DESPITE SOME promising signs of progress in the economy, the situation for most consumers remains dire and may well get worse in the coming year. Consumer confidence has bounced around all-time lows, and credit problems - the problems at the heart of the economic crisis - are the main culprit. Consumers understandably lack trust in lenders, banks, and other purveyors of credit. Many families have been burned by overzealous marketing, and by products with hosts of tricks and traps and undisclosed risks.
There is no single solution to the ailments of the economy, but a cheap, simple and powerful solution for much of America’s consumer confidence problem rests in a consumer financial protection regulator. First proposed by Harvard law scholar Elizabeth Warren, the idea of a safety regulator for consumer finance has been introduced as a bill into Congress.
Perhaps the most important benefit of a new agency is not consumer protection, but consumer confidence. A properly designed consumer protection agency will enhance financial markets by girding Americans’ trust in the financial system.Tens of millions of American consumers view credit cards and mortgages with the same wariness with which they view cigarettes: unsafe products that need strong regulation. Consumers know that cigarettes are not simply dangerous in and of themselves, but that they have been sold in dangerous and irresponsible ways.
The same is true for many retail financial products.
If a regulator could prevent the worst products from coming to market, or penalize those lenders who market irresponsibly and hazardously, then consumers would know, as they know with foods and drugs, that the most dangerous products are much less likely to come to market.
If a regulator could require mortgage lenders and credit card providers to study and disclose the risks of their loans and credit cards, then consumers would be better informed about the products that are on the market.
Food additives, new drugs, and other products are required to undergo testing before and after they come onto the market, and they are required to carry warning labels that clearly describe their risks. Even if only a small fraction of consumers read those labels, risk information gets communicated, and consumer confidence increases greatly.
Credit cards are not cigarettes, of course, and we certainly don’t want to make American consumers more confident about smoking. Yet government regulation of tobacco - from the surgeon general’s warning to limits on marketing to prohibitions on sales to minors - has done as much as anything else to make Americans more aware of the risks of cigarettes.
Critics of the consumer financial protection agency worry that “financial innovation’’ (an elusive concept they have never defined) will suffer. Set aside the fact that financial innovation, whatever its value, does not save lives like medical innovation does, and we regulate medical innovation far more stringently.
More important is the fact that this argument gets the relationship between regulation and innovation the wrong way around. Stringent food and drug regulation has been embraced worldwide and it has been accompanied by the dramatic medical and nutritional breakthroughs of the past four decades. Effective regulation is a friend of and precondition for innovation - not an enemy or destroyer of innovation. In American and global economic history, the pharmaceutical industry did not begin to develop and innovate in productive ways until the FDA set basic safety baselines.
Opponents of the consumer financial agency plan have not yet explained to Americans why increased transparency is not in their interest, but we should expect them to.
The economy will recover stronger - and Americans will live financially safer lives with more appropriate risk-taking and innovation - when regulation ensures that consumers are presented with clear and understandable information about the downside as well as the upside of a new product. The idea is simple: regulation “makes a market’’ by creating trust and space for innovation.
When lenders and banks stop competing on who can best mislead the consumer, competition will focus on the things that matter: price and quality. That is the promise of a new consumer agency.
Daniel Carpenter is a professor of government and director of the Center for American Political Studies at Harvard University. 
