[Senate Hearing 111-59]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 111-59

 
   CONSUMER PROTECTIONS IN FINANCIAL SERVICES: PAST PROBLEMS, FUTURE 
                               SOLUTIONS

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

  ESTABLISHING STRONG CONSUMER PROTECTIONS WHILE ENSURING A SAFE AND 
              SOUND FINANCIAL SYSTEM IN THE UNITED STATES

                               __________

                             MARCH 3, 2009

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  JIM DeMINT, South Carolina
JON TESTER, Montana                  DAVID VITTER, Louisiana
HERB KOHL, Wisconsin                 MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                 Colin McGinnis, Acting Staff Director

        William D. Duhnke, Republican Staff Director and Counsel

                       Amy Friend, Chief Counsel

                       Lynsey Graham Rea, Counsel

                Julie Chon, Senior International Adviser

               Jonathan Miller, Professional Staff Member

               Matthew Pippin, Professional Staff Member

                Tamara Fucile, Professional Staff Member

                Mark Oesterle,  Republican Chief Counsel

                    Jim Johnson, Republican Counsel

      Mark Calabria,  Republican Senior Professional Staff Member

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                         TUESDAY, MARCH 3, 2009

                                                                   Page

Opening statement of Senator Dodd................................     1
Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Akaka................................................     6
    Senator Merkley..............................................     6
    Senator Schumer..............................................    23

                               WITNESSES

Steve Bartlett, President and Chief Executive Officer, Financial 
  Services Roundtable............................................     7
    Prepared statement...........................................    37
    Response to written question of Senator Vitter...............    73
Ellen Seidman, Senior Fellow, New America Foundation, and 
  Executive Vice President ShoreBank Corporation.................     9
    Prepared statement...........................................    48
    Response to written question of Senator Vitter...............    74
Patricia A. McCoy, George J. and Helen M. England Professor of 
  Law, 
  University of Connecticut School of Law........................    11
    Prepared statement...........................................    52
    Response to written question of Senator Vitter...............    75

                                 (iii)


   CONSUMER PROTECTIONS IN FINANCIAL SERVICES: PAST PROBLEMS, FUTURE 
                               SOLUTIONS

                              ----------                              


                         TUESDAY, MARCH 3, 2009

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:06 a.m., in room 538, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. Good morning. The Committee will come to 
order. Let me welcome those of you here in the room, my 
colleagues and our witnesses, who will spend a few moments with 
us as we discuss ``Consumer Protections in Financial Services: 
Past Problems and Future Solutions.''
    Let me begin by commending all three of our witnesses. I 
went over your testimony yesterday and I found it very, very 
interesting, with different perspectives on this issue, not so 
much on how we got where we are, but where we need to go from 
here. I found it very, very worthwhile, very enlightening and 
interesting. And really, what I liked about it is, given we 
have spent a lot of time over the last year talking about it in 
general terms, it talks specifically about where we go, and all 
three of you really have offered some very specific ideas on 
how to move forward. That is what we need to be doing in the 
coming days.
    And, of course, I am delighted to be with my friend and 
colleague here from Alabama, who was the former Chairman of the 
Committee. We have had some great times working together over 
the last 2 years, some difficult times, but he has been a great 
partner and a good Senator. We have our differences from time 
to time, but we try to minimize those and do whatever we can to 
work together.
    And this is a subject matter where I am determined, and I 
believe he is determined, as I hope our colleagues are, too, to 
come together and do something historic in light of all the 
problems that we face in our country. You need only to pick up 
our morning newspapers to appreciate what people are going 
through. We read the numbers, but, obviously, out there behind 
all of those numbers are people watching their jobs disappear, 
their retirements evaporate, and they are losing their homes, 
and their children's future and education are in question. And 
that is what has to motivate us and drive us. We keep them in 
mind through all of this.
    So this morning, we continue the conversation we have been 
having about how we can make our economy stronger, our 
institutions more stable and reliable, and of course, in the 
final analysis, to make sure that the consumers of all of these 
products are going to receive the protection that they deserve.
    So today, the Banking Committee meets for another time in a 
series of hearings to discuss ways to modernize our financial 
architecture to help our nation grow, to prosper, and to lead 
our nation into the 21st century. This hearing will focus on 
critical consumer, investor, and shareholder protections in 
financial services.
    For the past year, as I have traveled in my home State of 
Connecticut, along, I am sure, with my colleagues in their own 
respective States, and our constituents have underscored the 
importance of rebuilding our financial system by injecting 
tough new consumer investor protections that have been missing 
or overlooked for far too long. They are literally banking on 
change in this area, and I believe we must give it to them this 
year, and our common hope is to do just that, because efficient 
and effective markets only work when all actors have good 
information.
    It also means increased accountability, disclosure and 
transparency to ensure that consumers and investors understand 
the rules of the road regarding their transactions. And it 
means doing these things in a way which doesn't unduly cramp 
the vitality, innovation, and creativity, which is the source 
of genius in our financial system. Striking that balance is a 
tall order, but that must be our charge.
    The President has now made clear that regulatory 
modernization, which will protect consumers and investors in 
this way, is a top priority for him. Senator Shelby and I, 
joined by Chairman Barney Frank and Ranking Member Spencer 
Baucus, met last week met at the White House, and we agreed to 
work toward that goal, informed by key principles outlined by 
the President in that meeting.
    It is an historic undertaking, one of the most important 
debates in which we have engaged here in a long time, maybe the 
most important debate that members of this Committee may ever 
engage in, considering the significance of what we are about to 
undertake. It will be challenging, and no doubt it will take 
twists and turns in the coming months. But I hope and expect 
that the process will culminate in a comprehensive regulatory 
modernization bill at its end.
    Senator Shelby and his colleagues have been partners in 
many such legislative efforts over the past couple of years 
that I have chaired this Committee, and I am very grateful to 
him specifically and to my colleagues as well, for the fine 
work they have done with us on this Committee.
    In the last Congress, this Committee and its subcommittees 
held 30 hearings to identify the causes and consequences of the 
financial crisis, which is at the root of our economic 
troubles. We looked at everything from predatory lending and 
foreclosures to the risks of derivatives in the banking system, 
and security and insurance industries. What we found at the 
heart of the problem in these areas was a single fundamental 
breakdown, an almost total failure to protect consumers, 
investors, and shareholders.
    By no means is this problem exclusive to financial 
services. Whether it is poisoned toys imported from China or 
meat with deadly pathogens knowingly sold to supermarkets, some 
for too long have been willing to cross the bright lines of 
basic business operations, and fair treatment of the consumer 
to bolster their bottom lines.
    Nowhere was that failure starker or more catastrophic for 
our economy than the housing market, where lenders, brokers, 
and banks offered or financed an array of unsuitable mortgage 
products without regard to the borrower's ability to repay. For 
too long, many in the industry focused solely on large profits 
and ignored the major risks that accompanied them. They were 
willing to gamble with not only their own futures, but those of 
their customers, who were encouraged to take on more and more 
risk.
    And the result is clear. With unemployment now at its 
highest in 16 years, 8 million homes in danger of foreclosure, 
and some of our largest financial institutions either in ruins 
or at the risk of being such, this house of cards has 
collapsed, and today the Committee meets to continue our 
discussion on how to rebuild a stronger and more stable 
structure.
    I pledge personally over the coming months that we will 
rebuild the nation's financial architecture from the bottom up 
and put the needs of consumers, investors, and shareholders who 
own these firms not at the margins of our financial service 
system, but at its very center. Just as failure to protect the 
American people was the cause of our financial collapse, so too 
must our efforts to rebuild be premised on a strong foundation 
of consumer and investor protections.
    Certainly, we have a ways to go, as we all know, when 
mortgage brokers can charge yield spread premiums for directing 
customers into riskier, costlier mortgages, and when credit 
card companies can raise rates on customers who have always 
paid their bills on time.
    Recently, I learned of a woman named Samantha Moore from 
Guilford, Connecticut, a paralegal whose husband owns a small 
business. Not long ago, she was 3 days late on a credit card 
payment, the first late payment in 18 years. For that seemingly 
minor transgression, she had her interest rate raised from 12 
percent to 27 percent and her credit line slashed from $31,400 
a year to $4,500. What is a middle-class family like the Moores 
supposed to do if they were counting on that credit line to 
help them through a medical crisis? That single decision could 
mean the difference between scraping by during a recession and 
a lifetime of financial catastrophe, all because a single 
payment after 18 years was 3 days late.
    With the average household carrying more than $10,000 in 
revolving debt on their credit cards and millions trapped in 
home loans with exploding interest rates, sweeping reform of 
abusive credit card and mortgage lending practices will be an 
essential component of this Committee's financial modernization 
efforts.
    Today, we will discuss broader regulatory reform questions 
that focus on how we treat customers of financial institutions. 
For instance, should bank regulators continue to have that 
authority? In 1994, Congress gave the Fed authority to ban 
abusive home mortgages and it failed miserably. Is it time to 
create a new regulator whose sole function is the fair 
treatment of individual customers?
    Certainly, we need strong cops on the beat in every 
neighborhood. Fifty-two percent of subprime mortgages 
originated with companies like stand-alone mortgage brokers and 
others that have no Federal supervision whatsoever. Who should 
be charged with consumer protection for these financial 
institutions? Some have suggested that we set up an entity 
modeled on the Consumer Product Safety Commission, which 
protects the public from products used in the home, the school, 
and for recreation. In this day and age, financial products are 
just as commonplace and some can be equally as dangerous.
    No one suggests that the buyer is to blame for a dangerous 
toaster that catches fire or a toy for a child that is 
contaminated with lead. Should it be any different for a 
borrower who takes out a mortgage or signs up for a credit 
card? I think it is a fair thing to ask, and one thing is 
clear: These complex financial transactions, including 
mortgages, can be much more dangerous than a family toaster.
    We are talking about huge financial decisions, often the 
most significant in a family's life, on which they stake their 
life's savings. We must do everything we can to make sure that 
they understand precisely the terms of those transactions and 
their implications and that they are protected from the kinds 
of abuses we have seen in recent years. These protections must 
be comprehensive and consistent over our regulatory 
architecture.
    For too long, we have allowed a misguided belief to 
persist, that when you protect a consumer, you stifle 
innovation and growth. That is truly a false choice. Efficient, 
dynamic marketplaces don't function in spite of people like 
Samantha Moore, they function because of people like her and 
millions of others who work, invest, and save to send their 
children to school, to buy homes, and to live the often-spoken-
of American dream.
    If we are going to grow a more sensible economy, a 
sustainable economy, with a safe and sound financial 
architecture that supports it, we need to protect and nurture 
and invest in our most precious resource, the American people. 
That starts with the work of this Committee.
    With that, let me turn to my colleague, Senator Shelby, and 
then I will ask my colleagues who are here if they would like 
to make any opening comments, and then we will turn to our 
witnesses. Richard?

                  STATEMENT OF SENATOR SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    There is no question that many home buyers were sold 
inappropriate mortgages over the past several years. We have 
heard their stories. We have heard some of those stories right 
here. There is also no question that many home buyers were 
willing parties to contracts that stretched them far beyond 
their financial means. Some of these home buyers were even 
willing to commit fraud to buy a new home. We have heard their 
stories, as well.
    As with any contract, there must be at least two parties to 
each mortgage. If either party chooses not to participate, 
there is no agreement. Unfortunately, during the real estate 
boom, willing participants were in abundance all along the 
transaction chain, from buyers to bankers, from Fannie and 
Freddie to investment banks, and from pension funds to 
international investors. There appeared to be no end to the 
demand for mortgage-backed securities. Underwriting standards 
seemed to go from relaxed to nonexistent as the model of 
lending known as originate to distribute proliferated the 
mortgage markets. The motto in industry seemed to be risk 
passed, risk avoided.
    However, as the risk was then passed around our financial 
markets like a hot potato, everyone taking their piece along 
the way, some of the risk was transferred back onto the balance 
sheets of regulated financial institutions. In many cases, 
banks were permitted to hold securities backed by loans that 
they were proscribed from originating. Interesting. How did our 
regulators allow this to happen? This is just one of the many 
facets of this crisis that this Committee will be examining 
over the months ahead.
    A key issue going forward is how do we establish good 
consumer protections while also ensuring the safety and 
soundness of our financial system? In many respects, consumer 
protection and safety and soundness go hand in hand. Poorly 
underwritten loans that consumers cannot afford are much more 
likely to go bad and inflict losses on our banks. In addition, 
an essential element of consumer protection is making sure that 
a financial institution has the capital necessary to fulfill 
its obligations to its customers.
    This close relationship between consumer protection and 
safety and soundness argues in favor of a unified approach to 
financial regulation. Moreover, the ongoing financial crisis 
has shown that fractured regulation creates loopholes and blind 
spots that can, over time, pose serious questions to our 
financial system.
    It is regulatory loopholes that have also spawned many of 
the worst consumer abuses. Therefore, we should be cautious 
about establishing more regulatory agencies just to create the 
appearance of improving consumer protections.
    We should also be mindful of the limits of regulation. Our 
regulators cannot protect consumers better than they can 
protect themselves. We should be careful not to construct a 
regulatory regime that gives consumers a false sense of 
security. The last thing we need to do is lead consumers to 
believe that they don't have to do their own due diligence. If 
this crisis teaches us anything, it should be that everyone, 
from the big banks and pension funds to small community banks 
and the average consumer, has to do a better job of doing their 
own due diligence before entering into any financial 
transactions. At the end of the day, self-reliance may prove to 
be the best consumer protection.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Akaka, any opening comments?

                   STATEMENT OF SENATOR AKAKA

    Senator Akaka. Thank you very much, Mr. Chairman. I want 
you to know that I appreciate your conducting this hearing and 
also appreciate your advocacy on behalf of consumers, Mr. 
Chairman and Ranking Member, Senator Shelby.
    I also want to welcome our witnesses this morning to this 
hearing.
    Well before the current economic crisis, our financial 
regulatory system was failing to adequately protect working 
families, home buyers, individuals from predatory practices and 
exploitations. Prospective home buyers were steered into 
mortgage products with risks and costs that they could not 
afford. Working families were being exploited by high-cost 
fringe financial service providers, such as payday lenders and 
check cashers. Low-income taxpayers had their Earned Income Tax 
Credit benefits unnecessarily diminished by refund anticipation 
loans. Individuals trying to cope with their debt burdens were 
pushed into inappropriate debt management plans by disreputable 
credit counselors.
    We must increase consumer education so that individuals are 
able to make better informed decisions. However, although it is 
essential, education is not enough. We must also restrict 
predatory policies, ensure that consumers' interests are better 
represented in the regulatory process, and increase effective 
oversight of financial services.
    Mr. Chairman, you mentioned this in your opening statement 
and I will certainly work with you on these measures. I 
appreciate the witnesses today and I look forward with all of 
you to educate, protect, and empower consumers.
    Thank you very much, Mr. Chairman.
    Chairman Dodd. Thank you.
    Senator Merkley, any opening thoughts?

                  STATEMENT OF SENATOR MERKLEY

    Senator Merkley. Thank you very much, Mr. Chair, and 
welcome to the experts testifying before us.
    I will say just simply that too often, the failure of 
regulation has turned the American dream of home ownership into 
an American nightmare of home ownership, and that the failure 
of regulation on Wall Street has created the situation where 
these same mortgages have contributed enormously to the 
meltdown of our economy, and just not our economy, but now to 
the world economy.
    So this is incredibly important to the success of our 
families that we get this right, and to the success of our 
economy and the world economy. I look forward to your 
testimony.
    Thank you very much, Mr. Chair.
    Chairman Dodd. Thank you very much, as well, Senator. I 
appreciate your opening comments.
    Let me just introduce our witnesses so we can get to them. 
As I said at the outset, I was very impressed with your 
testimony. It is very thorough and, in fact, my constituent is 
extremely thorough. His testimony was 28 pages. We are going to 
try and limit you this morning. I am going to challenge my 
colleagues to read all of it, but we will try and keep it down 
to about somewhere between five and 8 minutes or so, so that we 
can get to some questions with you.
    Our first witness is truth in advertising. He is a good 
friend of mine, Steve Bartlett. Steve is CEO of the Financial 
Services Roundtable, previously served as the Mayor of Dallas, 
a former Member of the Congress. In fact, he served on the 
Financial Services Committee when he served in the House, and 
so he has a familiarity with these issues as a chief executive 
of a city, as a Member of the Congress serving on the 
counterpart Committee to this Committee, and, of course, as the 
CEO of the Financial Services Roundtable. Steve, we thank you 
immensely for joining us today and being with us.
    Ellen Seidman is the former Director of the Office of 
Thrift Supervision and currently Senior Fellow of the New 
America Foundation and Executive Vice President on National 
Policy and Partnership Development at ShoreBank Corporation. We 
thank you very much once again for being before the Committee.
    And I am proud to introduce Professor Patricia McCoy, a 
nationally recognized authority on consumer finance law and 
subprime lending. She is the George J. and Helen M. England 
Professor of Law at the University of Connecticut. She was a 
partner of Mayer, Brown, Rowe and Maw in Washington, D.C., 
where she specialized in complex securities banking and 
commercial constitutional litigation. It is a pleasure to have 
you. I hope you are enjoying your tenure in Connecticut.
    Ms. McCoy. Very much so, Senator.
    Chairman Dodd. That is good.
    We will begin with you, Steve, and again, thank you all for 
your excellent testimony.

  STATEMENT OF STEVE BARTLETT, PRESIDENT AND CHIEF EXECUTIVE 
             OFFICER, FINANCIAL SERVICES ROUNDTABLE

    Mr. Bartlett. Thank you, Chairman Dodd and Ranking Member 
Shelby and members of the Committee.
    To start with the obvious, it is true that many consumers 
were harmed by the mortgage-lending practices that led to the 
current crisis, but what is even more true is that even more 
have been harmed by the crisis itself. The root causes of the 
crisis, to overly simplify, are twofold: One, mistaken policies 
and practices by many, but not all, not even most, financial 
services firms; and two, the failure of our fragmented 
financial regulatory system to identify and to prevent those 
practices and the systemic failures that resulted.
    This crisis illustrates the nexus, then, between consumer 
protection regulation and safety and soundness regulation. 
Safety and soundness, or prudential regulation, is the first 
line of defense for protecting consumers. It ensures that 
financial services firms are financially sound and further 
loans that borrowers can repay with their own income are 
healthy both for the borrower and for the lender. In turn, 
consumer protection regulation ensures that consumers are 
treated fairly. Put another way, safety and soundness and 
consumer protection are self-reinforcing, each strengthening 
the other.
    Given this nexus, we do not support, indeed, we oppose 
proposals to separate consumer protection regulation from 
safety and soundness regulation. Such a separation would 
significantly weaken both.
    An example, Mr. Chairman, in real time, today, a provision 
in the pending omnibus appropriations bill that would give 
State attorneys general the authority to enforce compliance 
with the Federal Truth in Lending Act illustrates this problem. 
It would create additional fragmented regulation, and 
attempting to separate safety and soundness and consumer 
protection would harm both.
    My testimony has been divided into two parts. First, I 
address what went wrong, and second, I address how to fix the 
problem.
    What went wrong? The proximate cause of the current 
financial crisis was the nationwide collapse of housing values. 
The root cause of the crisis are twofold. The first was a 
breakdown, as I said, in policies, practices, and processes at 
many, but not all financial services firms. Since 2007, 
admittedly long after all the horses were out of the barn and 
running around in the pasture, the industry identified and 
corrected those practices. Underwriting standards have been 
upgraded. Credit practices have been reviewed and recalibrated. 
Leverage has been reduced as firms were rebuilt. Capital 
incentives have been realigned. And some management teams have 
been replaced.
    The second underlying cause, though, is our overly complex 
and fragmented financial regulatory structure which still 
exists today as it existed during the ramp-up to the crisis. 
There are significant gaps in the financial regulatory system 
in which no one has regulatory jurisdiction. The system does 
not provide for sufficient coordination and cooperation among 
regulators and does not adequately monitor the potential for 
market failures or high-risk activities.
    So how to fix the problem? The Roundtable has developed 
over the course, literally, of 3 years a draft financial 
regulatory architecture that is intended to close those gaps, 
and our proposed architecture, which I submit for the record, 
has six key features.
    First, we propose to expand the membership of the 
President's Working Group on Financial Markets and rename it 
the Financial Markets Coordinating Council, but key, to give it 
statutory authority rather than merely executive branch 
authority.
    Second, to address systemic risk, we propose that the 
Federal Reserve Board be authorized as a market stability 
regulator. The Fed would be responsible for looking across the 
entire financial services sector to identify interconnections 
that could pose a risk to the entire financial system.
    Third, to reduce the gaps in regulation, we propose a 
consolidation of several existing Federal agencies, such as OCC 
and OTS, into a single national financial institutions 
regulator. The new agency would be a consolidated prudential 
and consumer protection agency for three broad sectors: 
Banking, securities, and insurance. The agency would issue 
national prudential and consumer protection standards for 
mortgage origination. Mortgage lenders, regardless of how they 
are organized, would be required to retain some of the risk for 
the loans they originate, also known as keeping some skin in 
the game, and likewise, mortgage borrowers, regardless of where 
they live or who their lender is, would be protected by the 
same safety and soundness and consumer standards.
    Fourth, we propose the creation of a national capital 
markets agency with the merger of the SEC and the Commodities 
Futures Trading Commission.
    And fifth, to protect depositors, policy holders, and 
investors, we propose that the Federal Deposit Insurance 
Corporation would be renamed the National Insurance Resolution 
Authority and that it manage insurance mechanisms for banking, 
depository institutions, but also federally chartered insurance 
companies and federally licensed broker dealers.
    Before I close, Mr. Chairman, I have also included in my 
testimony two other issues of importance to this Committee and 
the policymakers and the industry. One, lending by institutions 
that have received TARP funds is a subject of great comment 
around this table. And second, the impact of fair value 
accounting in illiquid markets.
    I have attached to my statement a series of tables that the 
Roundtable has compiled on lending by some of the nation's 
largest institutions. These tables are designed to set the 
record straight. The fact is that large financial services 
firms have increased their lending as a result of TARP capital.
    And second, fair value accounting continues to be of 
gargantuan concerns for the industry and should be for the 
public in general. We believe that the pro-cyclical effects of 
existing and past policies, which have not been changed, are 
unnecessarily exacerbating the crisis. We urge the Committee to 
take up this subject and deal with it.
    We thank you again for the opportunity to appear. I yield 
back.
    Chairman Dodd. Thank you, Steve, very, very much. I 
appreciate the testimony. You laid out, as well, rather 
specifically the structure of an architecture, which I found 
very interesting and appreciate the detailed proposal and 
worthy of our consideration.
    Mr. Bartlett. Thank you.
    Chairman Dodd. Ms. Seidman, thank you for being with us.

