“…fraud is endemic to modern capitalism,” so said Professor Edward Balleisen at a National History Center talk on his excellent, comprehensive, thoughtful Fraud: An American History from Barnum to Madoff. We need histories of consumer protection. Balleisen provides one such history, focusing on the idea of fraud—specifically those wrought by businesses against consumers and investors. The concept of “fraud” is complex, it is defined differently through disciplinary lenses, and when we think about FTC privacy and many other consumer protection efforts, we are addressing conduct that is different from Balleisen’s focus. Yet, Balleisen’s book offers lessons for consumer protection more broadly and I learned a great deal from it.
Balleisen’s observation of the policy pendulum of anti-fraud efforts is most clearly stated on page 309, and anyone involved in modern debates on the FTC will recognize it:
Forceful antifraud tactics tended to generate complaints about autocratic governance that ran roughshod over individual rights and American values, which then prompted adoption of procedural protections, which in turn limited the effectiveness of administrative remedies. Post–World War II proceduralism deepened the democratic legitimacy of antifraud regulation, but at the cost of extending the rights of accused businesses, whether in criminal or administrative contexts.
My copy of Balleisen’s book is heavily marked up. So here are two key questions answered by the book and some other reflections–
Why, despite our rich information environment and seeming greater accountability brought about by technology and institutions, do frauds still persist, largely in five basic forms (pump and dump, pyramid scheme, bait and switch, advanced fee frauds, control fraud)?
- There are businesses committed to fraud. The proceduralism described by Balleisen allowed committed fraudsters (Holland Furnace, Fritzel Television) to slow down intervention.
- Committed fraudsters keep a “squawk” fund to “cool of the mark” by paying the consumers who do complain.
- Especially in areas where products/services are new and norms do not yet exist, new market entrants have more space for deception.
- Concerns about the pace of innovation and creating breathing room for it makes tolerance for fraud a part of a dynamic economy.
- A turn to individualism in the 1970s caused institutions such as the BBB to embrace squawk fund approaches—instead of pursing big, collective actions, BBB started remedying individual claims, thus leaving the target free to continue operations.
- Frauds are often small scale and your typical collective action problems emerge in policing them (daunting costs of representation, limited recovery, risk of countersuit or retaliation, embarrassment, and the problem of “unclean hands”).
- Information asymmetry still exists!
- Fraudsters can take advantage of the biases and heuristic reasoning approaches that most of us use.
- We are strongly moved by forms of social proof over more objective evidence.
- We are overconfident, especially when we have a little knowledge of a subject. There is the problem that many of us cannot recognize our own incompetence (the Dunning-Kruger effect).
- We reason through “available” examples—easily recallable fraud events. As old frauds (such as the lightning rod sales of the last century) are interdicted, we forget about them and their lessons.
- We are vulnerable to anchoring, which skews our perception of price.
- We are loss adverse—and so when we anchor to a price, we act impulsively to capture discounts from the anchored price.
- We are not good at separating bundles, and so sellers that engage in bundling can influence our perception of value (act now and get not one, but two non-stick pans!).
- We are optimistic.
- Gullibility, dreams of quickly-acquired wealth.
- Only a small number of people need to fall for a fraud for the enterprise to be successful.
- The Holder in Due Course doctrine—obliterated by the FTC in the 1970s, the ability for a seller to transfer a debt obligation to a third party created intense incentives for fraudulent sales.
- On some level, we admire the guile of fraudsters—think about our centuries-long fascination with stories such as Reynard. The OED has over 300 words to describe deception, deceit, and trickery.
- And there are many, many ways of cheating. Balleisen covers the many ways 19th century companies defrauded each other—wetting cotton to make it heavier, enclosing a low-value project within an envelope of high-quality material, and so on.
- We are unwilling to criminally prosecute many consumer frauds, and when we do, convicted defendants receive laughably small sentences in light of the scale of their thefts.
- On some level, we resent victims of fraud, and suspect that victims were somehow complicit in the scheme. The OED has 200 words for dupes.
Related to the above, what are the tensions/tactics that enable fraud today?
- Product complexity. Complexity makes quality assessment difficult, leading us to fall back upon easily-manipulated signals, such as social proof.
- This is, by the way, one reason why I think institutions such as Yelp will aid consumer protection little. Yelp—and even the BBB—are easily manipulated. There are even services that will do it for you, just like buying “puffs” from a 19th century newspaperman.
- Economic complexity. As our economy becomes more complex, we have to rely and trust people we do not know—even people not in our own country.
- Agreement complexity. Basic business models such as compounding interest cannot be defined by many consumers.
- Corporate secrecy.
- The ability to quickly incorporate.
- Being able to acquire the “trappings of success.” Ponzi was known to have bought the most expensive car in production—merely possessing it offered proof of his legitimacy. Balleisen shows other examples—the importance of fraudsters to claim having a prestigious address, of having been in operation for many years, of having trademarks or other signals of brand.
- Disclosure pollution. If a regulatory regime requires disclosure of some fact pointing to a problem, “pollute” the communication by making tons and tons of disclosures. I suspect that drug companies do this with side effects of prescription medicines.
Some final reflections–
I was surprised to learn of the historical vigor of the Better Business Bureau. I’ve long thought it to be not the most agile or effective institution. But Balleisen recounts decades when it was a serious force for consumer protection enforcement. In its heyday, it was a key actor in big fraud investigations, and it assisted public authorities in prosecutions. Balleisen shows how a conservative faction asserted control over its priorities, defanged it, and in the process, made it slouch into a kind of arbitration service for individual claims, and an opponent of anything but self-regulatory approaches. Some of the problems that Balleisen paints in the 1970 takeover, such as the problem of adverse selection in BBB membership, replicated themselves in the self-regulatory regimes for the internet.
Thoughts of “fraud” conjure images of Ponzi and Madoff. Conservatives and liberals alike disapprove of fraud as such. A problem that arises is that we use the same institutions and laws to pursue pure fraudsters as we do companies that do not live up to their advertising promises. This brand of FTC target sees himself as an honest businessman not to be painted with the same brush as hucksters. Balleisen gives the historical example of Macy’s and its promise that all of its prices were 6% lower than competitors—we know that this claim cannot be true in all situations. Macy’s saw deviance from the 6% target as just an imperfection that does not amount to deception or wrongdoing. Today, when companies like LabMD react viscerally to FTC intervention, it acts out just as its forebears. It rightly sees itself as a honest business–why is the federal government breathing down its neck? Businesses that read the situation that way always do the same thing—they accuse the FTC of pinkoism and of standing on an insecure constitutional foundation. Balleisen’s point is that their interventions introduce more and more proceduralism, but they rarely limit the substantive authorities of consumer protection institutions.
Balleisen’s book does not end in a bang. He adheres to the idea that there is no “silver bullet” to fraud, that many institutions and legal tools are needed to contain it, and that prevention (incentives for truthfulness, public education, consumer friendly defaults) should be the strategy rather than ex post remedy. He does carefully present the conservative reaction to the FTC but seems unconvinced of its cogency, or perhaps unconvinced that the critiques justify dismantling of new institutions.