Annual Percentage Rate (APR): Why Won't Government Fix It?

 May 4, 1998, Revised January 3, 2008, August 7, 2010, Reviewed February 6, 2011

Bad disclosure rules don't get fixed because the costs of bad disclosures are not borne by the agencies responsible for them.

"Your columns explain clearly what is wrong with the APR and how it needs to be fixed. Why doesn't it get fixed?"

It isn’t because the responsible agency, the Federal Reserve Board, doesn’t understand the problems. I have been badgering them about it since 1984, and especially since 1998 when I started writing a newspaper column. The process through which mandatory disclosure rules are developed is extremely rigid, however, and it is virtually impossible for a bystander like me to influence it.

The best way to understand this is to compare the process of developing rules under which lenders are required to disclose information to consumers, with the process a private firm goes through that wants to sell information to consumers.

The first thing the private firm does is to pretest the information for acceptability by consumers. After adoption, the firm receives continuous feedback from the market on how well it is doing, on the basis of which the firm tries to improve the product. And if it never succeeds in finding a product that consumers buy, it pulls the plug to cut its losses.

Government rule-makers, in contrast, do not pretest mandatory disclosures with consumers, and receive no market feedback from them. They do not know whether the rule is "selling" in the sense that the information is being actively used by consumers, or not. And they are not forced by cost pressures to improve the product or scrap it because the major costs of implementing the mandatory disclosures are borne by lenders, not by the regulator.

The bottom line is that mandatory disclosures are not required to meet any sort of market test. The test the regulators must meet is political. Mandatory disclosures impose costs on the mortgage lending industry, which must implement the regulations, and the industry has the ear of Congress.

The industry is therefore the only major external influence on the rule-making process. But the overriding concern of the industry is minimizing compliance costs. The industry wants rules that are clear, so that lenders understand exactly what they must do to comply. Once rules are adopted which meet this test, which is unrelated to their usefulness to consumers, the industry has no interest in further changes because rule changes raise costs.

The industry thus has an unstated pact with the regulators -- "if you agree to make the rules clear enough for us to comply and thereafter don’t change them, we will agree not to tell you how utterly useless they are." And that’s why the flawed APR never gets fixed.

2008 Postscript: This was one of the first articles I wrote as a journalist, and it holds up pretty well. The only things worth adding are that consumer groups also have an impact on the rule-making process, but have not had any interest in improving the APR. And the Federal Reserve Board in 2007 began testing disclosures, though they had a lot to learn. See Will Early Disclosures Prompt Borrowers to Shop?

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