    STATEMENT OF ELLEN SEIDMAN, SENIOR FELLOW, NEW AMERICA 
FOUNDATION, AND EXECUTIVE VICE PRESIDENT, SHOREBANK CORPORATION

    Ms. Seidman. Thank you very much, Chairman Dodd, Ranking 
Member Shelby, and members of the Committee. I appreciate your 
inviting me here this morning. As the Chairman mentioned, my 
name is Ellen Seidman. I am a Senior Fellow at the New America 
Foundation as well as Executive Vice President at ShoreBank.
    My views are informed by my current experience, although 
they are mine alone, not those of New America or ShoreBank, as 
well as by my years at the Treasury Department, Fannie Mae, the 
National Economic Council, and as Director of the Office of 
Thrift Supervision.
    In quick summary, I believe the time has come to create a 
single well-funded Federal entity with the responsibility and 
authority to receive and act on consumer complaints about 
financial services and to adopt consumer protection regulations 
that with respect to specific products would be applicable to 
all and would be preemptive. However, I believe that prudential 
supervisors, and particularly the Federal and State banking 
regulatory agencies, should retain primary enforcement 
jurisdiction over the entities they regulate.
    Based on my OTS experience, I believe the bank regulators, 
given proper guidance from Congress and the will to act, are 
fully capable of effectively enforcing consumer protection 
laws. Moreover, because of the system of prudential supervision 
with its onsite examinations, they are ultimately in an 
extremely good position to do so and to do it in a manner that 
benefits both consumers and the safety and soundness of the 
regulated institutions.
    In three particular cases during my OTS tenure, concern 
about consumer issues led directly to safety and soundness 
improvements. However, I think the time has come to consider 
whether the consolidation of both the function of writing 
regulations and the receipt of complaints would make the system 
more effective.
    The current crisis has many causes, including an over 
reliance on finance to solve many of the problems of our 
citizens. Those needs require broader social and fiscal 
solutions, not financial engineering. Nevertheless, there were 
three basic regulatory problems.
    First, there was a lack of attention and sometimes 
unwillingness to effectively regulate products and practices, 
even where regulatory authority existed. The clearest example 
of this is the Federal Reserve's unwillingness to regulate 
predatory mortgage lending under HOEPA.
    Second, there were and are holes in the regulatory system, 
both in terms of unregulated entities and products and in terms 
of insufficient statutory authority.
    Finally, there was and is confusion for both regulated 
entities and consumers and those who work with them.
    The solutions are neither obvious nor easy. Financial 
products, even the good ones, can be extremely complex. Many, 
especially loans and investments, involve both uncertainty and 
difficult math over a long period of time. The differences 
between a good product and a bad one can be subtle, especially 
if the consumer doesn't know where to look. And different 
consumers legitimately have different needs.
    The regulatory framework, of course, involves both how to 
regulate and who does it. With respect to how, I suggest three 
guiding principles.
    First, products that perform similar functions should be 
regulated similarly, no matter what they are called or what 
kind of entity sells them.
    Second, we should stop relying on consumer disclosure as 
the primary method of protecting consumers. While such 
disclosures can be helpful, they are least helpful where they 
are needed the most, when products and features are complex.
    Third, enforcement is at least as important as writing the 
rules. Rules that are not enforced or are not enforced equally 
across providers generate both false comfort and confusion and 
tend to drive through market forces all providers to the 
practices of the least well regulated.
    As I mentioned at the start, I believe the bank regulators, 
given guidance from Congress to elevate consumer protection to 
the same level of concern of safety and soundness, can be 
highly effective in enforcing consumer protection laws. 
Nevertheless, I think it is time to give consideration to 
unifying the writing of regulations as to major consumer 
financial products, starting with credit products, and also to 
establish a single national repository for the receipt of 
consumer complaints.
    A single entity dedicated to the development of consumer 
protection regulations, if properly funded and staffed, will be 
more likely to focus on problems that are developing and to 
propose and potentially take action before the problems get out 
of hand. In addition, centralizing the complaint function in 
such an entity will give consumers and those who work with them 
a single point of contact and the regulatory body early warning 
of trouble. Such a body will also have the opportunity to 
become expert in consumer understanding and behavior, so as to 
regulate effectively without necessarily having a heavy hand. 
It could also become the focus for the myriad of Federal 
activities surrounding financial education.
    The single regulator concept is not, however, a panacea. 
Three issues are paramount.
    How will the regulator be funded, and at what level? It is 
essential that this entity be well funded. If it is not, it 
will do more harm than good as those relying on it will not be 
able to count on it.
    What will be the regulator's enforcement authority? My 
opinion is that regulators who engage in prudential 
supervision, whether Federal or State, with onsite 
examinations, should have primary regulatory authority with the 
new entity having the power to bring an enforcement action if 
it believes the regulations are not being effectively enforced, 
and having primary authority where there is no prudential 
supervision.
    And finally, will the regulations written by the new entity 
preempt both regulations and guidance of other Federal and 
State regulators? This is a difficult issue, both ideologically 
and because there will be disagreements about whether the 
regulator has set a high enough standard. Nevertheless, my 
opinion is that where the new entity acts with respect to 
specific products, their regulations should be preemptive. We 
have a single national marketplace for most consumer financial 
products. Where a dedicated Federal regulator has acted, both 
producers and consumers should be able to rely on those rules.
    The current state of affairs provides a golden opportunity 
to make significant improvements in the regulatory system to 
the benefit of consumers, financial institutions, and the 
economy. If we don't act now, what will compel us to act?
    Thank you, and I would be pleased to respond to questions.
    Chairman Dodd. Thank you very much, Ms. Seidman.
    Ms. McCoy?

STATEMENT OF PATRICIA A. McCOY, GEORGE J. AND HELEN M. ENGLAND 
   PROFESSOR OF LAW, UNIVERSITY OF CONNECTICUT SCHOOL OF LAW

    Ms. McCoy. Chairman Dodd and members of the Committee, 
thank you for inviting me here today to discuss restructuring 
financial regulation. My name is Patricia McCoy and I am a law 
professor at the University of Connecticut. I also had the 
pleasure of living in Alabama where I clerked for Judge Vance 
some years ago.
    I applaud the Committee for exploring bold new approaches 
to this issue. In my remarks today, I propose transferring 
consumer protection for consumer credit from Federal banking 
regulators to one agency whose sole mission is consumer 
protection. We need this to fix three problems.
    First, during the housing bubble, fragmented regulation 
drove lenders to shop for the easiest regulators and laws.
    Second, this put pressure on banking regulators, State and 
Federal, to relax credit standards.
    Finally, banking regulators often dismiss consumer 
protection in favor of the short-term profitability of banks.
    During the housing bubble, risky subprime mortgages and 
non-traditional mortgages crowded out safer, fixed-rate loans. 
Between 2003 and 2005, the market share of non-prime loans 
tripled, from 11 percent to 33 percent. Over half of them were 
interest-only loans and option payment ARMs. These loans seemed 
appealing to many borrowers because their initial monthly 
payments were often lower than fixed-rate loans, but they had 
many hidden risks that many borrowers did not suspect. So 
borrowers flocked to the loans with the lower monthly payments, 
causing dangerous loans to crowd out the safer loans. 
Conventional lenders then decided, well, if we can't beat them, 
let us join them, and they expanded into dangerous loans, as 
well.
    Meanwhile, lenders were able to shop for the easiest laws 
and regulators. There was one set of laws that applied to 
federally chartered depository institutions and their 
subsidiaries. There is a wholly different set of laws that 
applied to independent non-bank lenders and mortgage brokers. 
At the Federal level, of course, we all know that we have four 
banking regulators plus the Federal Trade Commission. The 
States add another 50 jurisdictions on top. Because lenders 
could threaten to change charters, they were able to play off 
regulators against one another. This put pressure on regulators 
to relax their standards in enforcement.
    For example, in 2007, Countrywide turned in its charters in 
order to drop the Federal Reserve and the OCC as its regulators 
and to switch to OTS. The result was a regulatory race to the 
bottom.
    We can see evidence of regulatory failure by the Federal 
Reserve, the OTS, and OCC. As the Committee knows, the Federal 
Reserve refused to exercise its authority under HOEPA to 
regulate unfair and deceptive mortgages under Chairman 
Greenspan. The Fed did not change its mind until last summer 
under the leadership of Chairman Ben Bernanke.
    Meanwhile, OTS allowed thrifts to expand aggressively into 
option payment ARMs and other risky loans. In 2007 and 2008, 
five of the seven largest depository failures were regulated by 
OTS, including IndyMac and WaMu. In addition, Wachovia Mortgage 
FSB and Countrywide Bank FSB were forced into shotgun marriages 
to avoid receivership. By the way, none of this happened on my 
colleague Ellen Seidman's watch. She was a leader in fighting 
mortgage abuses when she was Director of OTS.
    Finally, how about the OCC? During the housing boom, the 
OCC allowed all five of the largest banks--Bank of America, 
JPMorgan Chase, CitiBank, Wachovia, and Wells Fargo--to expand 
aggressively into low-doc and no-doc loans. The results were 
predictable. Today, as a result, the country is struggling with 
how to handle banks that are too big to fail as a result.
    Bottom line, when you look at all types of depository 
charters, State banks and thrifts had the best default rates. 
Federal thrifts had the worst, and national banks had the 
second worst. Placing consumer protection with bank regulators 
turned out to be no guarantee of safety and soundness. Having 
it in a separate agency would counteract the over-optimism of 
Federal banking regulators at the top of the credit cycle.
    To fix these problems, we need three reforms. First, 
Congress should adopt uniform minimum safety standards for all 
providers of consumer credit, regardless of the type of entity 
or charter. This should be a floor, not a ceiling. First of 
all, that is necessary to make sure that the entity, the 
regulator, does not have too weak of a standard. And second, we 
have seen that States are closer to people at home and more 
responsive to their problems.
    Second, the authority for administering these standards 
should be housed in one Federal agency whose sole mission is 
consumer protection. This agency could either be a new agency 
or the Federal Trade Commission. All responsibility for 
oversight of consumer credit should be transferred from Federal 
banking regulators to this agency.
    And then finally, to avoid the risk of agency inaction, 
Congress should give parallel enforcement authority to the 
States and allow consumers to bring private causes of action to 
recover for injuries they sustain.
    I would be glad to take any questions. Thank you.
    Chairman Dodd. Well, again, I thank our witnesses for their 
very excellent testimony and thoughts this morning.
    We have been joined by Senator Bennet of Colorado, as well. 
Michael, thank you for being here with us this morning.
    I have a series of questions. I will put a 5-minute clock 
on each of us up here. Actually, given the numbers we have, we 
can engage, and I would invite, by the way, if I raise a 
question with one of you and the other two would like to 
comment on it, that you please do. This is a very important 
discussion we are in the process of undertaking. In many ways, 
while we have had obviously a number of witnesses before us, 
including Paul Volcker and others, in many ways, today, the 
three of you are representing some ideas that really are far 
more specific than things we have heard, so I would invite the 
kind of conversation back and forth that could help us, even in 
a formal hearing like this, which is always a little more 
difficult.
    Let me begin, if I can, with you, Ms. Seidman. You note 
that while you were at OTC, there were situations when, I am 
quoting, ``a concern about consumer issues led directly to 
safety and soundness improvements.'' You also note that 
compliance has always had a hard time competing with safety and 
soundness for the attention of regulators. If we do not create 
a separate consumer protection regulator, how do we ensure that 
consumer protection will be given equal standing and attention?
    Ms. Seidman. I appreciate that dichotomy and I obviously 
put it in the testimony on purpose. I believe that there is a 
difference between writing the rules and enforcing them, and 
with respect to enforcement, I think that not only is it 
extremely valuable for the banking regulators to have 
responsibility for enforcing consumer protection laws, but as 
Mr. Bartlett has said, that can lead to safety and soundness 
improvements and it certainly did during my tenure at OTS.
    On the other hand, I will say that the writing of 
regulations on consumer protection issues is something that I 
found incredibly difficult when I was at OTS. There were any 
number of times where we wanted to move and we couldn't get the 
other three, or the other four regulators--either three or 
four, depending on whether the credit unions were in or out--to 
move with us. There were times when we wanted to take action 
and it was really hard to find the statutory authority on the 
consumer protection side because many of the consumer 
protection laws are written very, very specifically. They are 
sort of ``thou shalt not'' rules. Payday lending was a major 
example of that.
    And so I think that we need three things. One, I think it 
really would be useful to establish a separate regulator to 
write the rules, and whether it is the FTC expanded or a new 
agency I think is definitely worth a serious conversation.
    But I do think that we will benefit on both the safety and 
soundness side and the consumer protection side by leaving the 
initial enforcement authority, the primary enforcement 
authority, with the bank regulators where they have prudential 
supervision. The results of prudential supervision may not be 
perfect, but they are better than a complaint-based system 
where there has to be a lot of bad acting by a single entity 
with a lot of consumers who realize they have a problem and 
take the time to complain in order to get cases going. So I 
think we shouldn't throw away the prudential system.
    But the final piece is, I think if Congress is serious 
about consumer protection, and certainly this Committee is, it 
is time to amend the National Banking Act, amend HOLA, change 
the basic banking laws to say that consumer protection and 
making the financial system work for consumers is a critical 
element of our banking system.
    Chairman Dodd. Yes. Steve, let me say, you in effect are 
positioned here on the table, ironically, in a way in which you 
represent three different models that we are talking about. 
Ellen was the middle model. The question for you is, you heard 
me say in my previous question that compliance has always had a 
hard time competing with safety and soundness for the attention 
of regulators. I don't think there is much debate about that.
    I think most would probably agree with that statement, and 
history over the last 5 years certainly underscores that point. 
The Federal regulators clearly put consumer protection on the 
back burner, acting only well after it was too late to avoid a 
catastrophe, and even then, I might add, over the objections of 
many that we do anything at all.
    In the face of all the evidence, how do you conclude that 
keeping prudential and consumer regulation together won't 
simply result in consumer regulation continuing to be on the 
back bench here, as we have seen in the last 5 years?
    Mr. Bartlett. Mr. Chairman, Lyndon Johnson used to have a 
saying when he was Senate Majority Leader, and I will 
paraphrase it for this Committee: ``Grab them by the throats 
and their hearts and minds will follow.''
    [Laughter.]
    Mr. Bartlett. The fact is the prudential regulators, it is 
the supervisors that have them by the throats, that have the 
ability to get the attention with a cease and desist order and 
a requirement, and worse, in a receivership. So if you separate 
the power and the mandate to protect the consumers away from 
the grabbing them by the throat, well, at best, it will be the 
two different sets of regulators will give conflicting goals 
and one of them will be advice, the other one will be the 
throat. Or at worst, we would continue to have the system in 
which the consumer protection is ignored and it is only safety 
and soundness.
    I have to say that we are not advocating the status quo. We 
are not at all advocating that we just continue what we have 
been doing. We are, by contrary, advocating that we provide the 
specific and clear mandates for consumer protection, the 
mandates for enforcement, and then to consolidate the agencies 
so that these agencies that have them by the throats have the 
ability to enforce those, all of the sets of regulations.
    And then I guess last is safety and soundness and consumer 
protection are mirror images of the same thing. The ability to 
repay or documentation is both a consumer protection and it is 
also a safety and soundness protection.
    Chairman Dodd. Ms. McCoy, that is a pretty good argument. 
You are a law professor and have debates like this in your law 
school. We have had similar debates over the years in Congress 
on matters not relating to financial services, but in the area 
of consumer protection. There has been a strong argument that 
because the traditional regulators were not doing their job, 
there should be a Consumer Protection Agency in place to insist 
they do their job.
    The counter-argument was, well, they already should be 
doing their job. The fact that they were not doing it doesn't 
mean they shouldn't be, and therefore we ought to empower them 
to do it rather than creating yet a separate agency that would 
end up with the kind of potential conflicts that Steve just 
talked about. What is the answer to that?
    Ms. McCoy. Well, for the most part, they are empowered to 
do it, and what we saw over the past six or 8 years was a 
prolonged failure to exercise that power. I have been spending 
the last few months looking at the enforcement record of the 
three agencies I described, and I found with the OCC, the 
Federal Reserve, and OTS a distinct reluctance to bring formal 
cease and desist orders or anything stricter. In fact, in 
autopsies of failed institutions, generally what the regulators 
were doing at most--at most--was negotiating some sort of 
voluntary agreement with the banks' management. There were 
usually protracted delays in negotiating that agreement and 
over that period more lax lending happened and the banks slid 
toward insolvency. So while the regulators have the ability to 
hold the banks by the throats, they are distinctly reluctant to 
exercise it.
    With respect to Ms. Seidman's proposal, she and I, I think, 
are 95 percent in agreement. The two places where we have some 
difference are whether the enforcement authority should be 
consolidated strictly in this separately consumer product 
regulator or should be parceled out between the Federal banking 
regulators and this other regulator.
    My one concern there is if we parcel out the compliance 
examinations and other enforcement, leaving enforcement with 
Federal banking regulators for banks, that there still will be 
this opportunity to shop for the agency with the weakest, most 
accommodating enforcement posture.
    Now, one way, if we go with that model, to try to 
counteract that is to give this separate consumer protection 
agency the independent ability to institute enforcement if it 
feels that a Federal banking regulator is lax, so that it would 
not have to wait for the regulator to act.
    Chairman Dodd. Well, those are great answers and I 
appreciate it very, very much. It took a long time just on that 
one, but let me turn to Senator Shelby because I have overrun 
my time already.
    Senator Shelby. Thank you, Mr. Chairman.
    Professor McCoy, I know you had not only good leadership 
under Robert S. Vance, the late judge who was tragically 
murdered----
    Ms. McCoy. He was my hero.
    Senator Shelby. That is right, but he was also very 
exacting, was he not?
    Ms. McCoy. Yes. I can attest to that.
    Senator Shelby. Sure. Enforcement failures--I will ask you 
this first question--many have suggested, Professor McCoy, that 
the Federal Reserve should have acted much sooner under its 
Home Ownership Equity Protection Act rulemaking authority to 
regulate the conduct of all parties originating mortgage 
products. Are there other areas where you believe that the 
Federal banking regulators could have acted but failed to act 
to either draft rules or appropriately enforce rules that it 
promulgated?
    Ms. McCoy. Yes. So first of all, also with respect to the 
Federal Reserve, the Federal Reserve, of course, has 
jurisdiction over the Truth in Lending Act and it still 
astonishes me that to this day, the Fed has not updated its 
TILA rules on closed-end mortgages. It turns out that TILA 
disclosures just didn't work well for risk-based pricing. The 
Federal Reserve issued a report----
    Chairman Dodd. ``TILA'' is Truth in Lending, just so the 
record is clear.
    Ms. McCoy. Yes. My apologies. It is lawyer lingo. The 
Federal Reserve actually wrote a report in 1998 diagnosing this 
problem, but here we are 11 years later. It hasn't fixed it. 
That is one thing.
    The other Federal banking regulators also had authority 
under Section 5 of the Federal Trade Commission Act to regulate 
unfair and deceptive acts and practices. Their rulemaking 
authority was somewhat limited. I think that needs to be 
addressed. But they had full enforcement authority, and again, 
as I mentioned, they failed to exercise it.
    Senator Shelby. Well, that is troubling to me and I think 
to Senator Dodd, too, as we look toward a regulatory process 
that will work. The role of the Fed seems to have been a role 
of failure in a lot of instances as far as the regulation. They 
have been the regulator of a lot of things, especially our 
largest banks, and I think the question arises, where were 
they? Did they know what the banks were doing? Did they know 
the risk they were taking? Obviously, they didn't.
    Competition among regulators--the OCC and the OTS are 
funded by assessments on the institution that they regulate. 
Professor McCoy raises the possibility of regulators lowering 
their enforcement standards in order to attract more 
institutions to their specific charter. Specifically mentioned 
in her testimony is the long-term decline in the number of 
thrift institutions.
    Ms. Seidman, during your tenure as the OTS Director, did 
the OTS lower enforcement standards in order to maintain or 
increase the number of financial institutions that you 
supervised, and do you believe it is appropriate for financial 
regulators to be funded by assessments on the institutions that 
they regulate?
    Ms. Seidman. First of all, the answer to the first question 
is no, and I----
    Senator Shelby. OK. How about the second question?
    Ms. Seidman. I worked very hard to discourage charter 
shopping.
    Senator Shelby. OK.
    Ms. Seidman. As to the second question, Jerry Hawke, who 
was the Comptroller part of the time that I was at OTS, and I 
spent quite a while attempting to shop the notion that OTS and 
the OCC should not, in fact, be funded by the industries and 
that instead there should be some way of funding them through 
the Deposit Insurance System as the FDIC is funded.
    I think the issue of the industry funding government 
agencies is a difficult one under all circumstances, but it is 
an especially difficult one where there is not a monopoly. You 
know, we do have the agriculture industry to some extent 
funding the agriculture inspections and the pharmaceutical 
industry to some extent funding the FDA. But there is only one 
FDA. There is only one Department of Agriculture.
    Senator Shelby. The role of securitization in consumer 
protection generally--many argue that the securitization market 
lessens the incentive for financial institutions to make 
prudent loans based on a borrower's ability to repay. The 
rationale was simple. So long as the loans did not sit on the 
balance sheet, then the financial institution no longer carried 
the risk.
    Do you believe that realigning the incentive structure to 
give everyone within the securitization chain a stake in the 
loans' performance would greatly enhance consumer protection, 
or would it compound it? I want to ask Professor McCoy first.
    Ms. McCoy. Senator Shelby, thank you. This is a really 
critical question and the answer is yes. The basic problem 
which you put your finger on was the ability to shift risk to 
entities down the line, and so we need to make sure that every 
participant in the securitization process has skin in the game, 
and that can be through capital and also prudential regulation. 
In the end, we need to make sure that investors have an 
incentive to put pressure on investment banks to do proper due 
diligence and to have full, honest disclosures.
    My proposal for doing that is carefully crafted assignee 
liability that gives the investors incentives to put pressure 
on the investment banks to do their job right. We have seen 
from the State experience that this does not reduce loan 
volumes. I am working with economists. We have empirically 
tested that. It does not reduce access to credit because if it 
is carefully crafted, it can be priced into the loan. So it is 
eminently doable and a very good idea.
    Senator Shelby. Ms. Seidman, do you have any comment on 
that?
    Ms. Seidman. I also agree that one of the critical elements 
is that people need to have skin in the game, and Pat's 
assignee liability proposal is one that I have looked at and I 
would support.
    I would point out two other things. Pat mentioned this 
really briefly, but the capital rules are also absolutely 
critical here. To the extent that institutions were not 
required to hold capital against loans that they thought they 
had gotten rid of but, in fact, came back to them, that just 
encouraged more of that kind of origination for sale. We need 
to deal with that issue. And as Steve mentioned, we need to 
deal with it in a manner that is counter cyclical, not pro 
cyclical.
    And finally, I think that this is where the very tough 
issue of compensation also comes into play.
    Senator Shelby. Steve, do you have any comments?
    Mr. Bartlett. I think skin in the game or risk retention is 
an essential part of the set of reforms, not the only part, of 
course, but it is essential. It has to be combined with 
systemic risk regulation, which is currently done de facto but 
not de jure, so the Federal Reserve has sort of assumed 
authority, but not necessarily statutory authority. So we think 
that systemic risk regulation ought to be combined with risk 
retention in some form.
    Senator Shelby. Mr. Bartlett, in your draft financial 
regulatory architecture, you envision giving the Federal 
Reserve veto power over pro cyclical actions by FASB. Wouldn't 
giving the Federal Reserve this sort of power undermine the 
function of accounting standards, which are intended to provide 
investors with transparency? How do you explain?
    Mr. Bartlett. We think that accounting standard should give 
the investors transparency and strength and we think that is 
not happening right now in the case of fair value accounting. 
So in some part, our call for the Fed to help is out of 
desperation because all of the Federal agencies at this point, 
individually and collectively, are telling us that it is 
somebody else's problem and yet it is that misapplication of 
fair value accounting that is a large source of the current 
liquidity crisis portion of the crisis. So perhaps my call for 
the Fed to do it is just simply knowing that somebody has to do 
it and so we are looking for help.
    Ms. Seidman. Can I respond briefly to that, too?
    Chairman Dodd. Certainly.
    Ms. Seidman. I think that calling for counter cyclical 
capital regulations now turns into a conversation about fair 
value accounting. But 6 or 8 years ago--8 years ago, the 
question being asked was about loan loss reserves. In Spain, 
where their banking system has gone through a bubble and not 
been in as much trouble as ours, the loan loss reserves are 
required without particular reference to historical conditions. 
The banking regulators worked really hard to try to get the SEC 
to understand that bankers make more loans in good times and 
then those loans go bad in bad times and that we really need to 
have far greater loan loss reserves than historic experience, 
particularly with untested products, which is what the subprime 
mortgages were.
    Senator Shelby. By loan loss reserves, you talking about 
capital, aren't you?
    Ms. Seidman. Well, you know, loan loss reserves are the 
first line of defense and capital is the second, and frankly, 
if we can increase the loan loss reserves to the point where 
the combination is counter cyclical, that will do.
    Chairman Dodd. Those are good points, good questions by the 
former Chairman, as well.
    Let me turn now to Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and I 
appreciate the diversity of models that you are presenting for 
us to wrestle with.
    I wanted to present one specific issue and see how you 
might view that issue and how it might fit into the different 
models you are presenting, and that is the issue of steering 
payments. It has been an item of concern to me that consumers 
by and large have enormous protection in terms of conflict of 
interest when they go to a real estate agent. It is very 
clearly declared whether that agent is working for the buyer or 
for the seller, all kinds of disclosure. When they turn around 
and go to a broker, very few consumers realize that that broker 
whom they are paying and who is giving them advice that they 
think they are paying for is also being paid secretly, that is 
not on the settlement sheet, to provide--paid different amounts 
according to what type of loan they sell, and often the 
incentives are all for the broker to sell an expensive loan 
that is not in the interest of the consumer. But it is really a 
consumer, a lamb to the slaughter, if you will, because they 
aren't aware of this fundamental conflict of interest in that 
transaction.
    This is an issue States have tried to wrestle with but 
really have been prohibited from dealing with except with 
State-chartered institutions, which creates a distinction at 
the State level between State and federally chartered groups. 
So there is always the advocacy to do it at the Federal level.
    So if each of you could take your model and say, one, do 
you consider steering payments to be a problem? Second, how do 
you envision that the regulatory regime you are proposing would 
tackle such an item? And maybe we will just start in the order 
that the testimony was given.
    Mr. Bartlett. Thank you, Senator. Senator, we have long 
called for the national licensing and regulation of mortgage 
brokers, not as a way of casting blame, but just simply to say 
that they are the front end of it.
    Second is we believe that there should be a system within 
that national license for some type of a retention of risk by 
the brokers. Currently, the system of payment is that brokers 
get paid--and they should get paid, but they get paid for 
creating a loan or selling a loan, whether it is a good loan or 
a bad loan, and we think that is a misguided compensation.
    Third is that we believe that the originators, as the 
Chairman said, I believe it is 58 percent of all subprime loans 
were originated by non-regulated entities, but the originators, 
regulated and unregulated, should accept the responsibility for 
accepting a good loan and then should they sell those loans in 
a securitized model, the securitizers should accept the 
responsibility for those being good loans. So it is 
responsibility up and down the chain, but beginning with the 
brokers when that is appropriate.
    Senator Merkley. Just before I go on, would you envision, 
then, all the power occurring at the Federal level in this 
framework or giving any alternative power to the States to 
enhance----
    Mr. Bartlett. No. We believe in the dual banking system in 
the sense that there should be State-chartered banks. But the 
power of actually insisting that the system be regarded as a 
system has to come from the Federal level, of which the States 
have a big role. But the system itself, it is an interstate 
system. It is a national system, so it should be thought of as 
a national system with uniform standards.
    Senator Merkley. Thank you.
    Ellen?
    Ms. Seidman. By steering payments, I assume among other 
things you mean yield spread premiums. I believe, having 
wrestled with the problem of yield spread premiums, that the 
right answer really is to get rid of them, that disclosure 
isn't sufficient. There have been proposals that say, well, you 
should just disclose it. The Fed actually tried that and then 
backed off because they came to the conclusion that no consumer 
could understand the disclosure. They, of course, then didn't 
take the next step, which would have been to ban them.
    An alternative which I think is a partial solution but 
probably not the full solution here, but a good solution in 
general, is that it is time to put a fiduciary responsibility 
on brokers. At the very least, that creates the legal 
responsibility to behave in the best interest of the consumer. 
I think Steve's point and the point we have all made about skin 
in the game with respect to compensation is also important.
    In terms of how this would work in the system that I 
proposed, the single regulator would face the issue and make a 
decision about whether these payments should be banned or 
should be disclosed or make the relevant decision, and then the 
enforcement would be in the case of the banks with their 
prudential supervisors, in the case of mortgage bankers in 
Massachusetts, who are subject to prudential supervision with 
the Massachusetts regulator, and otherwise the primary 
jurisdiction would be with the single Federal entity.
    Senator Merkley. Thank you.
    Ms. McCoy?
    Ms. McCoy. Senator, I have personal experience with this. 
Back in 2003, when I applied for a mortgage to buy my house in 
Connecticut, I walked in with complete copies of my pay stubs, 
tax returns, my new contract, my job contract, and the broker 
said, oh no, we will put you in a no-doc loan. So I walked out. 
But I later got the rate sheet from the lender which showed 
that the no-doc loan would have paid a higher YSP, yield spread 
premium, to that broker.
    So in my mind, this is a legalized kickback and we need to 
ban it. Probably broker compensation needs to be a percentage 
of loan principal and also the full payout of that commission 
should probably be linked and to urge appending good 
performances alone.
    I agree that a fiduciary duty should be placed on brokers 
and we need to seriously think about higher capital 
requirements for brokers because they have very, very little 
skin in the game today.
    Finally, the responsibility for administering this under my 
plan would be with the consumer credit regulator. Thank you.
    Senator Merkley. Thank you very much, Mr. Chairman.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Bennet?
    Senator Bennet. Thank you, Mr. Chairman. I appreciate it.
    Ms. Seidman, you mentioned earlier in passing that even 
good products are complex or can be complex, which is true in 
these markets, and good products being ones that actually are 
collateralized, that actually have some value. When we are 
thinking about how to create a regulatory structure and a 
bureaucratic structure that makes sense, on the one hand, there 
is the issue of wanting the capital markets to be inventive, 
wanting to be able to lower costs for people that are in their 
homes and borrowing money or other kinds of things, and on the 
other hand we find ourselves in a place where we securitized--
we didn't, but all these loans were securitized. The bad 
products became very complex as well as good products and it 
inspired lots of, or incentivized a lot of behavior that 
probably wouldn't have happened otherwise because the market in 
some sense was insatiable and people started to say, well, we 
don't need to do 70 percent loan to value anymore, let us do 
100 percent, just to create a take-up, or a product for that 
take-up.
    And I wonder what the implications of all of that are for 
thinking about the bureaucratic design here so that we can 
allow the markets to continue to invent, on the one hand, but 
on the other hand say, is there a degree of complexity that we 
simply can't sustain or that the regulators will never catch up 
to, or--I am sorry for the long-winded question--or does it 
imply something about who needs to be in the room to pass on 
whether these structures actually make sense or not, these 
structures being these products?
    Ms. Seidman. I think that this current situation is really 
forcing us to take another look at the question of whether 
innovation and complexity in consumer financial products is 
something that we ought to value. It is not to say that 
everybody should have a 30-year fixed-rate mortgage. There are 
certainly situations in which a 30-year fixed-rate mortgage is 
not the best instrument for the consumer. And it is not to say 
that some good products like savings bonds aren't inherently 
complex. They are. They are extremely complex. But I do think 
that the notion that allowing continuous redesign and 
complexity is a good thing needs to be reevaluated.
    I do think that there are some suggestions that have been 
made recently about how to sort of come in the middle. The 
default product suggestion that I mentioned in my testimony is 
one of them. There would be a standard, relatively simple 
product that was the product that needed to be offered first in 
all situations, to avoid the situation that Pat's broker tried 
to get her into. If a consumer nevertheless decided to buy one 
of the non-default products, the seller's ability to enforce 
the contract would be subject to the seller having to prove 
that whatever disclosures they made initially were 
understandable to a reasonable man, which is your classic legal 
standard.
    I would prefer a system of standardized contracts, but I 
think that at least in certain areas like mortgages, we 
probably need multiple standardized contracts in order to cover 
the waterfront.
    Senator Bennet. Does anybody else have a comment on that?
    Mr. Bartlett. Well, Senator, it is awfully tempting, given 
the crisis that we are in now, to sit around this table and 
say, well, let us design the financial products and we will 
have three of them, but that would be a disaster for the 
American people, if not in the short-run, at least in the 
medium-run. Innovation does help consumers. That is why it is 
innovative.
    That is not to say that nothing should happen. In fact, I 
am calling for some massive additional more effective 
regulation to regulate the standards, responsibility, accepting 
the responsibility and accountability both by the agencies and 
by the companies, uniform national standards, and a system of 
enforcement. But the idea to then convert over to a system 
where the government simply in whatever form designs what a 
financial product should look like, I think would do a great 
disservice, both in the near-term and the long-term.
    Senator Bennet. Mr. Chairman, that is not what I am 
suggesting, but I think that even the most simple products, in 
some respects, at the consumer level, I think what we are 
seeing now is that in their aggregation and in the secondary 
markets into which they are sold, there is a level of 
complexity at that point that has, at the very least, created a 
lack of transparency about what is going on on the balance 
sheets of our major banks, and in the worst cases helped 
contribute to where we are. I think I am just trying to, with 
the other Committee members, figure out what we can do to 
redesign things so that we don't find ourselves here again, not 
to rewrite these rules.
    Professor McCoy, just one question. You mentioned this in 
your testimony, both written and spoken. I just wanted to come 
back to it. Tell us a little more about--and you proposed 
setting up a separate agency for consumer protection. But one 
of the reasons for that is your observation that you think 
there has been a reluctance on the part of the existing 
regulatory agencies to exercise their enforcement authority. 
Can you talk more about where you think that reluctance springs 
from?
    Ms. McCoy. I think there are various sources. One is this 
longstanding bank regulatory culture of dialog and cooperation 
with regulated banks. It may, in fact, be that the reluctance 
to bring formal enforcement action is part of a longstanding 
tradition of secrecy, lack of transparency in bank regulation 
due to fears about possible runs on deposit. But what we have 
ended up with is an enforcement system that is entirely opaque. 
It is very, very difficult to see what is happening behind the 
curtain.
    One other thing I failed to mention was that the late 
Governor Gramlich in 2007 stated that the Federal Reserve had 
not been doing routine examinations of the mortgage lending 
subsidiaries that were under its watch. It was not going in and 
examining at all except in emergency situations. Thank you.
    Senator Bennet. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator. Very good.
    Senator Schumer?

