The Tradeoffs of Consumer Privacy Protection
On the Internet, consumers exchange some of their personal information for free or cheaper access to services, including search engines, social networks, and e-tailers. It turns out that this type of exchange — of personal information in return for lower prices — has also been happening in the mortgage market. In his paper “Screening Incentives and Privacy Protection in Financial Markets: A Theoretical and Empirical Analysis," Liad Wagman, Assistant Professor of Economics, and co-author Jin-Hyuk Kim, University of Colorado at Boulder, reveal that a lender's ability to sell consumer information gathered during the mortgage screening process can lead not only to lower prices, but also to higher screening intensities — and, under some conditions, increased social welfare.
By studying variations in adopting financial privacy ordinances in five California Bay Area counties, they found that denial rates for both home-purchase and refinancing loans decreased in areas where opt-in (stricter) privacy ordinances were adopted. In addition, they demonstrate that estimated foreclosure start rates during the financial crisis of 2007-2008 were higher in counties where stricter privacy ordinances were adopted. Their theoretical model points to a possible explanation: when lenders are bound by a stricter privacy regime, they raise prices. As a result, their screening standards are not as strict since the cost of making a mistake decreases, whereby many high-risk borrowers end up being misidentified — and ultimately receiving loans. Wagman's and Kim's papers are forthcoming in the RAND Journal of Economics.
