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The Case for a Consumer Financial Protection Agency

posted by Adam Levitin

Yesterday, the White House released proposed statutory languagefor the creation of a Consumer Financial Protection Agency (CFPA).  The bill is long, but the CFPA, the brainchild of our co-blogger Elizabeth Warren, is by far the boldest part of the Obama financial restructuring plan.  I’d also venture to say that it is the most important. 


In this post I want to underscore why we need a CFPA.  In future blog posts, I hope to come back to what a CFPA will and won’t do.

Simply put, we need a CFPA because the current regulatory structure doesn’t work and it will almost inevitably cause future crises, if not of the scale of the current one, then still too serious to countenance. 

The economic disaster of 2008 is the chief exhibit in showing that the current system doesn't work.  There were many factors behind the economic disaster, but bad consumer credit products were an important factor.  A major lesson from this crisis is that consumer debt can affect global economic stability (no surprise as consumer spending is something like 70% of GDP). 


Unfortunately, the market drives the introduction of bad consumer credit products.  Credit is at core a commodity.  A dollar from Chase is no different than a dollar from Bank of America.  The only way high-cost products that skim consumer surplus are able to compete in the credit market is through price obfuscation.  Some of this obfuscation is through fine-print.  Some is through product design, as complexity and exploitation of consumers’ cognitive biases can mask pricing.  Credit cards have led the way with price obfuscation, but mortgages made up the gap, and other products are not far behind.  Basically, the consumer credit market is a market in which competition often encourages bad products, and this calls for regulatory intervention. 


We have a regulatory system for consumer financial products in place, but the current regulatory structure doesn’t work for three reasons.  First, it fractures consumer protection in financial services over multiple agencies.  Second, it couples consumer protection with an incompatible mission, bank safety-and-soundness regulation.  And third, there is a lack of centralized expertise on consumer financial products in the federal government. 


In the current regulatory structure, consumer protection is an orphan.  Consumer protection in financial services is divided among five federal banking regulatory agencies, the FTC, the Department of Justice, and 50 states (with banking regulators and attorneys general).  And that’s just for banking services (credit, deposit-taking, and payments).  It doesn’t count the additional regulators for securities, commodities, and insurance. 


This fractured system is rife with opportunities for regulatory arbitration by financial institutions, and makes coordination between agencies a major challenge.  The essential nature of the consumer financial services market is hydraulic—regulating one sort of institution or product will merely shift business to another sort of institution or product.  For example, stricter limits on payday loans could well result in a boom in auto title loans.  When agencies have authority over only a part of the consumer financial services market, they are often loathe to regulate lest they just push the problem—and the business—into another agency’s bailiwick. 


Among the alphabet soup of agencies that have consumer protection duties in financial services, there is only one whose primary mission is consumer protection:  the FTC.  The FTC, however, only has jurisdiction over fringe players in financial services; it has almost no authority over banks or thrifts or credit unions.  For the other regulators, consumer protection is thrown in with other missions, and it has often been an afterthought.  The key problem for federal banking regulators (Fed, OCC, OTS, FDIC, NCUA) is that they are charged with ensuring bank safety and soundness.  A bank cannot be safe and sound without being profitable, and abusive and exploitative lending practices are frequently quite profitable (there’s no other reason to engage in them).  If a regulator cracks down on an abusive lending practice, it might endanger its regulatory charge’s safety and soundness.  The result has been that consumer protection almost inevitably takes a back seat to safety and soundness. 


The fracturing of consumer protection in financial services has also inhibited the federal government from building up expertise in the area.  There are many able staffers at various federal agencies who study consumer finance, but their dispersion limits their effectiveness.  It also limits their ability to collect data.  Data is the lifeblood of consumer finance regulation, but the federal government knows shockingly little about mortgages or credit cards or payday loans, for example.  To provide a simple example, the federal government does not know with any precision the volume of credit card debt outstanding.  The Fed tracks revolving debt, but that includes bank account overdrafts and other revolving lines.  Likewise, the federal government lacks detailed knowledge about credit card terms and pricing.  In order to gauge the impact of regulations, that sort of knowledge is essential, and a major reason the federal government doesn’t have the sort of knowledge is that there is no single regulator with a field-wide purview. 

Creating a CFPA would solve the fractured authority problem, would solve the conflicting missions (a/k/a motivation) problem, and would become a locus of knowledge and expertise on consumer credit that would allow for better and more efficient regulation.  It would provide an important bulwark against abusive consumer finance products and practices not just for the next few years while the memory of the current crisis is still fresh, but well beyond the memory horizon.  It might not be failsafe (no regulatory regime is), but the current regulatory system can also be guaranteed to keep producing bad consumer financial products, and that’s something America can’t afford. 