                  STATEMENT OF SENATOR SCHUMER

    Senator Schumer. Thank you, Mr. Chairman. Thank you for 
holding this hearing, and unfortunately I got here a little 
late, so I am going to take a little bit of my time and read my 
opening statement, if you don't mind.
    And I want to thank you and Senator Shelby for holding this 
hearing. I think this hearing is really important. We have a 
great economic crisis in our country and it extends from one 
end to the other. We have had an explosion of consumer debt. 
Now we have 12 million households that owe more on their 
mortgages than their house is worth. The average American 
family has over $8,000 in credit card debt. Mortgages and 
credit cards are ordinary features of middle-class life and now 
they are at the heart of our financial crisis. Something went 
awry, seriously awry.
    During the 1980s, I worked to pass legislation that would 
require disclosure on credit card terms, the ``Schumer box,'' 
and it had a real effect. But it doesn't do enough now, because 
disclosure isn't enough, and when you hear of banking 
institutions just raising the rates, boom, for some small 
almost induced mistake, you say, well, we need more, and I know 
that Senator Dodd, Senator Menendez, and I have been working on 
credit card legislation.
    But the deceptive practices, the predatory practices, we 
have seen them in the mortgage industry. The Federal Reserve 
was in charge of all this and did nothing. Home buyers were 
enticed and misled, sometimes by banks, sometimes by 
independent mortgage brokers, more often by the latter, but 
there is a serious problem.
    And so I would say complexity ultimately stacks the deck in 
favor of the financial experts who peddle the products at the 
expense of the consumer. So again, I am not trying to point 
fingers of blame here. I am trying to correct the situation.
    In the early 1900s, Congress created the Food and Drug 
Administration to protect consumers from peddlers of medicinal 
concoctions whose miracle elixirs did more harm than good. In 
today's world, we need a comparable response to peddlers of 
unfair and deceptive financial practices and services.
    And I would just say to Mr. Bartlett that all too often, 
they don't come only from major banking institutions or 
financial institutions. They come from everywhere.
    So this week Senator Durbin and I plan to introduce 
legislation to create a new regulator to provide consumers with 
stronger protection from excessively costly and predatory 
financial products and practices. The idea for a Financial 
Product Safety Commission was first proposed by Elizabeth 
Warren, professor at Harvard, in 2007. She recognized that 
substantial changes in the credit markets have made debt far 
riskier for consumers today than a generation ago and that 
ordinary credit transactions have become complex undertakings. 
Consumers are at the mercy of those who write the contracts, 
and simple disclosure--it is never simple anymore because the 
terms are so complicated--it doesn't do the job.
    So consumers deserve to have someone on their side, a 
regulator that will watch out for the average American, who 
will review financial products and services to ensure they work 
without any hidden dangers or unreasonable tricks. So the time 
is right for a financial services regulator with consumer 
focus. Professor Warren and consumer groups--CFA, Consumers 
Union, Public Citizen, Center for Responsible Lending--have 
been instrumental in helping develop the objectives and 
responsibilities of such a regulator and I appreciate their 
efforts.
    I also think we have got to think beyond regulatory reform 
of the financial system. We need to think about a new way to 
live, because what has happened basically over the last decade 
and a half is we became a country that consumed more than we 
produced, borrowed more than we saved, and imported more than 
we exported. Something has to give. And I would say the 
greatest challenge President Obama has after he gets us out of 
this financial mess is to figure out how we get back to those 
traditional values.
    We have seen it up and down the line. There are the CEOs 
and their salaries. We all know about that, excessive, huge, 
based on the short-term. We have seen it here in government 
with all the deficits. And we have seen it with individuals who 
get into debt far beyond their means. So it has been a whole 
societal problem that we have to do something about.
    The proposal that Senator Durbin and I are making is one 
part of that, but there are lots of other parts, and I thank 
you all for listening. I particularly want to thank both Ellen 
Seidman and Professor McCoy for arguing for this kind of thing.
    Do I have time for one question, Mr. Chairman? Is that OK?
    Chairman Dodd. Yes.
    Senator Schumer. OK. My question is to both Ms. Seidman and 
Professor McCoy about this new agency. How would you propose it 
be funded? Should there be some kind of user fee, whether on 
the lender or the borrower? And how do you think enforcement 
ought to be done? Should it be done by the agency itself, by 
attorneys general, by the Justice Department? I will let Ellen 
Seidman answer first, and then Professor McCoy. And I won't ask 
Steve Bartlett because he probably does not support such an 
agency.
    Ms. Seidman. Thank you, Senator Schumer. As I said in my 
testimony, I think the critical thing is that this entity be 
well funded. My preference, just because I think it has 
something to do with honesty in budgeting, is that it be funded 
through appropriations rather than by user fees. If it were 
funded by user fees, it would be very good to be able to come 
up with a system something like the SEC's--actually, not the 
way the SEC is, the way the SEC brings in money. As we all 
know, it only gets a part of that to use.
    Senator Schumer. Yes.
    Ms. Seidman. But an automatic, very small tax on 
transactions rather than by an entity kind of funding.
    In terms of enforcement, I believe that where there is 
prudential supervision, it would be a mistake to throw it away 
with respect to consumers. So I think where there is prudential 
supervision, the primary enforcement entity should be the 
prudential supervisor. I think where there is not, the new 
entity ought to have the primary jurisdiction and it should 
have the back-up jurisdiction on its own motion. I mean, it 
would just have to make a finding with respect to the 
situations where there is prudential supervision.
    Senator Schumer. Right. Sort of like the FTC a little bit?
    Ms. Seidman. A little bit.
    Senator Schumer. Professor McCoy?
    Ms. McCoy. Thank you. The key thing that we are trying to 
fix here is regulatory arbitrage, this ability to shop for lax 
enforcement. If we consolidate both rulemaking and enforcement 
in this one agency, then I am comfortable with the funding 
model that Ms. Seidman proposed. If we parcel out enforcement 
among Federal banking regulators plus this other agency, we are 
going to have this same shopping phenomenon go on and then 
funding through assessments is going to become problematic and 
we will have to look at an appropriations model. So I think the 
two are linked. If you consolidate it in one agency, you stop 
the shopping problem and then you can have a user fee approach.
    Senator Schumer. Thank you, Mr. Chairman. Thank you both.
    Chairman Dodd. Thank you, Senator, very much.
    Let me say, if I can, and some of these questions have been 
asked, that we have talked a lot about the brokers and the lack 
of regulation at that level of the chain. In fact, I remember 
at a hearing we had here, I think Senator Shelby and Senator 
Schumer will remember, we had displayed the Web site of the 
brokers at the time--this was back about 2 years ago--and on 
the Web site, the first rule was, convince the borrower you are 
their financial advisor. That was the first rule. And, of 
course, that was fairly easy to do in Committee ways. You are 
talking about people who are relatively unaccustomed to all of 
this.
    I was with a group of bankers not long ago and I asked them 
a question I suppose all of us ask ourselves any time we have 
been to a closing. How many times do we find ourselves with the 
lawyers there with the tabs and sign the tabs and we don't find 
ourselves reading everything. We assume that these things are 
pretty boilerplate, standardized stuff and accept it for what 
it is.
    And so the idea that there is this level playing field 
between the borrower and the lender, any more than there is 
between the patient and a physician in cases of medical 
malpractice, is questionable. Obviously, the borrower and the 
patient have responsibilities. That is not to suggest they 
don't have any, but the suggestion somehow that they are both 
equal in terms of that moment of bargaining is, I think, 
something that most of us--all of us--would recognize as being 
unrealistic.
    I am interested in, and this is a point that Professor 
McCoy made, why we have focused largely on the problem at 
origination. Professor McCoy, you lay out in your testimony the 
role played by Wall Street. Essentially, you argue that it was 
the demand for product to securitize that drove the lending 
standards down, not the other way around. And I wonder whether 
or not you, Ms. Seidman, would agree with that and how you feel 
about that, Steve.
    Ms. Seidman. I think both work. The collapse of the 
subprime market was the trigger here, but the fact that there 
was a gigantic bubble to break happened because of the 
investment side demand. Who knows what other products would 
have been created to fill that demand if the mortgage products 
hadn't. The mortgage products had a big advantage. They were 
regarded as extremely safe and producing rates of return that 
were significantly higher than Treasuries. And, of course, back 
in the 1990s, mortgage products were extremely safe and 
produced higher returns than Treasuries.
    So I think both were definitely part of the problem and 
that if we had just had lax consumer protection without the 
investment side, we would have had a problem for a lot of 
consumers, but we probably wouldn't have had a global 
international crisis.
    Chairman Dodd. Steve, how do you----
    Mr. Bartlett. Mr. Chairman, I am here to posit for systemic 
reform and systemic regulation and for comprehensive reform. So 
to use your example in the case of the mortgage base, yes, the 
mortgage brokers were a significant part of the problem, but 
that doesn't eliminate the responsibility from the other parts.
    Then the originators, say what you will, the originators 
originated the loans, and they originated in many cases in the 
subprime markets bad loans for them and bad loans for the 
borrower. But at that point, some of those originators had 
regulators, 42 percent. Those regulators in many cases noticed 
that those were, quote, ``bad loans,'' what you and I would 
call bad loans, but they either didn't have or didn't believe 
they had the authority to say, therefore, you cannot originate 
those loans. They believe they only had the authority to say 
you couldn't own them, and so the originators said, OK, we 
won't own them. We will sell them upstream.
    And then there was no nexus, or there was a huge gap in the 
regulatory structure of no one from the originator, or 
supervising their originator, had any ability to talk to anyone 
on Wall Street who was buying the loans to say, that is a pool 
of bad loans, and yet it was sort of--it was clear. I mean, it 
was not as opaque as we like to make it out to be. There was 
transparency within those pools. So the pools were formed 
consisting of some number of bad loans and then sold to buyers, 
unregulated, and then those buyers then relied on mortgage 
insurance backed by the State insurance commissioners, both 
unregulated and not talking to each other.
    So there were literally hundreds--are, not were--are, in 
real time today, are literally hundreds of regulatory agencies 
that are each regulating individual toenails of the elephant 
while the elephant is stomping all over us. So the problem is 
the lack of systemic regulation. I have heard some talk about a 
twin peaks theory, and it is not twin peaks. It is multiple 
flagpoles, if you will, where people are sitting on the top of 
the flagpoles and there are more gaps between the flagpoles 
than there are the pillars of the regulation of the flagpoles.
    So it requires systemic, uniform national standards among 
them, and each of the pillars taking responsibility for their 
piece, but also a systemic regulation taking responsibility for 
the entire system.
    Chairman Dodd. That is a good point.
    Ms. McCoy, in your testimony, you raised a subject that I 
find interesting and I would like to get your co-panelists to 
respond to this. You called a light touch regulation by the OTS 
and the OCC, whereby most enforcement actions are done behind 
closed doors, privately through negotiations without any public 
knowledge. Would you describe the process to us and why you 
find this informal process inadequate, and would public 
disclosure of such actions create more accountability for 
regulators and give other institutions a signal of what kind of 
behavior is unacceptable?
    And the other side obviously is that you have got to have 
some gradation, I suppose, in all of this between what may be a 
minor infraction of some kind and a larger. But that debate 
about the light touch, the privacy, if you will, and not the 
public accountability, which can have its own--if you know 
something else has gone on, then other institutions start 
taking a closer look at what they are doing themselves. So that 
is an interesting point I thought you raised.
    Ms. McCoy. Sure. So with the light touch regulation, it had 
two major components. One was a preference for guidances rather 
than binding rules. Now, the banks were supposed to follow the 
guidances, but what I have been doing is going into securities 
filings of major banks after the issuance of each guidance to 
see if they are reporting continuing making loans that violate 
the guidances, and with most of the major five banks, I did 
find disclosures showing violations. And in some cases, they 
continued all the way until 2007. So apparently regulated 
banks, including ``too big to fail'' banks, felt that they 
could ignore guidances. So part of light touch is avoiding 
rules, guidances, and in my mind, it doesn't work.
    The enforcement side is relying on examinations and 
informal enforcement, which usually consists of these 
negotiated agreements and which are done on a confidential 
basis so that it is impossible on a real-time basis for me or 
any other researcher outside to know what is happening. I can 
only find that out if there are inadvertent press releases or 
if an institution fails afterwards.
    And we saw that, at least with the Federal Reserve, that it 
didn't do the examinations at all. We saw with the three 
agencies I mentioned that they were extremely reluctant to take 
any public formal enforcement action, and whatever informal 
action they took was really delayed, in some cases literally 
just days before the FDIC seized the institution, because the 
negotiations were drawn out.
    And I will just close by saying we saw this exact same 
pattern during the S&L crisis. It is not new. Thank you.
    Chairman Dodd. But is the complaint-driven process better?
    Ms. McCoy. The complaint-driven process, I think needs to 
be augmented with registration of all market actors and regular 
reporting. One of the problems that the FTC has in its 
complaint-driven process is a lack of information on a periodic 
basis from regulated institutions about what they are doing. 
And it seems to me that I would prefer to go with the SEC 
model, where you have registration, you have periodic 
reporting, and you have the ability based on that reporting to 
go in at any time to do an examination.
    One thing that I left out of my voluminous written 
testimony was I would also have a self-regulatory organization 
for the industry akin to FINRA. I think FINRA is an excellent 
supplement to the SEC's enforcement power and I would strongly 
urge the Committee to look at a model that includes a mandatory 
SRO.
    Chairman Dodd. Thank you very much.
    Senator Shelby?
    Senator Shelby. Thank you.
    If we make bad loans and they are securitized, you don't 
have bad securities. That is a given, is it not? And that is 
where we are today, isn't it?
    Ms. Seidman, the suitability standard for credit products, 
in your written testimony, you state, quote, ``the difference 
between a good product and a bad one can be subtle, especially 
if the consumer doesn't know where to look.'' You then 
suggested that perhaps a suitability standard such as the one 
used in the securities arena should be fashioned for consumer 
credit transactions. Who would be the person charged with 
carrying out that standard? Would it be the loan officers in a 
bank? How would this apply to credit card transactions and so 
forth? And how would the regulators enforce this provision?
    Ms. Seidman. I think--first of all, with respect to 
mortgage lending, most mortgage lending, particularly purchase 
money mortgages, is still done on a face-to-face basis and I 
see no difference in terms of the responsibility that a loan 
officer or a broker or somebody else would have with respect to 
the suitability of a mortgage product compared to the 
securities side. In fact, it is probably the case that the 
originator of the mortgage should be acquiring at least as much 
information as the broker acquires in order to understand what 
product is right.
    The credit card situation is somewhat more difficult, but I 
do think that in general, or in the old days, at least, one 
actually had to fill out a fairly extensive form in order to be 
able to get a credit card. I think that there are ways of 
determining from that kind of information--what is my income 
source, what other kinds of debts do I have--whether a credit 
card of one type or another is the most appropriate for that 
consumer.
    You know, we would have to work it through. There would be 
uncertainty, but this is not rocket science. This is really not 
very far away from the ability to pay standard. It just says, 
not only should you look at whether in the worst possible 
circumstances the borrower could pay, but also try to figure 
out what is good for that borrower.
    Senator Shelby. Professor McCoy, the subject would be the 
GSE affordable lending practices. You explain in your 
testimony, Professor McCoy, why you believe reckless lenders 
will crowd out good lenders. A variety of Federal efforts are 
aimed at providing borrowers alternatives. For instance, Fannie 
Mae and Freddie Mac have often claimed as their mission right 
here in this Committee the expansion of responsible home 
ownership, which we have supported--responsible home ownership.
    Do you believe that Fannie Mae and Freddie Mac's purchase 
of private-label subprime mortgage-backed securities added to 
borrowers' options for responsible home ownership?
    Ms. McCoy. Senator Shelby, first of all, while Fannie and 
Freddie starting around 2005 joined the party with respect to 
origination standards, they didn't start the party. They were 
one of these conventional good guys who----
    Senator Shelby. They got on the truck, didn't they?
    Ms. McCoy. They got on the truck, but they didn't start it 
and it is really the private-label market that started it.
    I did find it highly problematic that Fannie and Freddie 
purchased as part of their investment portfolios subprime 
mortgage-backed securities. They were among many other global 
investors, part of the glut of money that drove the 
securitization crisis and the drop in lending standards, but 
they do not deserve sole blame.
    Senator Shelby. Sure. So the rationale for the GSEs 
providing liquidity to the subprime market, although later, 
rather than focusing on the purchase of whole loans, 
exacerbated that problem, did it not?
    Ms. McCoy. Yes, I think that is right. But the purchase of 
loans by Fannie and Freddie is a very, very important device 
and I wouldn't want that to be compromised in the efforts to 
remove the investment portfolio authority.
    Senator Shelby. Absolutely. I agree with that. But on the 
other hand, they should purchase good loans or responsible 
loans, shouldn't they?
    Ms. McCoy. Yes. Yes. And they were doing that around 2000. 
They were----
    Senator Shelby. Oh, they were doing great for a while.
    Ms. McCoy. Right.
    Senator Shelby. But----
    Ms. McCoy. Things changed.
    Senator Shelby. They got on the truck. Sure.
    Mr. Bartlett, you would suppose that financial institutions 
have strong incentives well beyond legal compliance to treat 
their customers well, treat them fairly, and to maintain long-
term relationships. In other words, you take care of your 
customers and your customers will be around. In other words, 
consumer protection should amount to consumer retention, is 
what people try to do, I hope. Yet it seems that financial 
institutions sometimes have not chosen to pursue this course. 
How can we realign the incentives so that they will be 
realigned in the future?
    Mr. Bartlett. Senator, first of all, I believe firmly that 
that is what financial institutions do because that is their 
goal in life, is to help their customers and to keep their 
healthy customers. We got away from that during the subprime 
market, or many companies did, and those companies have taken 
action----
    Senator Shelby. Then there is no loyalty to your bank that 
way, is there?
    Mr. Bartlett. No. I think both the banks and the other 
financial institutions create a loyalty to their bank and with 
customer retention, so I think your proposition of your 
question is exactly correct. That is not to say that we don't 
need some more effective regulation to be certain that all of 
the sides of the bank talk to each other. There were banks that 
didn't participate in the subprime market because they believed 
those were bad loans, but their Wall Street affiliates 
purchased those same bad loans from their competitors so you 
didn't have the connection between the two, even within the 
same bank.
    Senator Shelby. What, Ms. Seidman----
    Ms. Seidman. Can I just add that one of the things that we 
sometimes lose sight of is that there are a lot of different 
kinds of banks and there are about 8,000 banks that have under 
a billion dollars in assets. There are Community Development 
Financial Institution banks, like ShoreBank. And those banks, 
in general, really did keep contact with their customers, not 
only their consumer customers, but their small business 
customers.
    I do think that one of the things that we need to be a 
little careful about in this rush to consolidation that we seem 
to be going through right now is retaining the best of the 
banking system.
    Senator Shelby. I hope we will not rush to consolidate all 
the bank regulatory systems. But I do believe that we need to 
go down that road and we need to do it right. Senator Dodd 
alluded to it earlier. We have seen gaps, big gaps out there in 
the regulation of institutions. We have seen sometimes, and I 
am going to bring up the Fed again, the Fed is the central 
bank, supposed to be the lender of last resort. Now it has 
become the lender of first resort, it seems to me. The big 
banks that they have regulated, gosh, so many of them are in 
trouble. So you have to ask from this podium up here, why? 
Where were they? And so forth.
    So we have to have, I believe, a comprehensive regulator, 
and along those same lines, look at AIG. Who were they 
regulated by basically? Their primary regulator was the New 
York State Insurance Commission, because under McCarran-
Ferguson, there are a lot of things the Fed even to this day 
doesn't have the power over. It assumed a lot of power over AIG 
because of systemic risk that Steve talks about. But I believe 
that whatever we do, we are going to have to be comprehensive 
and we are going to have to do it right, and I believe we are 
not going to rush to it, but we are really going to focus on 
it. We have no other choice.
    Ms. Seidman. My concern, let me just clarify, is the 
consolidation of the institutions, of the banking institutions, 
not the regulatory issue.
    Senator Shelby. OK.
    Chairman Dodd. Well, I am going to turn to Senator Merkley 
for any additional questions he has, but I want to thank you, 
Ms. Seidman, for making the point. I try to make it at every 
hearing we have on this subject matter and I didn't do it today 
and I should have at the outset.
    You are absolutely correct. There are 8,000 banks in the 
country. My community banks in Connecticut made choices, 
obviously, more conservative choices, thank goodness, and as a 
result, they get drawn into the pejorative, and I think we need 
to be very careful. There are so many different institutions 
that have the label of ``bank'' and there are very, very huge 
differences that exist within that universe of banks, and these 
differences have been rightly raised with me, as I am sure they 
have with my other colleagues. When we talk about banks, we 
ought to take a moment to make sure we are distinguishing 
between those who engage in some of these practices we are 
talking about and have accumulated many of these bad assets and 
the vast majority that have not.
    In fact, there are only a handful of banks--I forget the 
exact number, and one of you may correct me here--I think it is 
around 18 to 20 banks that have 80 or 85 percent of the assets 
in the country out of the 8,000 we are talking about. We too 
often draw everyone else into this discussion, so it is 
important to differentiate. And I appreciate your point about 
making sure that as we move forward with this we keep that in 
