I also think it depends a lot on what political scientists call state capacity, which means how much competence do you have within the civil service? The body of government employees who can execute these things. A country like Singapore is famous for its high stake capacity and I think they can do a lot of things publicly. I think in the US, particularly in the present environment, it’s just a very, very heavy lift.

And so our judgment is better to harness the capabilities of the private sector. But to be clear, we want to do that in an aggressive way where the government really is prescriptive and sets rules that direct the energies of the private sector. Let me contrast this with one other approach that we don’t recommend, which is the approach of just imposing a broad but vague fiduciary duty on all financial service providers just saying, you big banks, you big insurance companies, you do the right thing for your customers, and if you don’t, we’ll come after you and we will determine after the fact what doing the right thing was. That is too vague. What it does is it paralyzes innovation. It introduces a very costly risk averse system in which the private sector lawyers up. There was a problem with this recently in the UK where the consumer regulator there, the financial conduct authority brought in this duty of care, which was very vague and really caused a major problem. What we want to do is have the government be prescriptive in a rather precise way and say, this is exactly what we want to see. We design it, you set the price and you go out and sell it, but you must offer it. And we think that’s a sweet spot between relying too much on government and relying too little on government.

Tarun Ramadorai:

In some cases, and only in some cases, it may be valuable to have a government option. And one reason for that is because consumers may trust governments more than they trust private sector providers. So to give you a classic example, insurance is one of those cases, which is just a notoriously difficult product to sell. Commission structures are all over the place. If there were a government provided product alongside the menu of other products, that could be helpful, but we think of those cases as the exception rather than the rule.

Katie Gatti Tassin:

I see from where you two are sitting, as I assume you both have PhDs in economics and you’re very, very, very well-versed in this both domestically and internationally. The reason that I was getting stuck on that is because within American capitalism and the level of regulatory capture that we already have in this country, the deference that is given to finance and some of the issues that that sector has caused in the 21st century specifically, I guess I understand the concerns around political feasibility or what is realistic and what is the government capable of. I’m just not sure that enforcing aggressive guardrails for private financiers and capital is going to be any more realistic than creating a public option. To me, they both seem hard. They both seem like they’re going to get a lot of pushback, and so I just look at it and I think, I don’t know. I think the public option might actually be more desirable if they’re both going to be very challenging.

Tarun Ramadorai:

Fair enough. We were under no illusions when we wrote this book that this was going to be an easy sell. This is going to be an uphill sprint.

Katie Gatti Tassin:

Which for the record, I will take your solution. I would take that eight days a week. I’m just saying if we’re going moonshot, if we’re blue skying this…

John Campbell:

One reason why we try to keep a global perspective in the book is that we think progress can be made at different times in different countries. Right now, let’s be realistic. Right now in the US this is not going to be easy to get on.

Katie Gatti Tassin:

Yeah, we’re cooked, we’re totally cooked.

John Campbell:

We can wait and see what happens later. But meanwhile, there’s many other countries around the world where some of these things can happen and we hope our book is going to provide a roadmap and some inspiration for any country that’s in a position to take a step in this direction.

Tarun Ramadorai:

One of the things that we’re seeing in the United Kingdom is that what is ostensibly a left-wing administration is pushing financial deregulation very aggressively. They have historically, and they’re continuing to do that, whereas in more right wing, seemingly more populist administrations, maybe there is an appetite for more muscular regulation of the financial sector. So I think it remains to be seen that having been said.

I think the way we think about this is we think of the market as being a proven tool for creation of prosperity, and we don’t think that it should be eliminated, and there’s plenty of good in the financial sector in a sense. I think we want to see our approach as saving finance from itself. Guardrails are good, right? I mean, guardrails can help innovation flourish, help better outcomes for consumers, help the average person have a better, longer and happier financial life, and we’re trying to do the best we can given the tools that we have at our disposal to make that outcome happen.

Katie Gatti Tassin:

Absolutely. Well, thank you both so much for joining me today and for talking for so long about these ideas. It was really a pleasure.

John Campbell:

Thank you. A pleasure for us too.

Tarun Ramadorai:

Thank you. Likewise. Thanks a lot, Katie.

Katie Gatti Tassin:

That is all for this week, and I’ll see you next week. Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin with our audio engineering and sound design from Nick Torres. Devin Emery is president of Morning Brew Content and additional fact checking comes from Scott Wilson.