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Wanted: Product Liability for Financial Products

by Andy Bitterer  |  October 23, 2008  |  4 Comments

Of course, there is no point locking the barn door now, since the horse has bolted. I’m talking about those billions of dollars and euros being spent to save banks. In a nutshell, what caused the market meltdown were banks selling products and approving loans that came with an enormous risk, and unfortunately, that risk became reality. Sure, there were lots of people out there that should have never been given a loan, because they didn’t understand what an adjustable rate mortgage (ARM) is. But, of course, bankers pushed those loans down people’s throats to get a commission and generate revenue. And here is where I think the industry is missing something. Who is liable for the dangerous products the banker sold?

If you buy a coffee maker, or a toaster, or a lawn mower, pretty much anything, the manufacturer is liable for any injuries that product may have caused. As far as I can see, this is always focused on “bodily injury”… why? If someone loses the house, car, or job, because the “bank product” just imploded, isn’t that another injury caused by negligence?

“This plastic bag is not a toy.” or “Do not place animals into the microwave.” Duh. Everybody understands that. (At least I hope so). Where is the disclaimer on those “banking products” that hardly anybody (including the bankers themselves) understands. Where does it say “this derivative has a risk score of 89 (out of 100)” on a scale that says “you could lose that money”? Would people be more careful if they knew what they were getting into? I think so. But they just took the banker’s word for it. No data was made available to back up those claims.

Where was the bank’s risk management? Oh right, it was focused on the customer. If there was a product liability for banks, I’m sure the bankers would have been a little more hesitant with those loans. The data was all there, but nobody wanted to look. I’m hoping that the lawmakers in those governments in the US, the EU, Japan, Korea, and others, that are bailing out the financial institutions at the moment, are considering to extend the current liability law into the financial world.

If I’m reading this description from Wikipedia with banking products in mind, that would make a good start.

“The most fundamental rationale for strict liability is to force producers to internalize the external costs they impose on society. By placing liability for all injuries caused by a product on its manufacturer, the manufacturer is forced to take into account, when deciding whether and how much to produce the product, the harm caused by it. If this internalized harm is so great that the manufacturer cannot profit from producing the product, it will discontinue the product, or sell it only at a higher price to consumers who value it especially highly (in economic terms, modify its activity level). In this way, strict liability provides a mechanism for ensuring that the societal good of products in the marketplace outweighs their societal harm.”

Disclaimer: I’m no financial specialist, just an observer.

Category: current-events  finance  market  politics  

Tags: bailout  banking  liability  risk  

Andreas Bitterer
Research VP
9 years at Gartner
27 years IT industry

Andreas Bitterer is a research vice president in Gartner, where he specializes in business intelligence, data integration and data quality, with expertise in analytical applications, data warehousing and information management.Read Full Bio

Thoughts on Wanted: Product Liability for Financial Products

  1. Marc Dierens says:

    Totally agree. This Monday Belgian national TV re-broadcast a documentary on how banks pushed certain types of investments (usually funds from the own bank) down people’s throat, even if the product went against the risk profile of the customer.

    One 80-year old testified about how he signed up for a product with a lot more risk, based on the advice of his banker with whom he a had a business, and personal, relationship for over 50 years.

    A lot of trust has been violated in the past year, and it will take a long time to rebuild it.

  2. Dan Sholler says:

    On the other hand… what part of the word “adjustable” in the term “adjustable rate mortgage” didn’t you understand?

    If you put the pet in the microwave anyway, despite the warning, it seems to me you can hardly blame the microwave manufacturer for that.

  3. Dan Sholler says:

    (oops, hit the button too soon… comment continues)

    I know when I got my mortgage (admittedly a nice simple fixed rate job at what is now a very low interest rate) I was handed 22 pages of disclosure information, plus a form that I had to sign indicating that I head received all of that information. Yeah, it is a bit daunting, and lots of the legalese is probably hard for some people to understand, but by the same token the consequences of financial loss are not the same as those of bodily harm, so it is not clear that the same level of consumer protection should apply.

    After all, if you lose bodily function as a result of a defective product, you are in a situation where a lot of potential has been taken away from you. If you lose some money that sure does suck, but either you had earned that money in the first place, and therefore can earn some again, or you were purely speculating with money that you did not have. While I agree that we need to make sure that the disclosures are comprehensible, we do also need to insist on some degree of personal responsibility for those people who borrow more than they can afford. I was always told that if someone offered me a deal that seemed too good to be true, it probably was. Many people do not seem to have heeded this lesson.

    I for one do not believe that the challenges that we are facing now had a lot to do with consumer protection, at least in teh narrow sense you are describing it.

    There is no question that a lot of people were sold mortgages they could not afford. While some people were clearly just plain lied to, that is criminal no matter when it happens or whether you are lied to about a mortgage or a used car. Systemically, what seems to have failed is the banks oversight of the riskiness of loans (again, lots of reasons for this, mostly having to do with unregulated activities that appeared to lay off risk but in fact did not do so). While we can and should go after those salespeople who lied to their customers about the financial products they were sold, it is rather hypocritical to blame a person who is paid to sell things for selling the things they were supposed to sell.

    In the same way that we need to allow the bankers who screwed up the lending requirements to fail, we also need to allow the people who borrowed too much to fail as well. Obviously, the hard part is figuring out the difference between who was defrauded, who was overtaken by circumstances, and who was buying something they could not afford. IMHO there is no way consumer protection (especially with the way tort stuff works here in the US) can be the vehicle for this .

  4. Thomas Otter says:

    I think we also ought to talk about software liability sometime…

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