mind.
    I will have some closing thoughts in a minute, but let me 
turn to Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair.
    Thank you for all of your responses related to steering 
payments. It sounded like there was a consensus that there is a 
real problem there that needs to be fixed and I appreciated the 
range of remedies you mentioned, from fiduciary responsibility 
to an outright ban to a fixed-fee arrangement that doesn't 
depend on the type of the loan.
    I wanted to turn to another piece of this puzzle which are 
prepayment penalties combined with teaser rates. Very often, 
brokers have been able to say, hey, you don't want a fully 
amortizing 30-year loan. You want to have a discount for a 
couple of years. Your family can save up money. Your house will 
increase in value. You can refinance. And the teaser rates have 
been kind of the bait on the front end and the prepayment 
penalty has been the steel trap that captures families on the 
back end. Is this product inherently flawed and should it be 
banned?
    Mr. Bartlett. Senator, my sense is the market has spoken to 
that. Most of our companies don't have prepayment penalties. 
There was a value to them, but in some cases they were abused 
and the value, in essence, is you could give someone a lower 
rate if they planned to stay in that house and keep that 
mortgage for a longer period of time because you could lock in 
the rate. Having said that, the value has sort of long since 
been overcome by the abuses, so most of our banks--as far as I 
know, all of them--don't have the prepayment penalties anymore, 
I believe.
    Senator Merkley. Would it be appropriate to back up what 
the market has done with a specific ban on teaser rates and 
prepayment penalties?
    Mr. Bartlett. You know, it never strikes me as appropriate 
to go out and lock the barn door after the horses are out, but 
it wouldn't do any harm in the near term. The difficulty is any 
time that you create some kind of a Federal ban for something 
that somebody used to do, well, then 5 years from now, you will 
discover that it is getting in the way of something that 
consumers want. It wouldn't do any harm. It just doesn't strike 
me as being all that useful at this point.
    Senator Merkley. Ellen Seidman?
    Ms. Seidman. I think that the combination of teaser rates 
and a prepayment penalty is a combination that has no redeeming 
social value. I would ban it. And I am pleased to hear that 
Steve says that, in general, prepayment penalties are 
disappearing. I think they are pernicious and if they are to 
exist, they should be limited to a very short period of time, 
certainly as the Fed has done, no longer than the initial 
adjustment. They should come off before the initial adjustment 
in the mortgage rate.
    Senator Merkley. Thank you, and Professor?
    Ms. McCoy. I have nothing more to add with Ms. Seidman. I 
totally agree with her.
    Senator Merkley. There are those who have argued that, 
really, if you get rid of the prepayment penalty, teaser rates 
take care of themselves because obviously you are only going to 
get a slight discount. A finance lender is not going to offer 
you a big discount if you could go ahead and refinance 2 years 
later into another low discount. Do you all share that opinion, 
that really the focus is on the prepayment penalty? If you take 
care of that, the teaser rate issue takes care of itself?
    Ms. Seidman. That is probably right in logic. However, I 
think the problem on the teaser rates is that when you are 
dealing with a population that doesn't have a fiduciary looking 
out for them and is not really familiar with how mortgages 
work, it is too easy to sell the low monthly payment.
    Mr. Bartlett. Senator, our group concluded about 2 years 
ago, and I am joined here with the President of the Housing 
Policy Council that led this, we concluded about 2 years ago 
that the focus should be on the ability to repay, that a 
mortgage should have the ability to repay. There are a lot of 
ingredients to that, of which teaser rates and prepayments is 
part of it, but that should be the focus. It should be the 
ability to repay for the life of the loan. We adopted it 
ourselves for our companies, which is about 80 percent of the 
mortgage market, but then equally important, we then 
recommended it to the Fed, which they adopted it in perhaps a 
slightly less fulsome form than we did, but the same thing.
    Ms. McCoy. The problem with focusing just on the prepayment 
penalty is that assumes the consumer has the ability to 
refinance during the introductory period, and we have seen that 
that may not be true for a couple of reasons. First of all, 
their credit scores may be sinking. And second, house prices 
may fall.
    Now, we are in a very unusual situation now, but in the 
1990s, I lived in Cleveland, where housing price appreciation 
was pretty fragile. It was going up in other parts of the 
country, but you were never quite sure if you could sell your 
house for what you bought it at.
    Senator Merkley. Thank you. I think that is a very good 
point, and if I could just restate and make sure that we are on 
the save wavelength here, that even without a prepayment 
penalty, you may be locked into a loan, if it has a short 
teaser rate followed by high interest, but you may be locked in 
because the value of your house falls and you no longer have 
the equity to be able to refinance in a prime loan.
    Ms. McCoy. Correct.
    Senator Merkley. Thank you very much, Mr. Chairman.
    Chairman Dodd. Thank you, Senator. Those are good questions 
and ones we have spent a lot of time on over the last 2 years 
on going through the predatory lending practices. The yield 
spread premium issue is one that consumed a lot of attention of 
this Committee, as did teaser rates and prepayment penalties, 
so I am very appreciative of you raising it again here in 
today's discussion as we look down the road our work on 
predatory lending as well as credit cards.
    I wanted to make note, as well, that on Thursday, we will 
have a hearing on AIG before this Committee and a very 
interesting group of panelists to come, particularly in light 
of the decisions in the last 24 hours or so--36 hours--and so 
there will be a lot of interest, I presume, in hearing where 
that stands and where we are going with all of it.
    Let me underscore the point that Senator Shelby has made 
and I attempted to make at the outset. This is a large task we 
have in front of us and our common determination here is to get 
this right. I am very grateful to have a partner in this in 
Senator Shelby, who has sat in the chair that I am sitting in 
as Chair of this Committee and has a good understanding of 
these issues, as you have witnessed by his questions here today 
and his interest in the subject matter.
    And so it is our common determination to try and, as the 
Chair and Vice Chair or Co-Chair or Ranking Member of this 
Committee here, to work closely together with people like 
yourselves who are very, very informative and have a lot to 
offer in this discussion. This is a formal hearing today, but 
our intention is to have informal conversations and discussions 
with people as well, so we can have the kind of give and take 
as we move forward and start to build that architecture. So I 
am very grateful to all three of you for your participation 
today.
    Richard, do you have something else?
    Senator Shelby. Yes. I just want to follow up on the number 
of banks. You were talking about 8,000, more or less, smaller 
banks. And then we have the top 19 banks they are going to 
apply the stress test to if they can find the pulse and so 
forth.
    Steve, if you put the 19 banks that they are going to do a 
stress test on together, roughly how much of the deposits in 
the United States is that, roughly?
    Mr. Bartlett. Senator Shelby, I don't have the exact 
numbers----
    Senator Shelby. I know that.
    Mr. Bartlett. It is a significant portion----
    Senator Shelby. Would it be 80 percent?
    Mr. Bartlett. No, it wouldn't be 80 percent, but it perhaps 
could be around 70 percent----
    Senator Shelby. Seventy percent.
    Mr. Bartlett.----so you were closer than I was.
    Senator Shelby. You have got some good help back here.
    Mr. Bartlett. Yes, I do.
    Senator Shelby. Seventy percent, so say 19 banks in the 
United States have approximately 70 percent of all the 
deposits. Then you say every other bank, the 8,000 banks have 
30 percent. But a lot of those 30 percent, a lot of those 
banks, although small, are very important to their communities 
and a lot of them have stayed with the fundamentals of banking 
and are relatively, as I understand Professor McCoy, in 
relatively good shape, considering the plight of some of the 
bigger ones. Is that fair?
    Ms. McCoy. Yes. Yes. When I looked at the smaller banks, 
for the most part, they were not into these mortgages.
    Senator Shelby. They weren't buying credit default swaps 
and all this from AIG, were they?
    Ms. McCoy. No. They had pretty simple balance sheets.
    Senator Shelby. Balanced.
    Ms. Seidman. Let me just say, though, that while in general 
the small banks are doing better than the very big ones, it 
would be hard to do a lot worse. But even though they didn't 
participate in the kind of lending we are talking about, some 
smaller banks, particularly those that are in communities that 
have been devastated by that kind of lending----
    Senator Shelby. Sure.
    Ms. Seidman.----are running into trouble because the value 
of their loans is declining, and where you also have 
unemployment, the borrowers, even the prime borrowers, are in 
trouble. This is a big issue for some smaller banks.
    Senator Shelby. So a lot of that--I know it is everywhere 
to some extent, but a lot of the things you are referencing are 
in California, Florida, Nevada----
    Ms. Seidman. And in the Upper Midwest.
    Senator Shelby. In the Upper Midwest, the Rust Belt.
    Mr. Bartlett. Senator, Mr. Chairman, if I could take 30 
seconds, I think it is, though, fair to say that it is too 
broad a brush to say, well, the small banks are good and the 
big banks are bad----
    Senator Shelby. Sure.
    Mr. Bartlett.----because that is simply not accurate.
    Senator Shelby. That is what she was saying.
    Mr. Bartlett. I think that regions, being there in 
Birmingham, and BBVA in Birmingham and Webster Financial in 
Connecticut, Sun Trust in Atlanta, and others are banks that 
serve their communities quite well, make good decisions, good 
loans, have increased their lending as a result of TARP 
participation, and, in fact, we have an economic decline with 
unemployment and with frozen liquidity markets, but it is not a 
matter of those individual banks having made bad decisions. 
There are lots of bad decisions that have been made by all 
kinds--and lots of good decisions. Now the issue is how do we 
build out of it. So I think the banks I cited and others made 
quite good decisions. They are a big part of the solution.
    Chairman Dodd. No, no, you are right, absolutely right. Go 
ahead.
    Senator Shelby. Ms. Seidman, a lot of the smaller banks--
and large ones, too--bought mortgage-backed securities that 
were rated investment grade, you know, were packaged and sold 
back. In other words, they came right around the merry-go-
round. But they weren't allowed to hold those loans 
individually on their banking sheets, I understand it. Do you 
understand what I am getting at? Professor McCoy, do you want 
to comment?
    Ms. McCoy. Yes, I certainly do. First of all, there was a 
way to get around that, which was to make it on a low-doc or 
no-doc basis, so a seemingly safe loan actually didn't have the 
proper documentation. We did see that a lot among regulated 
depositories.
    But apart from that, yes. Banks were allowed to invest in 
investment grade subprime mortgage-backed securities under the 
standard rules that we have. I had a very interesting 
conversation with a regulator at the Bank of Italy who said 
that several years ago, the Bank of Italy called up all the 
banks in Italy and said, you shall not invest in these bonds. I 
don't care if they are investment grade. We forbid you from 
doing it.
    Senator Shelby. Deemed investment grade by a rating agency?
    Ms. McCoy. Correct.
    Senator Shelby. After they bought insurance and were 
wrapped and everything, is that correct?
    Ms. McCoy. Correct.
    Senator Shelby. Because anybody that was doing real due 
diligence knew there was a risk there, did they not?
    Ms. McCoy. That is right. That is right. Or they knew they 
couldn't tell what the risk was.
    Senator Shelby. OK. Thank you.
    Chairman Dodd. Let me just--one point I wanted to make 
before the conclusion, we are allowing the words ``subprime'' 
and ``predatory lending'' to become interchangeable and that is 
dangerous, in my view. If you have good underwriting standards, 
subprime lending can work, provided you don't have a lot of 
bells and whistles on it. This has been one of the great wealth 
creators for people who are moving up economically to be able 
to acquire a home and to watch equity build up. It becomes a 
great stabilizer, not to mention it does a lot for families and 
neighborhoods. Equity interest in homes is, I think, one of the 
great benefits. I think we are one of the few countries in the 
world that ever had a 30-year fixed-rate mortgage for people. 
Now, that is not always the best vehicle, I understand that, as 
well.
    But I wonder if you would agree with me or disagree with 
me. I just worry about this idea that we are going to exclude 
the possibility of poorer people becoming home owners. They 
have to meet standards, obviously. I think you pointed out 
where Community Investment Act requirements are in place, I 
think only 6 percent of those institutions ended up in some 
kind of problems. There has been an assumption that the 
Community Reinvestment Act gave mortgages to a lot of poor 
people who couldn't afford them. But, in fact, the evidence I 
have seen is quite the contrary. Where institutions followed 
CRA guidelines here and insisted upon those underwriting 
standards, there were very few problems, in fact. I wonder if 
you might comment on those two points.
    Ms. McCoy. If I may, Senator Dodd, the performance of CRA 
loans has, in fact, been much better. That turned out to be a 
viable model for doing subprime lending, and there are two 
other viable models. One are FHA guaranteed loans. That works 
pretty well. And then the activities, the lending activities of 
CDFIs such as ShoreBank are an excellent model to look at, as 
well.
    Ms. Seidman. Let me just add, first of all, you are 
certainly right that subprime used to mean a borrower with less 
than stellar credit.
    Chairman Dodd. Right.
    Ms. Seidman. It did not mean an ugly loan. And one has, 
unfortunately, morphed into the other.
    I think we did lending to borrowers with lower incomes and 
lower wealth extremely well during the 1990s because we worked 
on the notion that the borrower and the instrument should match 
and that the borrower should be well counseled. And I commend 
to the Committee and would ask you to put into the record a 
recent study by the Center for Community Capital at the 
University of North Carolina, who looked at essentially matched 
pairs of borrowers, one who had gotten a CRA loan and one who 
had gotten brokered loans with various other gizmos, ARMs or 
prepayment penalties. For the 2004 originations, the ARM-
brokered loans with prepayment penalties defaulted at 5.3 times 
the rate of the low-downpayment loans made to lower-income 
borrowers under CRA programs.
    Chairman Dodd. In fact, I think that--I forget which 
publication it was, it may have been the Wall Street Journal, 
and I may be a little bit off on this--somewhere around 60 
percent of the subprime loans to borrowers actually would have 
qualified for conventional mortgages.
    Ms. Seidman. That is right. Governor Kroszner, former Fed 
Governor Kroszner, has cited a study by Glenn Canner at the Fed 
that only 6 percent of the high-cost loans to low-income people 
were made by CRA-regulated institutions in their assessment 
areas.
    Chairman Dodd. Steve, do you want to comment on that at all 
before I call----
    Mr. Bartlett. Yes, I do, Mr. Chairman. Mr. Chairman, 
lending decisions should not be made by political correctness 
or by government fiat or by a law or by regulation. Those 
lending decisions should be based on safety and soundness, good 
underwriting standards and consumer protection, and every time 
we get into an attempt to have that, then we sort of skew the 
outcome. So subprime lending is in and of itself not bad. It is 
a good thing. We had a large number of terrible abuses, but it 
shouldn't be therefore outlawed.
    Second, loans, though, and mortgages should be made for the 
benefit of consumers by a competitive marketplace where 8,000 
lenders or 15,000 lenders compete against each other for the 
consumers' business. And then those lenders should be regulated 
for safety and soundness and for consumer protection. But the 
regulation should not be to design the exact terms and 
conditions of the loan, as in, well, I think this is what a 
good loan should be and somebody else says, I think this. The 
marketplace will do the best job.
    And then last, and I have some considerable experience with 
CRA as both a mayor and as a member of the other body, the 
purpose of CRA has worked quite well. It can be clumsy and so 
there are exceptions to that, but CRA is the government's 
requirement that regulated lenders, depository institutions, 
figure out how they should be making good loans in low-income 
neighborhoods because that was not occurring prior to CRA in 
large part, I regret to say, but it was not. So that is the 
purpose of CRA. That should be kept. It shouldn't be expanded 
to some other purpose or contracted for other purposes. But 
that was the underlying purpose and I think that is why the CRA 
debate is outside this debate that we are having today.
    Chairman Dodd. Very worthwhile, all of you. I can't thank 
you enough and thank my colleagues here. We will leave the 
record open for additional questions. By unanimous consent, we 
will accept that article you suggested to us from the 
University of North Carolina.
    With that, the hearing stands adjourned.
    [Whereupon, at 12:07 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
follow:]

                      STATEMENT OF STEVE BARTLETT
                President and Chief Executive Officer, 
                     Financial Services Roundtable
                             March 3, 2009

    Chairman Dodd, Ranking Member Shelby and Members of the Senate 
Banking Committee. I am Steve Bartlett, President and Chief Executive 
Officer of the Financial Services Roundtable. The Roundtable is a 
national trade association composed of the nation's largest banking, 
securities, and insurance companies. Our members provide a full range 
of financial products and services to consumers and businesses. 
Roundtable member companies provide fuel for America's economic engine, 
accounting directly for $85.5 trillion in managed assets, $965 billion 
in revenue, and 2.3 million jobs.
    On behalf of the members of the Roundtable, I wish to thank you for 
the opportunity to participate in this hearing on the role of consumer 
protection regulation in the on-going financial crisis. Many consumers 
have been harmed by this crisis, especially mortgage borrowers and 
investors. Yet, the scope and depth of this crisis is not simply a 
failure of consumer protection regulation. As I will explain in a 
moment, the root causes of this crisis are found in basic failures in 
many, but not all financial services firms, and the failure of our 
fragmented financial regulatory system.
    I also believe that this crisis illustrates the nexus between 
consumer protection regulation and safety and soundness regulation. 
Consumer protection and safety and soundness are intertwined. 
Prudential regulation and supervision of financial institutions is the 
first line of defense for protecting the interests of all consumers of 
financial products and services. For example, mortgage underwriting 
standards not only help to ensure that loans are made to qualified 
borrowers, but they also help to ensure that the lender gets repaid and 
can remain solvent.
    Given the nexus between the goals of consumer protection and safety 
and soundness, we do not support proposals to separate consumer 
protection regulation and safety and soundness regulation. Instead, we 
believe that the appropriate response to this crisis is the 
establishment of a better balance between these two goals within a 
reformed and more modern financial regulatory structure.
    Moreover, I would like to take this opportunity to express the 
Roundtable's concerns with the provision in the Omnibus Appropriations 
bill that would give State attorneys generals the authority to enforce 
compliance with the Truth-in-Lending Act (TILA) and would direct the 
Federal Trade Commission to write regulations related to mortgage 
lending. As I will explain further, we believe that one of the 
fundamental problems with our existing financial regulatory system is 
its fragmented structure. This provision goes in the opposite 
direction. It creates overlap and the potential for conflict between 
the Federal banking agencies, which already enforce compliance with 
TILA, and State AGs. It also creates overlap and the potential conflict 
between the Federal banking agencies, which are responsible for 
mortgage lending activities, and the Federal Trade Commission. While it 
may be argued that more ``cops on the beat'' can enhance compliance, 
more ``cops'' that are not required to act in any coordinated fashion 
will simply exacerbate the regulatory structural problems that 
contributed to the current crisis.
    My testimony is divided into three parts. First, I address ``What 
Went Wrong.'' Second, I address ``How to Fix the Problem.'' Finally, I 
take this opportunity to comment on the lending activities of TARP-
assisted firms, and the Roundtable's continuing concerns over the 
impact of fair value accounting.

What Went Wrong
    The proximate cause of the current financial crisis was the nation-
wide collapse of housing values, and the impact of that collapse on 
individual homeowners and the holders of mortgage-backed securities. 
The crisis has since been exacerbated by a serious recession.
    The root causes of the crisis are twofold. The first was a clear 
breakdown in policies, practices, and processes at many, but not all, 
financial services firms. Poor loan underwriting standards and credit 
practices, excessive leverage, misaligned incentives, less than robust 
risk management and corporate governance are now well known and fully 
documented. Corrective actions are well underway in the private sector 
as underwriting standards are upgraded, credit practices reviewed and 
recalibrated, leverage is reduced as firms rebuild capital, incentives 
are being realigned, and some management teams have been replaced, 
while whole institutions have been intervened by supervisors or merged 
into other institutions. So needed corrective actions are being taken 
by the firms themselves.
    More immediately, we need to correct the failures that the crisis 
exposed in our complex and fragmented financial regulatory structure. 
Crises have a way of revealing structural flaws in regulation, 
supervision, and our regulatory architecture that have long-existed, 
but were little noticed until the crisis exposed the underlying 
weaknesses and fatal gaps in regulation and supervision. This one is no 
different. It has revealed significant gaps in the financial regulatory 
system. It also revealed that the system does not provide for 
sufficient coordination and cooperation among regulators, and that it 
does not adequately monitor the potential for market failures, high-
risk activities, or vulnerable interconnections between firms and 
markets that can create systemic risk and result in panics like we saw 
last year and the crisis that lingers today.
    The regulation of mortgage finance illustrates these structural 
flaws in both regulation and supervision. Many of the firms and 
individuals involved in the origination of mortgage were not subject to 
supervision or regulation by any prudential regulator. No single 
regulator was held accountable for identifying and recommending 
corrective actions across the activity known as mortgage lending to 
consumers. Many mortgage brokers are organized under State law, and 
operated outside of the regulated banking industry. They had no 
contractual or fiduciary obligations to brokers who referred loans to 
them. Likewise, many brokers were not subject to any licensing 
qualifications and had no continuing obligations to individual 
borrowers. Most were not supervised in a prudential manner like 
depository institutions engaged in the same business line.
    The Federal banking regulators recognized many of these problems 
and took actions--belatedly--to address the institutions within their 
jurisdiction, but they lacked to power to reach all lenders. 
Eventually, the Federal Reserve Board's HOEPA regulations did extend 
some consumer protections to a broader range of lenders, but the Board 
does not have the authority to ensure that those lenders are engaged in 
safe and sound underwriting practices or risk management.
    The process of securitization suffered from a similar lack of 
systemic oversight and prudential regulation. No one was responsible 
for addressing the over-reliance investors placed upon the credit 
rating agencies to rate mortgage-backed securities, or the risks posed 
to the entire financial system by the development of instruments to 
transfer that risk worldwide.