I am in complete agreement. However, I signed on to discuss the new 125% LTV provision of HAMP for current yet underwater borrowers, and hoping someone else would be here already venting. The enhanced program will not assist those in default. It will not clean up Florida and Michigan or any place else suffering from massive unemployment---or about to--. These creditworthy borrowers were eligible for a refi; the appraisal was an obstacle. Now they'll be served. And we will have to worry about real estate appraisers churning out DEFLATED property values rather than INFLATED ones. The Treasury Department has yet to update financialstability.gov with this press release delivered yesterday by HUD Sec'y Donovan in Las Vegas. But Housingwire and the speech transcript mention this in ONLY FOR CURRENT BORROWERS. I hope the media will specify WHO EXACTLY this provision will assist. It appears to be a boon for financial institutions, not borrowers, to make some good loans and package them in MBS, sales of which have been declining due to lower interest rates (pension and mutual funds and foreign nations have been shying away from these products) and general fear of quality. However, it will flood the servicers already deluged (see NYTimes; 6/29/09 article) with requests from the common person. Lets face it, those most likely to qualify here will be owners of higher-end properties where the % drop has been high (its been high elsewhere but those people aren't CURRENT)and the borrower can afford to hire legal counsel to push the modification forward. The average turn-around time awaiting a yes or no on a loan mod request that I am seeing assisting consumers through our state (VT) program is 120 days. I am curious to see within what time frame these premier borrowers will witness resolution.

I dislike this legislation. Not because I disagree with the objective which I assume is to prevent people from taking on debt they can't handle, but because I disagree with the means, i.e., more bureaucracy and paperwork and administrative law processes and litigation. There is a litany of consumer financial protection laws on the books and none of it works. It's not because the agencies to enforce it are fragmented but because laws focused on paperwork and disclosure don't address the basic impulse to buy today and pay for it as far in the future as one can and people will blow by any disclosure that is in their way when they have their eyes fixed on a desirable purchase.

What would work better are three simple clear laws:
1) a national usury law which sets the maximum rate chargeable on any extension of credit at some amount over comparable Treasuries. Boom - payday loans go out of existence and so do many credit card practices.
2) a national down payment law - if you want to buy something over $XXX you have to pay 20% in cash. No more credit card binges and no money down mortgages.
3) a national debt incurrence limit - any extension of credit that causes a person to have debt greater than X% of their income is void and the burden is on the lender to verify that its extension is valid.

Citizens crave clear simple laws with clear enforcement mechanisms. Bureaucracies with staff and rule making and notice and comment and lobbyists and DC law firms and appeals and so on dis-serve us all in so many ways.

I agree with Marc as far as "There is a litany of consumer financial protection laws on the books and none of it works." But none of it works, not because it doesn't discourage basic consumer impulses (to paraphrase) but because there is no real, honest to god ENFORCEMENT of these laws as far as I can tell.

Consumer protection laws are viewed and prosecuted as nothing more than a "cost of doing business" tax for anyone caught violating them. Until such time as they have actual civil AND criminal prosecution and penalty behind them as well as the ability for individual citizens to enforce the laws through private action no real progress will be made in this area.

Until and unless a CFPA has the authority/ability/incentive to bring CRIMINAL action on behalf of INDIVIDUALS as opposed to "classes" of victims this will just be one more bureaucratic "land grab" aimed at appeasing consumer groups that have been begging for an entity such as this. I specifically mention "individuals" because I was informed several years ago that entities such as the Federal Trade Commission would/could not take action on an individual's behalf. If a CFPA is going to have to wait until a "class" of victims forms, as opposed to operating on a "where there's smoke there's potentially fire" philosophy then it will be no better than the current "regulatory" bodies already in place.

In order to properly protect the American people and uphold current, existing consumer protection law, at it's core a CFPA will need attorneys well versed in consumer and securities law and litigation (and actually be able to PROSECUTE it in plain language for juries as oppose to legalese) and forensic accountants with similar backgrounds. After that, whatever support staff (research/data crunchers, paralegals, investigators, etc.) and state of the art technology necessary to make the undertaking as efficient and effective as possible and you're good to go. If the new agency doesn't have at LEAST these tools in its arsenal it's going to be no more effective than what we've already got.

Mike Billon, I don't think CFPA or any other administrative agency has criminal prosecution power. I think that is what the Dept of Justice is for.

I think you and I wind up in the same place to the extent that, as you say, "it's going to be no more effective that what we've already got" and what we've already got isn't doing much good.

I think we should be more direct and radical. To borrow from Chief Justice Roberts, if you want to stop people from taking on too much debt, STOP people from taking on too much debt. Don't nudge them or counsel them or point out, by the way that's a lot of debt there, buddy.

Over 152 pages of added tax dollars to the middle class.

Current economic crisis was caused by Fannie Mae and Freddie Mac giving mortgage companies the go ahead to write garbage mortgages because they guaranteed those loans. Another federal agency will only stifle creation and improvements within the financial sector and lead to a new period of Malaise. The basic premise of your agreement that this crisis was caused primarily by business is completely false.

Businesses need to be left alone to succeed and fail without the crushing influence of overstaffed, and undereducated government agencies. If consumers are messed over by bad businesses they will stop using those businesses and they will go out of business. If a business getting involved in highly speculative derivatives trading and loses its shirt, government should let that business fail.

Additional government agencies bring great tax burdens to the citizens of this nation and take away freedoms guaranteed by the Constitution. As an academic, I certain you enjoy hypothesizing about how everyone can be protected by a benevolent government. As a student of history and a private citizen I can assure you that government has become too overbearing and burdensome.

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