How to Fix the Problem
    How do we fix this problem? Like others in the financial services 
industry, the members of the Financial Services Roundtable have been 
engaged in a lively debate over how to better protect consumers by 
addressing the structural flaws in our current financial regulatory 
system. While our internal deliberations continue, we have developed a 
set of guiding principles and a ``Draft Financial Regulatory 
Architecture'' that is intended to close the gaps in our existing 
financial regulatory system. We are pleased that the set of regulatory 
reform principles that President Obama announced last week are broadly 
consistent and compatible with the Roundtable's principles for much 
needed reforms. Our first principle in our 2007 Blueprint for U.S. 
Financial Modernization was to ``treat consumers fairly.'' Our current 
principles for regulatory reform this year build on that guiding 
principle and call for: 1) a new regulatory architecture; 2) common 
prudential and consumer and investor protection standards; 3) balanced 
and effective regulation; 4) international cooperation and national 
treatment; 5) failure resolution; and 6) accounting standards. Our plan 
also seeks to encourage greater coordination and cooperation among 
financial regulators, and to identify systemic risks before they 
materialize. We also seek to rationalize and simplify the existing 
regulatory architecture in ways that make more sense in our modern, 
global economy. The key features of our proposed regulatory 
architecture are as follows. 



Financial Markets Coordinating Council
    To enhance coordination and cooperation among the many and various 
financial regulatory agencies, we propose to expand membership of the 
President's Working Group on Financial Markets (PWG) and rename it as 
the Financial Markets Coordinating Council (FMCC). We believe that this 
Council should be established by law, in contrast to the existing PWG, 
which has operated under a Presidential Executive Order since 1988. 
This would permit Congress to oversee the Council's activities on a 
regular and ongoing basis. We also believe that the Council should 
include representatives from all major Federal financial agencies, as 
well as individuals who can represent State banking, insurance, and 
securities regulation.
    This Council could serve as a forum for national and State 
financial regulators to meet and discuss regulatory and supervisory 
policies, share information, and develop early warning detections. In 
other words, it could help to better coordinate policies within our 
still fragmented regulatory system. We do not believe that the Council 
should have independent regulatory or supervisory powers. However, it 
might be appropriate for the Council to have some ability to review the 
goals and objectives of the regulations and policies of Federal and 
State financial agencies, and thereby ensure that they are consistent.

Federal Reserve Board
    To address systemic risk, we believe the Federal Reserve Board 
(Board) should be authorized to act as a market stability regulator. As 
a market stability regulator, the Board should be responsible for 
looking across the entire financial services sector to identify 
interconnections that could pose a risk to our financial system. To 
perform this function, the Board should be empowered to collect 
information on financial markets and financial services firms, to 
participate in joint examinations with other regulators, and to 
recommend actions to other regulators that address practices that pose 
a significant risk to the stability and integrity of the U.S. financial 
services system.
    The Board's authority to collection information should apply not 
only to depository institutions, but also to all types of financial 
services firms, including broker/dealers, insurance companies, hedge 
funds, private equity firms, industrial loan companies, credit unions, 
and any other financial services firms that facilitate financial flows 
(e.g., transactions, savings, investments, credit, and financial 
protection) in our economy. Also, this authority should not be based 
upon the size of an institution. It is possible that a number of 
smaller institutions could be engaged in activities that collectively 
pose a systemic risk.

National Financial Institutions Regulator
    To reduce gaps in regulation, we propose the consolidation of 
several existing Federal agencies into a single, National Financial 
Institutions Regulator (NFIR). This new agency would be a consolidated 
prudential and consumer protection agency for banking, securities and 
insurance.
    More specifically, it would charter, regulate and supervise (i) 
banks, thrifts, and credit unions, currently supervised by the Office 
of the Thrift Supervision, the Office of the Comptroller of the 
Currency, and the National Credit Union Administration; (ii) licensed 
broker/dealers, investment advisors, investment companies, futures 
commission merchants, commodity pool operators, and other similar 
intermediaries currently supervised by the Securities and Exchange 
Commission or the Commodities Futures Trading Commission; and (iii) 
insurance companies and insurance producers that select a Federal 
charter. The AIG case illustrates the need for the Federal Government 
to have the capacity to supervise insurance companies. Also, with the 
exception of holding companies for banks, the NFIR would be the 
regulator for all companies that control broker/dealers or national 
chartered insurance companies.
    The NFIR would reduce regulatory gaps by establishing comparable 
prudential standards for all of these of nationally chartered or 
licensed entities. For example, national banks, Federal thrifts and 
federally licensed brokers/dealers that are engaged in comparable 
activities should be subject to comparable capital and liquidity 
standards. Similarly, all federally chartered insurers would be subject 
to the same prudential and market conduct standards.
    In the area of mortgage origination, we believe that the NFIR's 
prudential and consumer protection standards should apply to both 
national and State lenders. Mortgage lenders, regardless of how they 
are organized, should be required to retain some of the risk for the 
loans they originate (keep some ``skin-in-the-game''). Likewise, 
mortgage borrowers, regardless of where they live or who their lender 
is, should be protected by the same safety and soundness and consumer 
standards.
    As noted above, we believe that is it important for this agency to 
combine both safety and soundness (prudential) regulation and consumer 
protection regulation. Both functions can be informed, and enhanced, by 
the other. Prudential regulation can identify practices that could harm 
consumers, and can ensure that a firm can continue to provide products 
and services to consumers. The key is not to separate the two, but to 
find an appropriate balance between the two.

National Capital Markets Agency
    To focus greater attention on the stability and integrity of 
financial markets, we propose the creation of a National Capital 
Markets Agency through the merger of the Securities and Exchange 
Commission (SEC) and the Commodities Futures Trading Commission (CFTC), 
preserving the best features of each agency. The NCMA would regulate 
and supervise capital markets and exchanges. As noted above, the 
existing regulatory and supervisory authority of the SEC and CFTC over 
firms and individuals that serve as intermediaries between markets and 
customers, such as broker/dealers, investment companies, investment 
advisors, and futures commission merchants, and other intermediaries 
would be transferred to the NFIR. The NCMA also should be responsible 
for establishing standards for accounting, corporate finance, and 
corporate governance for all public companies.

National Insurance Resolution Authority
    To protect depositors, policyholders, and investors, we propose 
that the Federal Deposit Insurance Corporation (FDIC) would be renamed 
the National Insurance and Resolution Authority (NIRA), and that this 
agency act not only as an insurer of bank deposits, but also as the 
guarantor of retail insurance policies written by nationally chartered 
insurance companies, and a financial backstop for investors who have 
claims against broker/dealers. These three insurance systems would be 
legally and functionally separated. Additionally, this agency should be 
authorized to act as the receiver for large non-bank financial services 
firms. The failure of Lehman Brothers illustrated the need for such a 
better system to address the failure of large non-banking firms.

Federal Housing Finance Agency
    Finally, to supervise the Federal Home Loan Banks and to oversee 
the emergence and future restructuring of Fannie Mae and Freddie Mac 
from conservatorship we propose that the Federal Housing Finance Agency 
remain in place, pending a thorough review of the role and structure of 
the housing GSEs in our economy.

TARP Lending and Fair Value Accounting
    Before I close I would like to address two other issues of 
importance to policymakers and our financial services industry: lending 
by institutions that have received TARP funds, and the impact of fair 
value accounting in illiquid markets. Lending by institutions that have 
received TARP funds has become a concern, especially given the 
recessionary pressures facing the economy. I have attached to this 
statement a series of tables that the Roundtable has compiled on this 
issue. Those tables show the continued commitment of the nation's 
largest financial services firms to lending.
    Fair value accounting also is a major concern for the members of 
the Roundtable. We continue to believe that the pro-cyclical effects of 
existing policies are unnecessarily exacerbating this crisis. We urge 
this Committee to direct financial regulators to adjust current 
accounting standards to reduce the pro-cyclical effects of fair value 
accounting in illiquid markets. We also urge the U.S. and international 
financial regulators coordinate and harmonize regulatory policies to 
development accounting standards that achieve the goals of 
transparency, understandability, and comparability.

Conclusion
    Thank you again for the opportunity to appear today to address the 
connection between consumer protection regulation and this on-going 
financial crisis. The Roundtable believes that the reforms to our 
financial regulatory system we have developed would substantially 
improve the protection of consumers by reducing existing gaps in 
regulation, enhancing coordination and cooperation among regulators, 
and identifying systemic risks. We also call on Congress to address the 
continuing pro-cyclical effects of fair value accounting.
    Broader regulatory reform is important not only to ensure that 
financial institutions continue to meet the needs of all consumers but 
to restart economic growth and much needed job creation. Financial 
reform and ending the recession soon are inextricably linked--we need 
both. We need a financial system that provides market stability and 
integrity, yet encourages innovation and competition to serve consumers 
and meet the needs of a vibrant and growing economy. We need better, 
more effective regulation and a modern financial regulatory system that 
is unrivaled anywhere in the world. We deserve no less.
    At the Roundtable, we are poised and ready to work with you on 
these initiatives. As John F. Kennedy once cited French Marshall 
Lyautey, who asked his gardener to plant a tree. The gardener objected 
that the tree was slow growing and would not reach maturity for 100 
years. The Marshall replied, ``In that case, there is no time to lose; 
plant it this afternoon!'' The same is true with regard to the future 
of the United States in global financial services--there is no time to 
lose; let's all start this afternoon. 













                                 ______
                                 

                  PREPARED STATEMENT OF ELLEN SEIDMAN
               Senior Fellow, New America Foundation and
              Senior Vice President, ShoreBank Corporation
                             March 3, 2009

     Chairman Dodd, Ranking Member Shelby and members of the Committee. 
I appreciate your inviting me here this morning to discuss consumer 
protection and oversight in the financial services industry in the 
context of the current economic crisis, and to provide my thoughts on 
how the regulatory system should be restructured to enhance consumer 
protection in the future. In quick summary, I believe that the time has 
come to create a well-funded single Federal entity with the 
responsibility and authority to receive and act on consumer complaints 
about financial services and to adopt consumer protection regulations 
that would be applicable to all and would be preemptive. However, I 
believe that prudential supervisors, in particular the Federal and 
State banking regulatory agencies, should retain primary enforcement 
jurisdiction over the entities they regulate.
    My name is Ellen Seidman, and I am a Senior Fellow at the New 
America Foundation as well as Executive Vice President, National 
Program and Partnership Development at ShoreBank Corporation, the 
nation's first and leading community development bank holding company, 
based in Chicago. My views are informed by my current experience--
although they are mine alone, not those of New America or ShoreBank--as 
well as by my years at the Treasury Department, at Fannie Mae, at the 
National Economic Council under President Clinton, and as Director of 
the Office of Thrift Supervision from 1997 to 2001.
    During my tenure at OTS, we placed significant emphasis on both 
consumer and compliance issues and on the responsibility of the 
institutions we regulated to serve the communities in which they were 
chartered, both because of their obligations under the Community 
Reinvestment Act and because it was good business. We paid particular 
attention to compliance, building up our staff and examination 
capability, establishing a special award (done away with by my 
successor) to honor the best performer in compliance and community 
affairs, reaching out to consumers and communities, and enhancing our 
complaint function. We were by no means perfect, but we worked to put 
compliance on an equal footing with safety and soundness.
     Since I left OTS, I have spent much of my time working on issues 
relating to asset building and banking the underbanked, in which 
context the importance of consumer protection, for both credit and 
other products, is plainly apparent. Finally, my years at Fannie Mae 
and at ShoreBank and the community development work I have been doing 
have made me both conscious of and extremely sad about what has 
happened in the mortgage market and the effects it is having on both 
households and communities.
    Based on my OTS experience, I believe the bank regulators, given 
the proper guidance from Congress and the will to act, are fully 
capable of effectively enforcing consumer protection laws. Moreover, 
because of the system of prudential supervision, with its onsite 
examinations, they are also in an extremely good position to do so and 
to do it in a manner that benefits both consumers and the safety and 
soundness of the regulated institutions. In three particular cases 
during my OTS tenure, concern about consumer issues led directly to 
safety and soundness improvements. Two involved guidance that got 
thrifts out of sub-prime monoline credit card lending (just months 
before that industry got into serious trouble) and payday lending. In 
another case involving a specific institution, through our compliance 
examiners' concern about bad credit card practices, we uncovered 
serious fair lending and safety and soundness issues. Consumer 
protection can be the canary that gives early warning of safety and 
soundness issues--but only if someone is paying attention to dying 
birds.
    We also sounded the alarm on predatory lending. Sub-prime guidance 
issued in 1998 by all the bank regulators warned of both safety and 
soundness and consumer protection issues. In speeches and testimony I 
gave in 2000, concerns about predatory lending and discussion about 
what we were doing to respond were a consistent theme. Nevertheless, as 
I will discuss below, I think it is time to consider whether 
consolidation of both the function of writing regulations and the 
receipt of complaints would make the system more effective for 
consumers, for financial institutions and for the economy.

The Current Crisis
    The current crisis has many causes, including an over-reliance on 
finance to ``solve'' many of the needs of our citizens. When real 
incomes stagnate while the cost of housing, health care and education 
skyrocket, there are really only two possible results: people do 
without or they become more and more overleveraged. Financial 
engineering and cheap investor funding, largely from abroad, enabled 
the overleveraging, but a lack of adequate attention to the manner in 
which the financial services system interacted with consumers certainly 
kept the process going and caused consumers and the economy to fall 
harder when it ended. There were really two parallel problems: the 
proliferation of bad products and practices and the sale of hard-to-
understand credit and investment products to consumers for whom they 
were not suitable; and the lack of high quality products that meet 
consumer needs, well priced and effectively marketed, especially in 
lower income communities.
    I believe that there where three basic regulatory problems. First, 
there was a lack of attention, and sometimes unwillingness, to 
effectively regulate products and practices even where regulatory 
authority existed. The clearest example of this is the Federal 
Reserve's unwillingness to regulate mortgage lending under HOEPA. 
However, as the recent actions by the Federal Reserve, OTS and NCUA 
have demonstrated, there was also authority under the FTC Act that went 
unused. It is important to understand that this is not only an issue of 
not issuing regulations or guidance; it is perhaps even more 
importantly a lack of effective enforcement.
    Compliance has always had a hard time competing with safety and 
soundness for the attention of regulators--which is one reason I spent 
a good deal of my tenure at OTS emphasizing its importance--but there 
was a deliberate downgrading of the compliance function at the Federal 
level at the start of the Bush Administration. Moreover, neither the 
Federal Reserve nor the OTS--at least until fairly recently--has 
seriously probed the consumer practices of non-depository subsidiaries 
of the holding companies they regulate. This is not just an issue at 
the Federal level. While there are certain states--North Carolina, 
Maryland and Massachusetts prominent among them--that have consistently 
engaged in effective enforcement of consumer protection laws with 
respect to the entities under their regulation, others, including 
California, the home of many of the most aggressive mortgage lenders, 
were even less aggressive than the Federal regulators. Moreover, 
ineffective enforcement is not just an issue of consumer protection 
regulation per se; the ability to move badly underwritten products 
completely off the balance sheet, earning fees for originating them, 
but holding no responsibility for them and no capital against them, 
only encouraged the proliferation of such activities.
    Second, we need to acknowledge that there were, and are, holes in 
the regulatory system, both in terms of unregulated entities and 
products, and in terms of insufficient statutory authority. The 
clearest case relates to mortgage brokers, where there was no Federal 
regulation at all, no regulation beyond simple registration in many 
states, and ineffective regulation even in most of the states that 
actually asserted some regulatory authority. But there are other 
examples--payday lending is prohibited in some states, regulated more 
or less effectively in others, and pretty much allowed without 
restriction in still others. And then of course there is the question 
of what kind of responsibility sellers of non-investment financial 
products have to customers. We know we have not imposed a fiduciary 
duty on them, but does that mean there is no responsibility to match 
customer with product?
    Finally, there is and was confusion, for both the regulated 
entities and consumers and those who work with them. Consumer 
protection comes in many forms, from substantive prohibitions like 
usury ceilings and payday lending prohibitions, through required terms 
and practices, to disclosures and marketing rules. I would assert it 
also includes the affirmative mandate of the Community Reinvestment 
Act; recent experience has demonstrated that where well-regulated 
entities do not provide quality services that meet needs and are well 
marketed, expensive and sometimes predatory substitutes will move in.
    Multiple regulators and enforcement channels exacerbate the 
confusion. At the Federal level, there are multiple bank regulators, 
not to mention the NCUA, the FTC and HUD, and their jurisdiction is 
frequently overlapping. States and even localities also regulate 
consumer protection, again often through multiple agencies. And of 
course, sometimes the Federal and State laws overlap. The enforcement 
mechanisms are just as confusing, involving examinations, complaints, 
collateral consequences such as limitations on municipal deposits or 
procurement, and both public and private lawsuits.
    The system clearly could be improved. But as we do so, we should 
not be lulled into thing the solutions are obvious or easy. In general 
they're not, and I would assert that they are harder and more subtle 
than is the case with manufactured consumer products. The products, 
even the good ones, can be extremely complex. Just try describing the 
lifetime interest rate on a Savings Bond or how a capped ARM works. Or 
for that matter whether a payday loan or a bounced check is more 
expensive. Many products, especially loans and investments, involve 
both uncertainty and difficult math over a long period of time, which 
is hard for even the most educated consumer. And the differences 
between a good product and a bad one can be subtle, especially if the 
consumer doesn't know where to look. An experienced homeowner knows the 
importance of escrowing insurance and taxes, but the dire consequences 
of the lack of an escrow are easy for a first-time homebuyer to miss. 
And a relatively safe ARM can turn into a risky one when caps are 
removed or a prepayment penalty added.
    Finally, different consumers legitimately have different needs. To 
take the example economists love, when there is a normal, upward 
sloping yield curve, most homebuyers are better off with a 5-year ARM 
than with a 30-year fixed rate mortgage, because with the long-term 
loan they are paying a higher interest rate for an option they are 
unlikely ever to use, since they will likely move, prepay or refinance 
long before 30 years are up. But for a consumer whose income is 
unlikely to increase, who has few other resources, or who has 
difficulty budgeting--or who is just plain risk-averse--the certainty 
of the fixed rate mortgage may well be worth the additional cost.

Looking Forward
    Before turning to regulatory issues, I suggest there is a broader 
social context of change that we need to consider. To what extent can 
we turn some of the complex, long-term financial obligations that we 
have foisted on individual consumers--most clearly retirement and 
health care--back to more collective management? We also should 
recognize that there is some level of interest and some level of 
financial engineering at which ``availability of credit'' is an excuse 
for both not having sufficient income and collateral supports (such as 
health care) and an insufficient level of financial understanding--it's 
not a way of life. We need to educate our children from day one about 
what money means, how interest rates work, and who to get help from, 
and we need to create systems of helpers, which can include the 
internet and things like overdraft alarms, but which also requires low-
cost access to people who are competent to give advice and have a 
fiduciary duty to the consumer.
    In this period when consumers are being forced to deleverage and 
cut back, and are actually beginning to save more on their own accord, 
we should once again make saving easy and an expected part of life. 
Having an account at a bank or credit union helps encourage saving, 
although the account needs to be designed so consumers have the 
liquidity they need without paying for it through excessive overdraft 
fees. Tying savings to credit, such as by requiring part of a mortgage 
payment to go into a savings account for emergencies like repairs or 
temporary inability to make a payment, can also help. And so would 
moving toward more savings opt-outs, like payroll deductions for non-
restricted savings accounts that can be used in an emergency (as well 
as for retirement accounts), a concept we are testing at the New 
America Foundation as AutoSave.

Principles for Regulation
    The regulatory framework, of course, involves both how to regulate 
and who does it. With respect to how, I suggest three guiding 
principles. First, to the maximum extent possible, products that 
perform similar functions should be regulated similarly, no matter what 
they are called or what kind of entity sells them. For example, we know 
that many people regarded money market mutual funds and federally 
insured deposit accounts as interchangeable. Either they are, and both 
the products and--to the extent the regulation has to do with making 
sure the money is there when the customer wants it--the regulation 
should be similar, or they are not and they should not be treated as 
such, including by regulators who are assessing capital requirements. 
To take another example, payday loans and bounced check protection have 
a good deal in common, and probably should be regulated in a similar 
manner. This also means that a mortgage sold directly through a bank 
should be subject to the same regulatory scheme and requirements as one 
sold through a broker.
    Second, we should stop relying on consumer disclosure as the 
primary method of protecting consumers. While such disclosures can be 
helpful, they are least helpful where they are needed the most, when 
products and features are complex. The Federal Reserve's recognition of 
this with respect to double cycle credit card billing was a critical 
breakthrough: by working with consumers, they came to understand that 
no amount of disclosure was going to enable consumers to understand the 
practice. The same is true of very complex mortgage products. The ``one 
page disclosure'' is great for simple mortgage products, but where 
there are multiple difficult-to-understand concepts in a single 
mortgage--indexes and margins, caps on rate increases and on payments, 
per adjustment and over the loan's lifetime, escrows or not, prepayment 
penalties that change over time, option payments and negative 
amortization, and many different fees--the likelihood is low that any 
disclosure will enable those for whom these issues really make a 
difference to understand them.
    In the last few years, several academics have suggested some 
potential substitutes for disclosure that go beyond the traditional 
type of prohibitory consumer protection rules. For example, Professor 
Ronald Mann has suggested that credit card contracts be standardized, 
with competition allowed on only a few easily understood terms, such as 
annual fees and interest rates.\1\ In some ways, this is what the 
situation was with mortgages well into the 1990s. Professors Michael 
Barr, Eldar Shafir and Sendil Mullainathan have suggested the 
development of high quality, easily understood ``default'' products 
such as mortgages, credit cards and bank accounts, allowing other 
products to be sold, but with more negative consequences for sellers if 
the products go bad, such as requiring the seller to prove that the 
disclosures were reasonable as a condition to enforcing the contract, 
including in a mortgage foreclosure action.\2\
---------------------------------------------------------------------------
    \1\ Ronald Mann, `` `Contracting' for Credit,'' 104 Mich LR 899 
(2006) at 927-28.
    \2\ Michael Barr, Sendhil Mullainathan, and Eldar Shafir, ``A One-
Size-Fits-All Solution,'' New York Times, December 26, 2007, available 
at http://www.nytimes.com/2007/12/26/opinion/
26barr.html?scp=1&sq=michael percent20barr percent20mortgage&st=cse. 
See also Michael Barr, Sendhil Mullainathan, and Eldar Shafir, 
``Behaviorally Informed Financial Services Regulation'' (Washington, 
DC: New America Foundation, October 2008), available at http://
www.newamerica.net/files/naf_behavioral_v5.pdf. 
---------------------------------------------------------------------------
    Third, enforcement is at least as important as writing the rules. 
Rules that are not enforced, or not enforced equally across providers, 
generate both false comfort and confusion, and tend to drive, through 
market forces, all providers to the practices of the least well 
regulated. This is in many ways what we have seen with respect to 
mortgages; it is not just that some entities were not subject to the 
same rules as others, but also that the rules were not enforced 
consistently across entities.

Who Should Regulate
    As discussed above, that there are currently a myriad of regulators 
both making the rules and enforcing them. This situation makes 
accomplishment of the substantive principles discussed above very 
difficult. To a substantial extent, both the Federal Reserve and the 
FTC have broad jurisdiction already; whether they take action to write 
rules depends to some extent on capacity, will and priorities. But even 
where they have such authority and take it, significant problems remain 
concerning both enforcement and to what extent their rules trump State 
rules. The bank regulators, both together when they can agree and 
separately when they can't, also write rules and guidance that is often 
as effective as rules, but those apply only to entities under their 
jurisdiction, and generate very substantial controversy concerning the 
extent to which regulations of the OCC and OTS preempt State laws and 
regulations.
    As I mentioned at the start, I believe the bank regulators, given 
the guidance from Congress to elevate consumer protection to the same 
level of concern as safety and soundness, can be highly effective in 
enforcing consumer protection laws. Nevertheless, I think it is time to 
give consideration to unifying the writing of regulations as to major 
consumer financial products--starting with credit products--and also to 
establish a single national repository for the receipt of consumer 
complaints.
    The mortgage situation has shown that a single set of regulations 
that governs all parties is a precondition to keeping the market at the 
level of those engaged in best practices--or at least the practices 
condoned by the regulators--not the worst. The situation with payday 
lending, especially in multi-State metropolitan areas, is similar. And 
among regulators with similar jurisdictions, whether the Federal bank 
regulators or State regulators, having major consumer products governed 
by a single set of regulations will reduce the opportunity for 
regulatory arbitrage.
    A single entity dedicated to the development of consumer protection 
regulations, if properly funded and staffed--unfortunately the 
experience of both the FTC and CPSC over the last 8 years, but in fact 
for many more years suggests that's a big ``if''--will be more likely 
to focus on problems that are developing and to propose, and 
potentially, take action before they get out of hand. In addition, 
centralizing the complaint function in such an entity will give 
consumers and those who work with them a single point of contact and 
the regulatory body the early warning of trouble that consumer 
complaints provide.
    Such a body will also have the opportunity to become expert in 
consumer understanding and behavior. This will enable it to use the 
theories and practices being developed about consumer understanding and 
how to maximize positive consumer behavior--the learnings of behavioral 
economics--to regulate effectively without necessarily having a heavy 
hand. The regulator could also become the focus for the myriad of 
scattered and inefficient Federal efforts surrounding financial 
education.
    The single regulator concept is not, however, a panacea. Three 
major issues that could stymie such a regulator's effectiveness are 
funding, preemption, and the extent of its enforcement authority.
    How will the new regulator be funded, and at what level? It is 
tempting to think that annual appropriations will be sufficient, but is 
that really the case? Political winds and priorities change, and 
experience suggests that consumer regulatory agencies are at risk of 
reduced funding. Is this a place for user fees--a prospect more 
palatable if there is a single regulator covering all those in the 
business rather than multiple regulatory bodies for whom lower fees can 
become a marketing tool? In any event, it is essential that this entity 
be well funded; if it is not, it will do more harm than good, as those 
relying on it will not be able to count on its being effective.
    What will be the regulator's enforcement authority? Will it have 
primary authority over any group of entities? Will the authority be 
secondary to other regulatory bodies that license or charter those 
providing financial services? My opinion is that regulators who engage 
in prudential supervision (Federal and State), with onsite 
examinations, should have primary regulatory authority, with the new 
entity empowered to bring an enforcement action if it believes the 
regulations are not being effectively enforced. Coupled with 
Congressional direction to the prudential supervisors to place 
additional emphasis on consumer protection, the supplemental authority 
of the consumer protection regulator to act should limit the number of 
situations in which the new regulator is forced to take action.
    And finally, will the regulations written by the new entity preempt 
both regulations and guidance of other Federal regulators and State 
regulation? My opinion is that where the new entity acts, their 
regulations should be preemptive. We have a single national marketplace 
for most consumer financial products. Whereas in the past the argument 
that providers can't be expected to respond to a myriad of rules held 
sway, as technology has advanced this argument has lost its potency. 
But consumers are entitled to a consistent level of protection no 
matter where they live and with whom they deal. Yes, there may be times 
when the agency does not work as fast or as broadly as some advocates 
would like. But the point of having a single agency with responsibility 
in this area is to create a single focal point for action that will 
benefit all Americans. Where the agency does take action, it should 
fill the field. But preemption may well be the most difficult issue of 
all, not only because preemption is ideologically difficult, but also 
because the uniformity that a single regulator can provide will always 
be in tension with the attempts of some actors to get around the 
regulations and of regulators and other parties to move in to respond.

Conclusion
    While the current crisis has many causes, the triggering event was 
almost certainly the collapse of the sub-prime mortgage market. That is 
an event that need never have happened if both our regulatory system 
and regulators had been more completely and effectively focused on 
protecting consumers. For many years, many of us have been pointing out 
that bad consumer practices are also bad economic practices. Not only 
because of the damage it does to consumers, but also because when the 
music stops, we all get hurt. The current state of affairs provides a 
golden opportunity to make significant improvements in the regulatory 
system. If not now, when?
                                 ______
                                 
                PREPARED STATEMENT OF PATRICIA A. McCOY
            George J. and Helen M. England Professor of Law
                University of Connecticut School of Law
                             March 3, 2009

    Chairman Dodd and Members of the Committee: Thank you for inviting 
me here today to discuss the problem of restructuring the financial 
regulatory system. I applaud the Committee for exploring bold new 
approaches to financial regulation on the scale needed to address our 
nation's economic challenges.
    In my remarks today, I propose transferring consumer protection 
responsibilities in the area of consumer credit from Federal banking 
regulators to a single, dedicated agency whose sole mission is consumer 
protection. This step is essential for three reasons. First, during the 
housing bubble, our current system of fragmented regulation drove 
lenders to shop for the easiest legal regime. Second, the ability of 
lenders to switch charters put pressure on banking regulators--both 
State and Federal--to relax credit standards. Finally, banking 
regulators have routinely sacrificed consumer protection for short-term 
profitability of banks. Creating one, dedicated consumer credit 
regulator charged with consumer protection would establish uniform 
standards and enforcement for all lenders and help eliminate another 
death spiral in lending. Although I examine this issue through the lens 
of mortgage regulation, my discussion is equally relevant to other 
forms of consumer credit, such as credit cards and payday lending.
    The reasons for the breakdown of the home mortgage market and the 
private-label market for mortgage-backed securities are well known by 
now. Today, I wish to focus on lax lending standards for residential 
mortgages, which were a leading cause of today's credit crisis and 
recession. Our broken system of mortgage finance and the private actors 
in that system--ranging from mortgage brokers, lenders, and appraisers 
to the rating agencies and securitizers--bear direct responsibility for 
this breakdown in standards.
    There is more to the story, however. In 2006, depository 
institutions and their affiliates, which were regulated by Federal 
banking regulators, originated about 54 percent of all higher-priced 
home loans. In 2007, that percentage rose to 79.6 percent.\1\ In some 
states, mortgages originated by State banks and thrifts and independent 
nonbank lenders were regulated under State anti-predatory lending laws. 
In other states, however, mortgages were not subject to meaningful 
regulation at all. Consequently, the credit crisis resulted from 
regulatory failure as well as broken private risk management. That 
regulatory failure was not confined to states, moreover, but pervaded 
Federal banking regulation as well.
---------------------------------------------------------------------------
    \1\ Robert B. Avery, Kenneth P. Brevoort & Glenn B. Canner, The 
2007 HMDA Data, Fed. Res. Bull. A107, A124 (Dec. 2008), available at 
http://www.federalreserve.gov/pubs/bulletin/2008/pdf/hmda07final.pdf.
---------------------------------------------------------------------------
    Neither of these phenomena--the collapse in lending criteria and 
the regulatory failure that accompanied it--was an accident. Rather, 
they occurred because mortgage originators and regulators became locked 
in a competitive race to the bottom to relax loan underwriting and risk 
management. The fragmented U.S. system of financial services regulation 
exacerbated this race to the bottom by allowing lenders to shop for the 
easiest regulators and laws.
    During the housing bubble, consumers could not police originators 
because too many loan products had hidden risks. As we now know, these 
risks were ticking time bombs. Lenders did not take reasonable 
precautions against default because they able to shift that to 
investors through securitization. Similarly, regulators failed to clamp 
down on hazardous loans in a myopic attempt to boost the short-term 
profitability of banks and thrifts.
    I open by examining why reckless lenders were able to take market 
share away from good lenders and good products. Next, I describe our 
fragmented financial regulatory system and how it encouraged lenders to 
shop for lenient regulators. In part three of my remarks, I document 
regulatory failure by Federal banking regulators. Finally, I end with a 
proposal for a separate consumer credit regulator.

I. Why Reckless Lenders Were Able To Crowd Out the Good
    During the housing boom, the residential mortgage market was 
relatively unconcentrated, with thousands of mortgage originators. 
Normally, we would expect an unconcentrated market to provide vibrant 
competition benefiting consumers. To the contrary, however, however, 
highly risky loan products containing hidden risks--such as hybrid 
adjustable-rate mortgages (ARMs), interest-only ARMs, and option 
payment ARMs--gained market share at the expense of safer products such 
as standard fixed-rate mortgages and FHA-guaranteed loans.\2\
---------------------------------------------------------------------------
    \2\ A hybrid ARM offers a 2- or 3-year fixed introductory rate 
followed by a floating rate at the end of the introductory period with 
substantial increases in the rate and payment (so-called ``2-28'' and 
``3-27'' mortgages). Federal Reserve System, Truth in Lending, Part II: 
Proposed rule; request for public comment, 73 Fed. Reg. 1672, 1674 
(January 9, 2008). An interest-only mortgage allows borrowers to defer 
principal payments for an initial period. An option payment ARM 
combines a floating rate feature with a variety of payment options, 
including the option to pay no principal and less than the interest due 
every month, for an initial period. Choosing that option results in 
negative amortization. Department of the Treasury et al., Interagency 
Guidance on Nontraditional Mortgage Product Risks: Final guidance, 71 
Fed. Reg. 58609, 58613 (Oct. 4, 2006).
---------------------------------------------------------------------------
    These nontraditional mortgages and subprime loans inflicted 
incalculable harm on borrowers, their neighbors, and ultimately the 
global economy. As of September 30, 2008, almost 10 percent of U.S. 
residential mortgages were 1 month past due or more.\3\ By year-end 
2008, every sixth borrower owed more than his or her home was worth.\4\ 
The proliferation of toxic loans was the direct result of the ability 
to confuse borrowers and to shop for the laxest regulatory regime.\5\
---------------------------------------------------------------------------
    \3\ See Mortgage Bankers Association, Delinquencies Increase, 
Foreclosure Starts Flat in Latest MBA National Delinquency Survey (Dec. 
5, 2008), available at www.mbaa.org/NewsandMedia/PressCenter/66626.htm. 

    \4\ Michael Corkery, Mortgage `Cram-Downs' Loom as Foreclosures 
Mount, Wall St. J., Dec. 31, 2008.
    \5\ The discussion in this section was drawn, in part, from 
Patricia A. McCoy, Andrey D. Pavlov, & Susan M. Wachter, Systemic Risk 
through Securitization: The Result of Deregulation and Regulatory 
Failure,__Conn. L. Rev. __(forthcoming 2009) and Oren Bar-Gill & 
Elizabeth Warren, Making Credit Safer,__ U. Penn. L. Rev. __ 
(forthcoming 2009).
---------------------------------------------------------------------------
A. The Growth in Dangerous Mortgage Products
    During the housing boom, hybrid subprime ARMs, interest-only 
mortgages, and option payment ARMs captured a growing part of the 
market. We can see this from the growth in nonprime mortgages.\6\ 
Between 2003 and 2005, nonprime loans tripled from 11 percent of all 
home loans to 33 percent.\7\
---------------------------------------------------------------------------
    \6\ I use the term ``nonprime'' to refer to subprime loans plus 
other nontraditional mortgages. Subprime mortgages carry higher 
interest rates and fees and are designed for borrowers with impaired 
credit. Nontraditional mortgages encompass a variety of risky mortgage 
products, including option payment ARMs, interest-only mortgages, and 
reduced documentation loans. Originally, these nontraditional products 
were offered primarily in the ``Alt-A'' market to people with near-
prime credit scores but intermittent or undocumented income sources. 
Eventually, interest-only ARMs and reduced documentation loans 
penetrated the subprime market as well.
    \7\ FDIC Outlook, Breaking New Ground in U.S. Mortgage Lending 
(Summer 2006), available at www.fdic.gov/bank/analytical/regional/
ro20062q/na/2006_summer04.html. 
---------------------------------------------------------------------------
    If we unpack these numbers, it turns out that hybrid ARMs, 
interest-only mortgages, and option payment ARMs accounted for a 
growing share of nonprime loans over this period. Option payment ARMs 
and interest-only mortgages went from 3 percent of all nonprime 
originations in 2002 to well over 50 percent by 2005. (See Figure 1). 
Low- and no-documentation loans increased from 25 percent to slightly 
over 40 percent of subprime loans over the same period. By 2004 and 
continuing through 2006, about three-fourths of the loans in subprime 
securitizations consisted of hybrid ARMs.\8\
---------------------------------------------------------------------------
    \8\ See generally McCoy, Pavlov & Wachter, supra note 5; FDIC 
Outlook, Breaking New Ground in U.S. Mortgage Lending (Summer 2006), 
available at www.fdic.gov/bank/analytical/regional/ro20062q/na/
2006_summer04.html. 
---------------------------------------------------------------------------
  Figure 1. Growth in Nontraditional Mortgages, 2002-2005\9\
---------------------------------------------------------------------------
    \9\ FDIC Outlook, Breaking New Ground in U.S. Mortgage Lending 
(Summer 2006), available at www.fdic.gov/bank/analytical/regional/
ro20062q/na/2006_summer04.html. 



    As the product mix of nonprime loans became riskier and riskier, 
two default indicators for nonprime loans also increased substantially. 
Loan-to-value ratios went up and so did the percentage of loans with 
combined loan-to-value ratios of over 80 percent. This occurred even 
though the credit scores of borrowers with those loans remained 
relatively unchanged between 2002 and 2006. At the same time, the 
spreads of rates over the bank cost of capital tightened. To make 
matters worse, originators layered risk upon risk, with borrowers who 
were the most at risk obtaining low equity, no-amortization, reduced 
documentation loans. (See Figure 2).

  Figure 2. Underwriting Criteria for Adjustable-Rate Mortgages, 2002-
        2006

        
        
    Many of these risky mortgage instruments were made in areas where 
housing was least affordable, such as California, Florida and Arizona, 
leading to concentrated areas of unsustainable housing values. (See 
Figures 3 and 4). This concentration of risky loans put the entire 
local markets at risk, due to the sudden and extreme withdrawal of 
credit in the aftermath of a bubble.\10\

    \10\ See Susan M. Wachter, Andrey D. Pavlov & Zoltan Pozsar, 
Subprime Lending and Real Estate Markets, in Mortgage and Real Estate 
Finance__(Stefania Perrucci, ed., Risk Books 2008).
---------------------------------------------------------------------------
  Figure 3. Geographic Distribution of Interest-Only Loans, 2006.\11\
---------------------------------------------------------------------------
    \11\ Anthony Pennington-Cross, Mortgage Product Substitution and 
State Predatory Lending Laws, Presentation at the 2008 Mid-Year Meeting 
of the American Real Estate and Urban Economics Association, 
Washington, D.C., May 27, 2008.


  Figure 4. Geographic Distribution of Low-Documentation Loans, 
        2006\12\
---------------------------------------------------------------------------
    \12\ Id. 
    
    
    The combination of easing credit standards and a growing economy 
resulted in a sharp increase in homeownership rates through 2004. As 
the credit quality of loans steadily grew worse over 2005 through 
2007,\13\ however, the volume of unsustainable loans grew and 
homeownership rates dropped.\14\ (See Table 1).
---------------------------------------------------------------------------
    \13\ Subprime mortgage originated in 2005, 2006 and 2007 had 
successively worse default experiences than vintages in prior years. 
See Freddie Mac, Freddie Mac Update 19 (December 2008), available at 
www.freddiemac.com/investors/pdffiles/investor-presentation.pdf.
    \14\ See Jesse M. Abraham, Andrey Pavlov & Susan Wachter, 
Explaining the United States' Uniquely Bad Housing Market, XII Wharton 
Real Estate Rev. 24 (2008).
---------------------------------------------------------------------------
  Table 1. U.S. Homeownership Rates, by Year (U.S. Census Bureau)



    The explosion of nontraditional mortgage lending was timed to 
maintain securitization deal flows after traditional refinancings 
weakened in 2003. The major take-off in these products occurred in 
2002, which coincided with the winding down of the huge increase in 
demand for mortgage securities through the refinance process. Coming 
out of the recession of 2001, interest rates fell and there was a 
massive securitization boom through refinancing that was fueled by low 
interest rates. The private-label securitization industry had grown in 
capacity and profits.
    But in 2003, rising interest rates ended the potential for 
refinancing at ever lower interest rates, leading to an increased need 
for another source of mortgages to maintain and grow the rate of 
securitization and the fees it generated. The ``solution'' was the 
expansion of the market through nontraditional mortgages, especially 
interest-only loans and option payment ARMs offering negative 
amortization. (See Figure 1 supra). This expansion of credit swept a 
larger portion of the population into the potential homeowner pool, 
driving up housing demand and prices, and consumer indebtedness. 
Indeed, consumer indebtedness grew so rapidly that between 1975 and 
2007, total household debt soared from around 43 percent to nearly 100 
percent of gross domestic product.\15\
---------------------------------------------------------------------------
    \15\ U.S. Federal Reserve Board, Bureau of Economic Analysis.
---------------------------------------------------------------------------
    The growth in nonprime mortgages was accomplished through market 
expansion of nontraditional mortgages and by qualifying more borrowing 
through easing of traditional lending terms. For example, while 
subprime mortgages were initially made as ``hard money'' loans with low 
loan-to-value ratios, by the height of their growth, combined loan-to-
value ratios exceeded that of the far less risky prime market. (See 
Figure 3 supra). While the demand for riskier mortgages grew fueled by 
the need for product to securitize, the potential risk due to 
deteriorating lending standards also grew.

B. Consumer Confusion
    If borrowers had been able to distinguish safe loans from highly 
risky loans, risky loans would not have crowded out the market. But 
numerous borrowers were not able to do so, for three distinct reasons. 
First, hybrid subprime ARMs, interest-only mortgages, and option 
payment ARMs were baffling in their complexity. Second, it was 
impossible to obtain binding price quotes early enough to permit 
meaningful comparison shopping in the nonprime market. Finally, 
borrowers usually did not know that mortgage brokers got higher 
compensation for steering them into risky loans.
    Hidden Risks--The arcane nature of hybrid ARMs, interest-only 
loans, and option payment ARMs often made informed consumer choice 
impossible. These products were highly complex instruments that 
presented an assortment of hidden risks to borrowers. Chief among those 
risks was payment shock--in other words, the risk that monthly payments 
would rise dramatically upon rate reset. These products presented 
greater potential payment shock than conventional ARMs, which had lower 
reset rates and manageable lifetime caps. Indeed, with these exotic 
ARMs, the only way interest rates could go was up. Many late vintage 
subprime hybrid ARMs had initial rate resets of 3 percentage points, 
resulting in increased monthly payments of 50 percent to 100 percent or 
more.\16\
---------------------------------------------------------------------------
    \16\ Statement of Sheila C. Bair, Chairman, Federal Deposit 
Insurance Corporation, on Strengthening the Economy: Foreclosure 
Prevention and Neighborhood Preservation, before the Committee on 
Banking, Housing and Urban Affairs, U.S. Senate, 538 Dirksen Senate 
Office Building, January 31, 2008, www.fdic.gov/news/news/speeches/
chairman/spjan3108.html. 
---------------------------------------------------------------------------
    For a borrower to grasp the potential payment shock on a hybrid, 
interest-only, or option payment ARM, he or she would need to 
understand all the moving parts of the mortgage, including the index, 
rate spread, initial rate cap, and lifetime rate cap. On top of that, 
the borrower would need to predict future interest rate movements and 
translate expected rate changes into changes in monthly payments. 
Interest-only ARMs and option payment ARMs had the added complication 
of potential deferred or negative amortization, which could cause the 
principal payments to grow. Finally, these loans were more likely to 
carry large prepayment penalties. To understand the effect of such a 
prepayment penalty, the borrower would have to use a formula to compute 
the penalty's size and then assess the likelihood of moving or 
refinancing during the penalty period.\17\ Truth-in-Lending Act 
disclosures did not require easy-to-understand disclosures about any of 
these risks.\18\
---------------------------------------------------------------------------
    \17\ Federal Reserve System, Truth in Lending, Part III: Final 
rule, official staff commentary, 73 Fed. Reg. 44522, 44524-25 (July 30, 
2008); Federal Reserve System, Truth in Lending, Part II: Proposed 
rule; request for public comment, 73 Fed. Reg. 1672, 1674 (January 9, 
2008).
    \18\ Patricia A. McCoy, Rethinking Disclosure in a World of Risk-
Based Pricing, 44 Harv. J. Legis. 123 (2007), available at http://
www.law.harvard.edu/students/orgs/jol/vol44_1/mccoy.pdf. 
---------------------------------------------------------------------------
    Inability to Do Meaningful Comparison Shopping--The lack of binding 
rate quotes also hindered informed comparison-shopping in the nonprime 
market. Nonprime loans had many rates, not one, which varied according 
to the borrower's risk, the originator's compensation, the 
documentation level of the loan, and the naivety of the borrower. 
Between their complicated price structure and the wide variety of 
products, subprime loans were not standardized. Furthermore, it was 
impossible to obtain a binding price quote in the subprime market 
before submitting a loan application and paying a non-refundable fee. 
Rate locks were also a rarity in the subprime market. In too many 
cases, subprime lenders waited until the closing to unveil the true 
product and price for the loan, a practice that the Truth in Lending 
Act rules countenanced. These rules, promulgated by the Federal Reserve 
Board, helped foster rampant ``bait-and-switch'' schemes in the 
subprime market.\19\
---------------------------------------------------------------------------
    \19\  Id.; Federal Reserve System, Truth in Lending--Proposed rule; 
request for public comment, 73 Fed. Reg. 1672, 1675 (Jan. 9, 2008).
---------------------------------------------------------------------------
    As a result, deceptive advertising became a stock-in-trade of the 
nonprime market. Nonprime lenders and brokers did not advertise their 
prices to permit meaningful comparison-shopping. To the contrary, 
lenders treated their rate sheets--which listed their price points and 
pricing criteria--as proprietary secrets that were not to be disclosed 
to the mass consumer market. Subprime advertisements generally focused 
on fast approval and low initial monthly payments or interest rates, 
not on accurate prices.
    While the Federal Reserve exhorted people to comparison-shop for 
nonprime loans,\20\ in reality, comparison-shopping was futile. 
Nonprime lenders did not post prices, did not provide consumers with 
firm price quotes, and did not offer lock-in commitments as a general 
rule. Anyone who attempted to comparison-shop had to pay multiple 
application fees for the privilege and, even then, might not learn the 
actual price until the closing if the lender engaged in a bait-and-
switch.
---------------------------------------------------------------------------
    \20\  See, e.g., Federal Reserve Board, Looking for the Best 
Mortgage, www.federalreserve.gov/pubs/mortgage/mortb_11.htm.
---------------------------------------------------------------------------
    As early as 1998, the Federal Reserve Board and the Department of 
Housing and Urban Development were aware that Truth in Lending Act 
disclosures did not come early enough in the nonprime market to allow 
meaningful comparison shopping. That year, the two agencies issued a 
report diagnosing the problem. In the report, HUD recommended changes 
to the Truth in Lending Act to require mortgage originators to provide 
binding price quotes before taking loan applications. The Federal 
Reserve Board dissented from the proposal, however, and it was never 
adopted.\21\ To this day, the Board has still not revamped Truth in 
Lending disclosures for closed-end mortgages.
---------------------------------------------------------------------------
    \21\ See Bd. of Governors of the Fed. Reserve Sys. & Dep't of Hous. 
& Urban Dev., Joint Report to the Congress, Concerning Reform to the 
Truth in Lending Act and the Real Estate Settlement Procedures Act, at 
28-29, 39-42 (1998), available at www.federalreserve.gov/boarddocs/
rptcongress/tila.pdf.
---------------------------------------------------------------------------
    Perverse Fee Incentives--Finally, many consumers were not aware 
that the compensation structure rewarded mortgage brokers for riskier 
loan products and higher interest rates. Mortgage brokers only got paid 
if they closed a loan. Furthermore, they were paid solely through 
upfront fees at closing, meaning that if a loan went bad, the losses 
would fall on the lender or investors, not the broker. In the most 
pernicious practice, lenders paid brokers thousands of dollars per loan 
in fees known as yield spread premiums (or YSPs) in exchange for loans 
saddling borrowers with steep prepayment penalties and higher interest 
rates than the borrowers qualified for, based on their incomes and 
credit scores.
    In sum, these three features--the ability to hide risk, thwart 
meaningful comparison-shopping, and reward steering--allowed lenders to 
entice unsuspecting borrowers into needlessly hazardous loans.

C. The Crowd-Out Effect
    The ability to bury risky product features in fine print allowed 
irresponsible lenders to out-compete safe lenders. Low initial monthly 
payments were the most visible feature of hybrid ARMs, interest-only 
loans, and option payment ARMs. During the housing boom, lenders 
commonly touted these products based on low initial monthly payments 
while obscuring the back-end risks of those loans.\22\
---------------------------------------------------------------------------
    \22\ See, e.g., Julie Haviv & Emily Kaiser, Web lenders woo 
subprime borrowers despite crisis, Reuters (Apr. 22, 2007); E. Scott 
Reckard, Refinance pitches in sub-prime tone, Los Angeles Times, 
October 29, 2007.
---------------------------------------------------------------------------
    The ability to hide risks made it easy to out-compete lenders 
offered fixed-rate, fully amortizing loans. Other things being equal, 
the initial monthly payments on exotic ARMs were lower than on fixed-
rate, amortizing loans. Furthermore, some nonprime lenders qualified 
borrowers solely at the low initial rate alone until the Federal 
Reserve Board finally banned that practice in July 2008.\23\
---------------------------------------------------------------------------
    \23\ In fall 2006, Federal regulators issued an interagency 
guidance advising option ARM lenders to qualify borrowers solely at the 
fully indexed rate. Nevertheless, Washington Mutual (WaMu) apparently 
continued to qualify applicants for option ARMs at the low, 
introductory rate alone until mid-2007. It was not until July 30, 2007 
that WaMu finally updated its ``Bulk Seller Guide'' to require its 
correspondents to underwrite option ARMs and other ARMs at the fully 
indexed rate.
---------------------------------------------------------------------------
    Of course, many sophisticated customers recognized the dangers of 
these loans. That did not deter lenders from offering hazardous 
nontraditional ARMs, however. Instead, the ``one-sizefits-one'' nature 
of nonprime loans permitted lenders to discriminate by selling safer 
products to discerning customers and more lucrative, dangerous products 
to naive customers. Sadly, the consumers who were least well equipped 
in terms of experience and education to grasp arcane loan terms \24\ 
ended up with the most dangerous loans.
---------------------------------------------------------------------------
    \24\ Howard Lax, Michael Manti, Paul Raca & Peter Zorn, Subprime 
Lending: An Investigation of Economic Efficiency, 15 Housing Pol'y 
Debate 533, 552-554 (2004), http://www.fanniemaefoundation.org/
programs/hpd/pdf/hpd_1503_Lax.pdf. 
---------------------------------------------------------------------------
    In the meantime, lenders who offered safe products--such as fixed-
rate prime loans--lost market share to lenders who peddled exotic ARMs 
with low starting payments. As conventional lenders came to realize 
that it didn't pay to compete on good products, those lenders expanded 
into the nonprime market as well.

II. The Regulatory Story: Race to the Bottom
    Federal banking regulators added fuel to the crisis by allowing 
reckless loans to flourish. It is a basic tenet of banking law that 
banks should not extend credit without proof of ability to repay. 
Federal banking regulators \25\ had ample authority to enforce this 
tenet through safety and soundness supervision and through Federal 
consumer protection laws. Nevertheless, they refused to exercise their 
substantial powers of rulemaking, formal enforcement, and sanctions to 
crack down on the proliferation of poorly underwritten loans until it 
was too late. Their abdication allowed irresponsible loans to multiply. 
Furthermore, their green light to banks to invest in investment-grade 
subprime mortgage-backed securities and CDOs left the nation's largest 
banks struggling with toxic assets. These problems were a direct result 
of the country's fragmented system of financial regulation, which 
caused regulators to compete for turf.
---------------------------------------------------------------------------
    \25\ The four Federal banking regulators include the Federal 
Reserve System, which serves as the central bank and supervises State 
member banks; the Office of the Comptroller of the Currency, which 
oversees national banks; the Federal Deposit Insurance Corporation, 
which operates the Deposit Insurance Fund and regulates State nonmember 
banks; and the Office of Thrift Supervision, which supervises savings 
associations.
---------------------------------------------------------------------------
A. The Fragmented U.S. System of Mortgage Regulation
    In the United States, the home mortgage lending industry operates 
under a fragmented regulatory structure which varies according to 
entity.\26\ Banks and thrift institutions are regulated under Federal 
banking laws and a subset of those institutions--namely, national 
banks, Federal savings associations, and their subsidiaries--are exempt 
from State anti-predatory lending and credit laws by virtue of Federal 
preemption. In contrast, mortgage brokers and independent non-
depository mortgage lenders escape Federal banking regulation but have 
to comply with all State laws in effect. Only State-chartered banks and 
thrifts in some states (a dwindling group) are subject to both sets of 
laws.
---------------------------------------------------------------------------
    \26\ This discussion is drawn from Patricia A. McCoy & Elizabeth 
Renuart, The Legal Infrastructure of Subprime and Nontraditional 
Mortgage Lending, in Borrowing to Live: Consumer and Mortgage Credit 
Revisited 110 (Nicolas P. Retsinas & Eric S. Belsky eds., Joint Center 
for Housing Studies of Harvard University & Brookings Institution 
Press, 2008).
---------------------------------------------------------------------------
    Under this dual system of regulation, depository institutions are 
subject to a variety of Federal examinations, including fair lending, 
Community Reinvestment Act, and safety and soundness examinations, but 
independent nondepository lenders are not. Similarly, banks and thrifts 
must comply with other provisions of the Community Reinvestment Act, 
including reporting requirements and merger review. Federally insured 
depository institutions must also meet minimum risk-based capital 
requirements and reserve requirements, unlike their independent non-
depository counterparts.
    Some Federal laws applied to all mortgage originators. Otherwise, 
lenders could change their charter and form to shop for the friendliest 
regulatory scheme.

B. Applicable Law
    Despite these differences in regulatory regimes, the Federal 
Reserve Board did have the power to prohibit reckless mortgages across 
the entire mortgage industry. The Board had this power by virtue of its 
authority to administer a Federal anti-predatory lending law known as 
``HOEPA.''

1. Federal Law
    Following deregulation of home mortgages in the early 1980's, 
disclosure became the most important type of Federal mortgage 
regulation. The Federal Truth in Lending Act (TILA),\27\ passed in 
1968, mandates uniform disclosures regarding cost for home loans. Its 
companion law, the Federal Real Estate Settlement Procedures Act of 
1974 (RESPA),\28\ requires similar standardized disclosures for 
settlement costs. Congress charged the Federal Reserve with 
administering TILA and the Department of Housing and Urban Development 
with administering RESPA.
---------------------------------------------------------------------------
    \27\ 15 U.S.C.  1601-1693r (2000).
    \28\ 12 U.S.C.  2601-2617 (2000).
---------------------------------------------------------------------------
    In 1994, Congress augmented TILA and RESPA by enacting the Home 
Ownership and Equity Protection Act (HOEPA).\29\ HOEPA was an early 
Federal anti-predatory lending law and prohibits specific abuses in the 
subprime mortgage market. HOEPA applies to all residential mortgage 
lenders and mortgage brokers, regardless of the type of entity.
---------------------------------------------------------------------------
    \29\ 15 U.S.C.  1601, 1602(aa), 1639(a)-(b).
---------------------------------------------------------------------------
    HOEPA has two important provisions. The first consists of HOEPA's 
high-cost loan provision,\30\ which regulates the high-cost refinance 
market. This provision seeks to eliminate abuses consisting of ``equity 
stripping.'' It is hobbled, however, by its extremely limited reach--
covering only the most exorbitant subprime mortgages--and its 
inapplicability to home purchase loans, reverse mortgages, and open-end 
home equity lines of credit.\31\ Lenders learned to evade the high-cost 
loan provisions rather easily by slightly lowering the interest rates 
and fees on subprime loans below HOEPA's thresholds and by expanding 
into subprime purchase loans.
---------------------------------------------------------------------------
    \30\ 15 U.S.C. Sec.  1602(aa)(1)-(4); 12 C.F.R.  226.32(a)(1), 
(b)(1).
    \31\ 15 U.S.C. Sec.  1602(i), (w), (bb); 12 C.F.R.  226.32(a)(2) 
(1997); Edward M. Gramlich, Subprime Mortgages: America's Latest Boom 
and Bust 28 (Urban Institute Press, 2007).
---------------------------------------------------------------------------
    HOEPA also has a second major provision, which gives the Federal 
Reserve Board the authority to prohibit unfair or deceptive lending 
practices and refinance loans involving practices that are abusive or 
against the interest of the borrower.\32\ This provision is potentially 
broader than the high-cost loan provision, because it allows regulation 
of both the purchase and refinance markets, without regard to interest 
rates or fees. However, it was not self-activating. Instead, it 
depended on action by the Federal Reserve Board to implement the 
provision, which the Board did not take until July 2008.
---------------------------------------------------------------------------
    \32\ 15 U.S.C.  1639(l)(2).
---------------------------------------------------------------------------
2. State Law
    Before 2008, only the high-cost loan provision of HOEPA was in 
effect as a practical matter. This provision had a serious Achilles 
heel, consisting of its narrow coverage. Even though the Federal 
Reserve Board lowered the high-cost triggers of HOEPA effective in 
2002, that provision still only applied to 1 percent of all subprime 
home loans.\33\
---------------------------------------------------------------------------
    \33\ Gramlich, supra note 31 (2007, p. 28).
---------------------------------------------------------------------------
    After 1994, it increasingly became evident that HOEPA was incapable 
of halting equity stripping and other sorts of subprime abuses. By the 
late 1990s, some cities and states were contending with rising 
foreclosures and some jurisdictions were contemplating regulating 
subprime loans on their own. Many states already had older statutes on 
the books regulating prepayment penalties and occasionally balloon 
clauses. These laws were relatively narrow, however, and did not 
address other types of new abuses that were surfacing in subprime 
loans.
    Consequently, in 1999, North Carolina became the first State to 
enact a comprehensive anti-predatory lending law.\34\ Soon, other 
states followed suit and passed anti-predatory lending laws of their 
own. These newer State laws implemented HOEPA's design but frequently 
expanded coverage or imposed stricter regulation on subprime loans. By 
year-end 2005, 29 States and the District of Columbia had enacted one 
of these ``mini-HOEPA'' laws. Some States also passed stricter 
disclosure laws or laws regulating mortgage brokers. By the end of 
2005, only six States--Arizona, Delaware, Montana, North Dakota, 
Oregon, and South Dakota--lacked laws regulating prepayment penalties, 
balloon clauses, or mandatory arbitration clauses, all of which were 
associated with exploitative subprime loans.\35\
---------------------------------------------------------------------------
    \34\ N.C. Gen Stat.  24-1.1E (2000).
    \35\ See Raphael Bostic, Kathleen C. Engel, Patricia A. McCoy, 
Anthony Pennington-Cross & Susan Wachter, State and Local Anti-
Predatory Lending Laws: The Effect of Legal Enforcement Mechanisms, 60 
J. Econ. & Bus. 47-66 (2008), full working paper version available at 
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1005423. 
---------------------------------------------------------------------------
    Critics, including some Federal banking regulators, have blamed the 
states for igniting the credit crisis through lax regulation. 
Certainly, there were states that were largely unregulated and there 
were states where mortgage regulation was weak. Mortgage brokers were 
loosely regulated in too many states. Similarly, the states never 
agreed on an effective, uniform system of mortgage regulation.
    Nevertheless, this criticism of the states disregards the hard-
fought efforts by a growing number of states--which eventually grew to 
include the majority of states--to regulate abusive subprime loans 
within their borders. State attorneys general and State banking 
commissioners spearheaded some of the most important enforcement 
actions against deceptive mortgage lenders.\36\
---------------------------------------------------------------------------
    \36\ For instance, in 2002, State authorities in 44 states struck a 
settlement with Household Finance Corp. for $484 million in consumer 
restitution and changes in its lending practices following enforcement 
actions to redress alleged abusive subprime loans. Iowa Attorney 
General, States Settle With Household Finance: Up to $484 Million for 
Consumers (Oct. 11, 2002), available at www.iowa.gov/government/ag/
latest_news/releases/oct_2002/Household_
Chicago.html. In 2006, forty-nine states and the District of Columbia 
reached a $325 million settlement with Ameriquest Mortgage Company over 
alleged predatory lending practices. See, e.g., Press Release, Iowa 
Dep't of Justice, Miller: Ameriquest Will Pay $325 Million and Reform 
its Lending Practices (Jan. 23, 2006), available at http://
www.state.ia.us/government/ag/latest_news/releases/jan_2006/
Ameriquest_Iowa.html. 
---------------------------------------------------------------------------
C. The Ability to Shop For Hospitable Laws and Regulators
    State-chartered banks and thrifts and their subsidiaries had to 
comply with the State anti-predatory lending laws. So did independent 
nonbank lenders and mortgage brokers. For the better part of the 
housing boom, however, national banks, Federal savings associations, 
and their mortgage lending subsidiaries did not have to comply with the 
State anti-predatory lending laws due to Federal preemption rulings by 
their Federal regulators. This became a problem because Federal 
regulators did not replace the preempted State laws with strong Federal 
underwriting rules.

1. Federal Preemption
    The states that enacted anti-predatory lending laws did not 
legislate in a vacuum. In 1996, the Federal regulator for thrift 
institutions--the Office of Thrift Supervision or OTS--promulgated a 
sweeping preemption rule declaring that henceforth Federal savings 
associations did not have to observe State lending laws.\37\ Initially, 
this rule had little practical effect because any State anti-predatory 
lending provisions on the books then were fairly narrow.\38\
---------------------------------------------------------------------------
    \37\ 12 C.F.R.  559.3(h), 560.2.
    \38\ Bostic et al., supra note 35; Office of Thrift Supervision, 
Responsible Alternative Mortgage Lending: Advance notice of proposed 
rulemaking, 65 Fed. Reg. 17811, 17814-16 (2000).
---------------------------------------------------------------------------
    Following adoption of the OTS preemption rule, Federal thrift 
institutions and their subsidiaries were relieved from having to comply 
with State consumer protection laws. That was not true, however, for 
national banks, State banks, State thrifts, and independent nonbank 
mortgage lenders and brokers.
    The stakes rose considerably starting in 1999, when North Carolina 
passed the first comprehensive State anti-predatory lending law. As 
State mini-HOEPA laws proliferated, national banks lobbied their 
regulator--a Federal agency known as the Office of the Comptroller of 
the Currency or OCC--to clothe them with the same Federal preemption as 
Federal savings associations. They succeeded and, in 2004, the OCC 
issued its own preemption rule banning the states from enforcing their 
laws impinging on real estate lending by national banks and their 
subsidiaries.\39\ In a companion rule, the OCC denied permission to the 
states to enforce their own laws that were not federally preempted--
state lending discrimination laws are one example--against national 
banks and their subsidiaries. After a protracted court battle, the 
controversy ended up in the U.S. Supreme Court, which upheld the OCC 
preemption rule.\40\
---------------------------------------------------------------------------
    \39\ Office of the Comptroller of the Currency, Bank Activities and 
Operations; Final rule, 69 Fed. Reg. 1895 (2004) (codified at 12 C.F.R. 
 7.4000); Office of the Comptroller of the Currency, Bank Activities 
and Operations; Real Estate Lending and Appraisals; Final rule, 69 Fed. 
Reg. 1904 (2004) (codified at 12 C.F.R.  7.4007-7.4009, 34.4). 
National City Corporation, the parent of National City Bank, N.A., and 
a major subprime lender, spearheaded the campaign for OCC preemption. 
Predatory lending laws neutered, Atlanta Journal Constitution, Aug. 6, 
2003.
    \40\ Watters v. Wachovia Bank, N.A., 550 U.S. 1 (2007); Arthur E. 
Wilmarth, Jr., The OCC's Preemption Rules Exceed the Agency's Authority 
and Present a Serious Threat to the Dual Banking System, 23 Ann. Rev. 
Banking & Finance Law 225 (2004). The Supreme Court recently granted 
certiorari to review the legality of the OCC visitorial powers rule. 
Cuomo v. Clearing House Ass'n, L.L.C.,__U.S.__, 129 S. Ct. 987 (2009).
    The OCC and the OTS left some areas of State law untouched, namely, 
State criminal law and State law regulating contracts, torts, homestead 
rights, debt collection, property, taxation, and zoning. Both agencies, 
though, reserved the right to declare that any State laws in those 
areas are preempted in the future. For fuller discussion, see. McCoy & 
Renuart, supra note 26.
---------------------------------------------------------------------------
    OTS and the OCC had institutional motives to grant Federal 
preemption to the institutions that they regulated. Both agencies 
depend almost exclusively on fees from their regulated entities for 
their operating budgets. Both were also eager to persuade State-
chartered depository institutions to convert to a Federal charter. In 
addition, the OCC was aware that if national banks wanted Federal 
preemption badly enough, they might defect to the thrift charter to get 
it. Thus, the OCC had reason to placate national banks to keep them in 
its fold. Similarly, the OTS was concerned about the steady decline in 
thrift institutions. Federal preemption provided an inducement to 
thrift institutions to retain the Federal savings association charter.
2. The Ability to Shop for the Most Permissive Laws
    As a result of Federal preemption, State anti-predatory lending 
laws applied to State-chartered depository institutions and independent 
nonbank lenders, but not to national banks, Federal savings 
associations, or their mortgage lending subsidiaries. The only anti-
predatory lending provisions that national banks and federally 
chartered thrifts had to obey were HOEPA and agency pronouncements on 
subprime and nontraditional mortgage loans.\41\ Of these, HOEPA had 
extremely narrow scope. Meanwhile, agency guidances lacked the binding 
effect of rules and their content was not as strict as the stronger 
State laws.
---------------------------------------------------------------------------
    \41\ Board of Governors of the Federal Reserve System et al., 
Interagency Guidance on Subprime Lending (March 1, 1999); OCC, Abusive 
Lending Practices, Advisory Letter 2000-7 (July 25, 2000); OCC et al., 
Expanded Guidance for Subprime Lending Programs (Jan. 31, 2001); OCC, 
Avoiding Predatory and Abusive Lending Practices in Brokered and 
Purchased Loans, Advisory Letter 2003-3 (Feb. 21, 2003); OCC, 
Guidelines for National Banks to Guard Against Predatory and Abusive 
Lending Practices, Advisory Letter 2003-2 (Feb. 21, 2003); OCC, OCC 
Guidelines Establishing Standards for Residential Mortgage Lending 
Practices, 70 Fed. Reg. 6329 (2005); Department of the Treasury et al., 
Interagency Guidance on Nontraditional Mortgage Product Risks; Final 
guidance, 71 Fed. Reg. 58609 (2006); Department of the Treasury et al., 
Statement on Subprime Mortgage Lending; Final guidance, 72 Fed. Reg. 
37569 (2007). Of course, these lenders, like all lenders, are subject 
to prosecution in cases of fraud. Lenders are also subject to the 
Federal Trade Commission Act, which prohibits unfair and deceptive acts 
and practices (UDAPs). However, Federal banking regulators were slow to 
propose rules to define and punish UDAP violations by banking companies 
in the mortgage lending area.
---------------------------------------------------------------------------
    This dual regulatory system allowed mortgage lender to play 
regulators off one another by threatening to change charters. Mortgage 
lenders are free to operate with or without depository institution 
charters. Similarly, depository institutions can choose between a State 
and Federal charter and between a thrift charter and a commercial bank 
charter. Each of these choices allows a lender to change regulators.
     A lender could escape a strict State law by switching to a Federal 
bank or thrift charter or by shifting its operations to a less 
regulated State. Similarly, a lender could escape a strict regulator by 
converting its charter to one with a more accommodating regulator.
    Countrywide, the nation's largest mortgage lender and a major 
subprime presence, took advantage of this system to change its 
regulator. One of its subsidiaries, Countrywide Home Loans, was 
supervised by the Federal Reserve. This subsidiary switched and became 
an OTS-regulated entity as of March 2007. That same month, Countrywide 
Bank, N.A., converted its charter from a national bank charter under 
OCC supervision to a Federal thrift charter under OTS supervision. 
Reportedly, OTS promised Countrywide's executives to be a ``less 
antagonistic'' regulator if Countrywide switched charters to OTS. Six 
months later, the regional deputy director of the OTS West Region, 
where Countrywide was headquartered, was promoted to division director. 
Some observers considered it a reward.\42\
---------------------------------------------------------------------------
    \42\ Richard B. Schmitt, Regulator takes heat over IndyMac, Los 
Angeles Times, Oct. 6, 2008; see also Binyamin Appelbaum & Ellen 
Nakashima, Regulator Played Advocate Over Enforcer, Washington Post, 
November 23, 2008.
---------------------------------------------------------------------------
    The result was a system in which lenders could shop for the loosest 
laws and enforcement. This shopping process, in turn, put pressure on 
regulators at all levels--state and local--to lower their standards or 
relax enforcement. What ensued was a regulatory race to the bottom.

III. Regulatory Failure
    Federal preemption would not have been such a problem if Federal 
banking regulators had replaced State laws with tough rules and 
enforcement of their own. Those regulators had ample power to stop the 
deterioration in mortgage underwriting standards that mushroomed into a 
full-blown crisis. However, they refused to intervene in disastrous 
lending practices until it was too late. As a result, federally 
regulated lenders--as well as all lenders operating in states with weak 
regulation--were given carte blanche to loosen their lending standards 
free from meaningful regulatory intervention.

A. The Federal Reserve Board
    The Federal Reserve Board had the statutory power, starting in 
1994, to curb lax lending not only for depository institutions, but for 
all lenders across-the-board. It declined to exercise that power in any 
meaningful respect, however, until after the nonprime mortgage market 
collapsed.
    In the mortgage lending area, the Fed's supervisory process has 
three major parts and breakdowns were apparent in two out of the three. 
The only part that appeared to work well was the Fed's role as the 
primary Federal regulator for State-chartered banks that are members of 
the Federal Reserve System.\43\
---------------------------------------------------------------------------
    \43\ In general, these are community banks on the small side. In 
2007 and 2008, only one failed bank--the tiny First Georgia Community 
Bank in Jackson, Georgia, with only $237.5 million in assets--was 
regulated by the Federal Reserve System. It is not clear whether the 
Fed's performance is explained by the strength of its examination 
process, the limited role of member banks in risky lending, the fact 
that State banks had to comply with State anti-predatory lending laws, 
or all three.
    In the following discussion on regulatory failure by the Federal 
Reserve Board, the OTS, and the OCC, the data regarding failed and 
near-failed banks and thrifts come from Federal bank regulatory and 
S.E.C. statistics, disclosures, press releases, and orders; rating 
agency reports; press releases and other web materials by the companies 
mentioned; statistics compiled by the American Banker; and financial 
press reports.
---------------------------------------------------------------------------
    As the second part of its supervisory duties, the Fed regulates 
nonbank mortgage lenders owned by bank holding companies but not owned 
directly or indirectly by banks or thrifts. During the housing boom, 
some of the largest subprime and Alt-A lenders were regulated by the 
Fed, including the top- and third-ranked subprime lenders in 2006, HSBC 
Finance and Countrywide Financial Corporation, and Wells Fargo 
Financial, Inc.\44\ The Fed's supervisory record with regard to these 
lenders was mixed. On one notable occasion, in 2004, the Fed levied a 
$70 million civil money penalty against CitiFinancial Credit Company 
and its parent holding company, Citigroup Inc., for subprime lending 
abuses.\45\ Apart from that, the Fed did not take public enforcement 
action against the nonbank lenders that it regulated. That may be 
because the Federal Reserve did not routinely examine the nonbank 
mortgage lending subsidiaries under its supervision, which the late 
Federal Reserve Board Governor Edward Gramlich revealed in 2007. Only 
then did the Fed kick off a ``pilot project'' to examine the nonbank 
lenders under its jurisdiction on a routine basis for loose 
underwriting and compliance with Federal consumer protection laws.\46\
---------------------------------------------------------------------------
    \44\ Data provided by American Banker, available at 
www.americanbanker.com. 
    \45\ Federal Reserve, Citigroup Inc. New York, New York and 
Citifinancial Credit Company Baltimore, Maryland: Order to Cease and 
Desist and Order of Assessment of a Civil Money Penalty Issued Upon 
Consent, May 27, 2004.
    \46\ Edward M. Gramlich, Boom and Busts, The Case of Subprime 
Mortgages, Speech given August 31, 2007, Jackson Hole, Wyo., at 
symposium titled ``Housing, Housing Finance & Monetary Policy,'' 
sponsored by the Federal Reserve Bank of Kansas City, pp. 8-9, 
available at www.kansascityfed.org/publicat/sympos/2007/pdf/
2007.09.04.gramlich.pdf; Speech by Governor Randall S. Kroszner At the 
National Bankers Association 80th Annual convention, Durham, North 
Carolina, October 11, 2007.
---------------------------------------------------------------------------
    Finally, the Board is responsible for administering most Federal 
consumer credit protection laws, including HOEPA. When former Governor 
Edward Gramlich served on the Fed, he urged then-Chairman Alan 
Greenspan to exercise the Fed's power to address unfair and deceptive 
loans under HOEPA. Greenspan refused, preferring instead to rely on 
non-binding statements and guidances.\47\ This reliance on statements 
and guidances had two disadvantages: one, major lenders routinely 
dismissed the guidances as mere ``suggestions'' and, two, guidances did 
not apply to independent nonbank mortgage lenders.
---------------------------------------------------------------------------
    \47\ House of Representatives, Committee on Oversight and 
Government Reform, ``The Financial Crisis and the Role of Federal 
Regulators, Preliminary Transcript'' 35, 37-38 (Oct. 23, 2008), 
available at http://oversight.house.gov/documents/20081024163819.pdf. 
Greenspan told the House Oversight Committee in 2008:

        Well, let's take the issue of unfair and deceptive practices, 
which is a fundamental concept
        to the whole predatory lending issue.
        The staff of the Federal Reserve . . . say[ ] how do they 
determine as a regulatory group
        what is unfair and deceptive? And the problem that they were 
concluding . . . was the
        issue of maybe 10 percent or so are self-evidently unfair and 
deceptive, but the vast
        majority would require a jury trial or other means to deal with 
it . . .

    Id. at 89.
---------------------------------------------------------------------------
    The Federal Reserve did not relent until July 2008, when under 
Chairman Ben Bernanke's leadership, it finally promulgated binding 
HOEPA regulations banning specific types of lax and abusive loans. Even 
then, the regulations were mostly limited to higher-priced mortgages, 
which the Board confined to first-lien loans of 1.5 percentage points 
or more above the average prime offer rate for a comparable 
transaction, and 3.5 percentage points for second-lien loans. Although 
shoddy nontraditional mortgages below those triggers had also 
contributed to the credit crisis, the rule left those loans--plus prime 
loans--mostly untouched.\48\
---------------------------------------------------------------------------
    \48\ Federal Reserve System, Truth in Lending: Final rule; official 
staff commentary, 73 Fed. Reg. 44522, 44536 (July 30, 2008). The Board 
set those triggers with the intention of covering the subprime market, 
but not the prime market.  See id. at 44536-37.
---------------------------------------------------------------------------
    The rules, while badly needed, were too little and too late. On 
October 23, 2008, in testimony before the U.S. House of Representatives 
Oversight Committee, Greenspan admitted that ``those of us who have 
looked to the self-interest of lending institutions to protect 
shareholder's equity (myself especially) are in a state of shocked 
disbelief.'' House Oversight Committee Chairman Henry Waxman asked 
Greenspan whether ``your ideology pushed you to make decisions that you 
wish you had not made?'' Greenspan replied:\49\
---------------------------------------------------------------------------
    \49\ House of Representatives, Committee on Oversight and 
Government Reform, ``The Financial Crisis and the Role of Federal 
Regulators, Preliminary Transcript'' 36-37 (Oct. 23, 2008), available 
at http://oversight.house.gov/documents/20081024163819.pdf. 

        Mr. GREENSPAN. . . . [Y]es, I found a flaw, I don't know how 
        significant or permanent it is, but I have been very distressed 
        by that fact . . .
        Chairman WAXMAN. You found a flaw?

        Mr. GREENSPAN. I found a flaw in the model that defines how the 
        world works, so to speak.

        Chairman WAXMAN. In other words, you found that your view of 
        the world, your ideology, was not right, it was not working.

        Mr. GREENSPAN. Precisely. That's precisely the reason I was 
        shocked, because I had been going for 40 years or more with 
        very considerable evidence that it was working exceptionally 
        well.\50\

    \50\ Testimony of Dr. Alan Greenspan before the House of 
Representatives Committee of Government Oversight and Reform, October 
23, 2008, available at http://oversight.house.gov/documents/
20081023100438.pdf.
---------------------------------------------------------------------------
B. Regulatory Lapses by the OCC and OTS
    Federal preemption might not have devolved into a banking crisis of 
systemic proportions had OTS and the OCC replaced State regulation for 
their regulated entities with a comprehensive set of binding rules 
prohibiting lax underwriting of home mortgages. Generally, in lieu of 
binding rules, Federal banking regulators, including the OCC and OTS, 
issued a series of ``soft law'' advisory letters and guidelines against 
predatory or unfair mortgage lending practices by insured depository 
institutions.\51\ Federal regulators disavowed binding rules during the 
run-up to the subprime crisis on grounds that the guidelines were more 
flexible and that the agencies enforced those guidelines through bank 
examinations and informal enforcement actions.\52\ Informal enforcement 
actions were usually limited to negotiated, voluntary agreements 
between regulators and the entities that they supervised, which made it 
easy for management to drag out negotiations to soften any restrictions 
and to bid for more time. Furthermore, examinations and informal 
enforcement are highly confidential, making it easy for a lax regulator 
to hide its tracks.
---------------------------------------------------------------------------
    \51\ See note 41 supra.
    \52\ Office of the Comptroller of the Currency, Bank Activities and 
Operations; Real Estate Lending and Appraisals; Final rule, 69 Fed. 
Reg. 1904 (2004).
---------------------------------------------------------------------------
1. The Office of Thrift Supervision
    Although OTS was the first agency to adopt Federal preemption, it 
managed to fly under the radar during the subprime boom, overshadowed 
by its larger sister agency, the OCC. After 2003, while commentators 
were busy berating the OCC preemption rule, OTS allowed the largest 
Federal savings associations to embark on an aggressive campaign of 
expansion through option payment ARMs, subprime loans, and low-
documentation and no-documentation loans.
    Autopsies of failed depository institutions in 2007 and 2008 show 
that five of the seven biggest failures were OTS-regulated thrifts. Two 
other enormous thrifts during that period--Wachovia Mortgage, FSB and 
Countrywide Bank, FSB--were forced to arrange hasty takeovers by large 
bank holding companies to avoid failing. By December 31, 2008, thrifts 
totaling $355 billion in assets had failed in the previous sixteen 
months on OTS' watch.
    The reasons for the collapse of these thrifts evidence fundamental 
regulatory lapses by OTS. Almost all of the thrifts that failed in 2007 
and 2008--and all of the larger ones--succumbed to massive levels of 
imprudent home loans. IndyMac Bank, FSB, which became the first major 
thrift institution to fail during the current crisis in July 2008, 
manufactured its demise by becoming the nation's top originator of low-
documentation and no-documentation loans. These loans, which became 
known as ``liar's loans,'' infected both the subprime market and credit 
to borrowers with higher credit scores. By 2006 and 2007, over half of 
IndyMac's home purchase loans were subprime loans and IndyMac Bank 
approved up to half of those loans based on low or no documentation.
    Washington Mutual Bank, popularly known as ``WaMu,'' was the 
nation's largest thrift institution in 2008, with over $300 billion in 
assets. WaMu became the biggest U.S. depository institution in history 
to fail on September 25, 2008, in the wake of the Lehman Brothers 
bankruptcy. WaMu was so large that OTS examiners were stationed there 
permanently onsite. Nevertheless, from 2004 through 2006, despite the 
daily presence of the resident OTS inspectors, risky option ARMs, 
second mortgages, and subprime loans constituted over half of WaMu's 
real estate loans each year. By June 30, 2008, over one fourth of the 
subprime loans that WaMu originated in 2006 and 2007 were at least 
thirty days past due. Eventually, it came to light that WaMu's 
management had pressured its loan underwriters relentlessly to approve 
more and more exceptions to WaMu's underwriting standards in order to 
increase its fee revenue from loans.\53\
---------------------------------------------------------------------------
    \53\ Peter S. Goodman & Gretchen Morgenson, Saying Yes, WaMu Built 
Empire on Shaky Loans, N.Y. Times, Dec. 28, 2008.
---------------------------------------------------------------------------
    Downey Savings & Loan became the third largest depository 
institution to fail in 2008. Like WaMu, Downey had loaded up on option 
ARMs and subprime loans. When OTS finally had to put it into 
receivership, over half of Downey's total assets consisted of option 
ARMs and nonperforming loans accounted for over 15 percent of the 
thrift's total assets.
    In short, the three largest depository institution failures in 2007 
and 2008 resulted from high concentrations of poorly underwritten 
loans, including low- and no-documentation ARMs (in the case of 
IndyMac) and option ARMs (in the case of WaMu and Downey) that were 
often only underwritten to the introductory rate instead of the fully 
indexed rate. During the housing bubble, OTS issued no binding rules to 
halt the proliferation by its largest regulated thrifts of option ARMs, 
subprime loans, and low- and no-documentation mortgages. Instead, OTS 
relied on oversight through guidances. IndyMac, WaMu, and Downey 
apparently treated the guidances as solely advisory, however, as 
evidenced by the fact that all three made substantial numbers of 
hazardous loans in late 2006 and in 2007 in direct disregard of an 
interagency guidance on nontraditional mortgages issued in the fall of 
2006 and subscribed to by OTS that prescribed underwriting ARMs to the 
fully indexed rate.\54\
---------------------------------------------------------------------------
    \54\ Department of the Treasury et al., Interagency Guidance on 
Nontraditional Mortgage Product Risks; Final guidance, 71 Fed. Reg. 
58609 (2006).
---------------------------------------------------------------------------
    The fact that all three institutions continued to make loans in 
violation of the guidance suggests that OTS examinations failed to 
result in enforcement of the guidance. Similarly, OTS fact sheets on 
the failures of all three institutions show that the agency 
consistently declined to institute timely formal enforcement 
proceedings against those thrifts prohibiting the lending practices 
that resulted in their demise. In sum, OTS supervision of residential 
mortgage risks was confined to ``light touch'' regulation in the form 
of examinations, nonbinding guidances, and occasional informal 
agreements that ultimately did not work.

2. The Office of the Comptroller of the Currency
    The OCC has asserted that national banks made only 10 percent of 
subprime loans in 2006. But this assertion fails to mention that 
national banks moved aggressively into Alt-A low-documentation and no-
documentation loans during the housing boom.\55\ This mattered a lot, 
because the biggest national banks are considered ``too big to fail'' 
and pose systemic risk on a scale unmatched by independent nonbank 
lenders. We might not be debating the nationalization of Citibank and 
Bank of America today had the OCC stopped them from expanding into 
toxic mortgages, bonds, and SIVs.
---------------------------------------------------------------------------
    \55\ Testimony by John C. Dugan, Comptroller, before the Senate 
Committee on Banking, Housing, and Urban Affairs, March 4, 2008.
---------------------------------------------------------------------------
    Like OTS, ``light touch'' regulation was apparent at the OCC. 
Unlike OTS, the OCC did promulgate one rule, in 2004, prohibiting 
mortgages to borrower who could not afford to repay. However, the rule 
was vague in design and execution, allowing lax lending to proliferate 
at national banks and their mortgage lending subsidiaries through 2007.
    Despite the 2004 rule, through 2007, large national banks continued 
to make large quantities of poorly underwritten subprime loans and low- 
and no-documentation loans. In 2006, for example, fully 62.6 percent of 
the first-lien home purchase mortgages made by National City Bank, 
N.A., and its subsidiary, First Franklin Mortgage, were higher-priced 
subprime loans. Starting in the third quarter of 2007, National City 
Corporation reported five straight quarters of net losses, largely due 
to those subprime loans. Just as with WaMu, the Lehman Brothers 
bankruptcy ignited a silent run by depositors and pushed National City 
Bank to the brink of collapse. Only a shotgun marriage with PNC 
Financial Services Group in October 2008 saved the bank from FDIC 
receivership.
    The five largest U.S. banks in 2005 were all national banks and too 
big to fail. They too made heavy inroads into low- and no-documentation 
loans. The top-ranked Bank of America, N.A., had a thriving stated-
income and no-documentation loan program which it only halted in August 
2007, when the market for private-label mortgage-backed securities 
dried up. Bank of America securitized most of those loans, which may be 
why the OCC tolerated such lax underwriting practices.
    Similarly, in 2006, the OCC overrode public protests about a 
``substantial volume'' of no-documentation loans by JPMorgan Chase 
Bank, N.A., the second largest bank in 2005, on grounds that the bank 
had adequate ``checks and balances'' in place to manage those loans.
    Citibank, N.A., was the third largest U.S. bank in 2005. In 
September 2007, the OCC approved Citibank's purchase of the 
disreputable subprime lender Argent Mortgage, even though subprime 
securitizations had slowed to a trickle. Citibank thereupon announced 
to the press that its new subsidiary--christened ``Citi Residential 
Lending''--would specialize in nonprime loans, including reduced 
documentation loans. But not long after, by early May 2008 after Bear 
Stearns narrowly escaped failure, Citibank was forced to admit defeat 
and dismantle Citi Residential's lending operations.
    The fourth largest U.S. bank in 2005, Wachovia Bank, N.A., 
originated low- and no-documentation loans through its two mortgage 
subsidiaries. Wachovia Bank originated such large quantities of these 
loans--termed Alt-A loans--that by the first half of 2007, Wachovia 
Bank was the twelfth largest Alt-A lender in the country. These loans 
performed so poorly that between December 31, 2006 and September 30, 
2008, the bank's ratio of net write-offs on its closed-end home loans 
to its total outstanding loans jumped 2400 percent. Concomitantly, the 
bank's parent company, Wachovia Corporation, was reported its first 
quarterly loss in years due to rising defaults on option ARMs made by 
Wachovia Mortgage, FSB, and its Golden West predecessor. Public concern 
over Wachovia's loan losses triggered a silent run on Wachovia Bank in 
late September 2008, following Lehman Brothers' failure. To avoid 
receivership, the FDIC brokered a hasty sale of Wachovia to Wells Fargo 
after Wells Fargo outbid Citigroup for the privilege.
    Wells Fargo Bank, N.A., was in better financial shape than 
Wachovia, but it too made large quantities of subprime and reduced 
documentation loans. In 2006, over 23 percent of the bank's first-lien 
refinance mortgages were high-cost subprime loans. Wells Fargo Bank 
also securitized substantial numbers of low- and no-documentation 
mortgages in its Alt-A pools. In 2007, a Wells Fargo prospectus for one 
of those pools stated that Wells Fargo had relaxed its underwriting 
standards in mid-2005 and did not verify whether the mortgage brokers 
who had originated the weakest loans in that loan pool complied with 
its underwriting standards before closing. Not long after, as of July 
25, 2008, 22.77 percent of the loans in that loan pool were past due or 
in default.
    As the Wells Fargo story suggests, the OCC depended on voluntary 
risk management by national banks, not regulation of loan terms and 
practices, to contain the risk of improvident loans. A speech by the 
then-Acting Comptroller, Julie Williams, confirmed as much. In 2005, 
Comptroller Williams, in a speech to risk managers at banks, coached 
them on how to ``manage'' the risks of no-doc loans through debt 
collection, higher reserves, and prompt loss recognition. 
Securitization was another risk management device favored by the OCC.
    Three years later, in 2008, the Treasury Department's Inspector 
General issued a report that was critical of the OCC's supervision of 
risky loans.\56\ Among other things, the Inspector General criticized 
the OCC for not instituting formal enforcement actions while lending 
problems were still manageable in size. In his written response to the 
Inspector General, the Comptroller, John Dugan, conceded that ``there 
were shortcomings in our execution of our supervisory process'' and 
ordered OCC examiners to start initiating formal enforcement actions on 
a timely basis.\57\
---------------------------------------------------------------------------
    \56\ Office of Inspector General, Department of the Treasury, 
``Safety and Soundness: Material Loss Review of ANB Financial, National 
Association'' (OIG-09-013, Nov. 25, 2008).
    \57\ Id.
---------------------------------------------------------------------------
    The OCC's record of supervision and enforcement during the subprime 
boom reveals many of the same problems that culminated in regulatory 
failure by OTS. Like OTS, the OCC usually shunned formal enforcement 
actions in favor of examinations and informal enforcement. Neither of 
these supervisory tools obtained compliance with the OCC's 2004 rule 
prohibiting loans to borrowers who could not repay. Although the OCC 
supplemented that rule later on with more detailed guidances, some of 
the largest national banks and their subsidiaries apparently decided 
that they could ignore the guidances, judging from their lax lending in 
late 2006 and in 2007. The OCC's emphasis on managing credit risk 
through securitization, reserves, and loss recognition, instead of 
through product regulation, likely encouraged that laissez faire 
attitude by national banks.

C. Judging by the Results: Loan Performance By Charter
    OCC and OTS regulators have argued that their agencies offer 
``comprehensive'' supervision resulting in lower default rates on 
residential mortgages. The evidence shows otherwise.
    Data from the Federal Deposit Insurance Corporation show that among 
depository institutions, Federal thrift institutions had the worst 
default rate for one-to-four family residential mortgages from 2006 
through 2008. (See Figure 5).

  Figure 5. Total Performance of Residential Mortgages by Depository 
        Institution Lenders 

        
        
    Source: FDIC Statistics on Depository Institutions

    The second-worst performance record among depository institution 
lenders went to national banks. State thrifts had better default rates 
than either type of federally chartered institution in 2007 and 2008. 
State banks consistently had the lowest default rates of all.
    Among these charter types, the only ones that enjoy Federal 
preemption are national banks regulated by the OCC and Federal thrift 
institutions regulated by the OTS. State banks and State thrift 
institutions do not. Thus it appears, at least among depository 
institutions, that Federal preemption was associated with higher 
default rates, not lower rates, during 2006 through 2008, when credit 
standards hit bottom and the mortgage market imploded.
    These data do not address whether that independent nonbank lenders 
have even higher default rates in some states and that may in fact be 
the case. Nevertheless, the data undercut the assertion that Federal 
preemption reduces default rates among mortgages by depository 
institution lenders. To the contrary, the lowest default rates were at 
State banks and thrifts, which are subject both to State and Federal 
regulation.

IV. What to Do
    Dual regulation and the resulting crazy quilt of laws encouraged 
lenders to shop for the lightest rules. In turn, this pressured 
regulators to weaken their standards and to relax enforcement of safety 
and soundness and consumer protection laws.
    Casting underwriting standards to the wind in a seemingly obscure 
corner of the consumer credit market ended up triggering a global 
recession. This crisis shows that the United States ignores consumer 
protection at its peril. If it was not clear before, we now know that 
systemic stability and consumer protection are inextricably linked.
    To correct the regulatory lapses that I have described, our 
financial regulatory system needs to adopt three reforms:

    First, Congress should adopt uniform minimum safety 
        standards for all providers of consumer credit, regardless of 
        the type of entity or charter.

    Second, the authority for administering and enforcing these 
        standards should be housed in one Federal agency whose sole 
        mission is consumer protection.

    Third, to avoid the risk of agency inaction, Congress 
        should give parallel enforcement authority to the states and 
        allow consumers to bring private causes of action to recover 
        for injuries they sustain.

I expand on these proposals below.

A. Uniform Federal Safety Standards For Consumer Credit
    The downward spiral in underwriting standards drove home the need 
for minimum, uniform consumer credit safety standards. Adopting a 
uniform Federal floor would prevent lenders and brokers from seeking 
safe havens in legal regimes that do little or nothing to protect 
consumers.
    The purpose of these uniform Federal standards is three-fold. 
First, the standards should ensure proper loan underwriting based on 
the consumer's ability to repay. Second, the standards should prohibit 
unfair or deceptive practices in consumer credit products and 
transactions. Finally, the standards should promote transparency 
through improved consumer disclosures, product simplification and 
product standardization. Bottom-line, Federal standards should make it 
possible for consumers to engage in meaningful comparison shopping, 
with no hidden surprises.
    The experience with the high-cost loan provisions of HOEPA reveals 
that a detailed regulatory statute limited to specific loan terms is 
not an effective approach. HOEPA has proven too rigid and has failed to 
address new abuses as they appeared in the mortgage market. Instead, 
Congress should authorize a broad statutory mandate to give the 
implementing agency the flexibility to respond promptly to industry 
innovations (both good and bad) in the consumer credit industry. This 
broad statutory model would be akin to the open-ended provisions found 
in Section 5 of the Federal Trade Commission Act and Section 10(b) of 
the Securities Exchange Act of 1934, instead of the highly detailed 
prohibitions found in HOEPA. Congress should then delegate broad 
authority to the implementing agency to promulgate rules--preferably 
objective ones--to implement the statute.
    The uniform standards should constitute a floor, in which weaker 
State laws are federally preempted. Under the statute, however, states 
should remain free to enact stricter consumer protections so long as 
those protections are consistent with the Federal statute.
    A minimum Federal floor, instead of a ceiling, is critical for 
three reasons. First, states are closer to local conditions and often 
more responsive to emerging problems at home. A Federal floor would 
preserve the states' ability to protect their citizens. Second, giving 
latitude to states to adopt stricter standards would preserve the 
states' important role as laboratories of experimentation. Finally, a 
Federal floor, not a ceiling, would provide an important safeguard 
against the possibility that the implementing agency might adopt weak 
rules or fail to update the rules.
    As part of or in addition to creating the uniform Federal standards 
just outlined, Congress should transfer the authority to administer 
other existing Federal consumer credit laws to the implementing agency. 
At a minimum, oversight for the Truth in Lending Act, HOEPA, the Real 
Estate Settlement and Procedures Act, the Fair Credit Reporting Act, 
the Fair Debt Collection Practices Act, the fair lending laws, the Fair 
Credit Billing Act, and the Home Mortgage Disclosure Act should be 
transferred to this agency.\58\ Responsibility for administering 
Section 5 of the Federal Trade Commission Act as it applies to all 
providers of consumer credit should also be consolidated in this 
agency.
---------------------------------------------------------------------------
    \58\ This agency should also receive sole responsibility for 
administering the Consumer Leasing Act, the Right to Financial Privacy 
Act, the Electronic Fund Transfer Act, the Expedited Funds Availability 
Act, the Women's Business Ownership Act, the Fair Credit and Charge 
Card Disclosure Act, the Home Equity Loan Consumer Protection Act, the 
Truth in Savings Act, title V of the Gramm-Leach-Bliley Act, and the 
Fair and Accurate Credit Transaction Act.
---------------------------------------------------------------------------
B. A Dedicated Federal Agency Whose Sole Mission is Consumer Protection

1. Federal Regulators Cannot Serve Two Masters
    The housing bubble and hazardous mortgages by federally regulated 
depository institutions show that we cannot expect consumer protection 
to be paramount to Federal banking regulators. Recent history has shown 
that the safety and soundness mandate of Federal banking regulators 
regularly eclipses concern for consumer protection. For this reason, 
the consumer protection function should be removed from Federal banking 
regulators and housed in its own agency whose sole mission is consumer 
protection.
    The bank regulatory agencies' own mission statements make it clear 
that consumer protection is a low priority. For example, the Federal 
Reserve Board divides its duties into four general areas:\59\
---------------------------------------------------------------------------
    \59\ The Federal Reserve System, Purposes & Functions 1 (9th ed. 
2005).

    ``conducting the nation's monetary policy by influencing 
        the monetary and credit conditions in the economy in pursuit of 
        maximum employment, stable prices, and moderate long-term 
---------------------------------------------------------------------------
        interest rates

    ``supervising and regulating banking institutions to ensure 
        the safety and soundness of the nation's banking and financial 
        system and to protect the credit rights of consumers

    ``maintaining the stability of the financial system and 
        containing systemic risk that may arise in financial markets

    ``providing financial services to depository institutions, 
        the U.S. Government, and foreign official institutions, 
        including playing a major role in operating the nation's 
        payments system.''

In the Fed's description, monetary policy comes first, followed by 
banking supervision. Consumer protection does not even merit its own 
bullet point.
    Similarly, safety and soundness regulation is the paramount mission 
of the OCC and OTS. The OCC describes its mission as having four 
objectives, the last of which is consumer protection:\60\
---------------------------------------------------------------------------
    \60\ Comptroller of the Currency, About the OCC (viewed February 
28, 2009), available at http://www.occ.treas.gov/aboutocc.htm.

    ``To ensure the safety and soundness of the national 
---------------------------------------------------------------------------
        banking system.

    ``To foster competition by allowing banks to offer new 
        products and services.

    ``To improve the efficiency and effectiveness of OCC 
        supervision, including reducing regulatory burden.

    ``To ensure fair and equal access to financial services for 
        all Americans.''

Like the OCC, OTS describes safety and soundness as its principal 
job:\61\
---------------------------------------------------------------------------
    \61\ Office of Thrift Supervision, Mission and Goals (viewed 
February 28, 2009), available at http://www.ots.treas.gov/
?p=MissionGoal.

        To supervise savings associations and their holding companies 
        in order to maintain their safety and soundness and compliance 
        with consumer laws, and to encourage a competitive industry 
---------------------------------------------------------------------------
        that meets America's financial services needs.

    In theory, safety and soundness should serve consumer protection. 
In practice, it has not, as recent experience shows. During the housing 
boom, Federal banking regulators too often mistook short-term 
profitability, including profits from excessive fees on consumers,\62\ 
with safety and soundness. In their effort to protect the short-term 
profitability of banks and thrifts, Federal regulators often dismissed 
consumer protection as conflicting with that mission. When agencies 
derive most of their operating budgets from assessments on the entities 
they regulate--as do the OCC and OTS--the pressure to sacrifice 
consumer protection for profit maximization by those entities can be 
overwhelming.\63\
---------------------------------------------------------------------------
    \62\ Examples include regulators' slow response to curtailing large 
prepayment penalties and their continued indecision on costly overdraft 
protection.
    \63\ For instance, the OCC derives 95 percent of its budget from 
assessments on national banks. The twenty largest national banks 
contribute almost 60 percent of those assessments. See, e.g., Bar-Gill 
& Warren, supra note 5, at 193-94 (working draft version); Testimony of 
Arthur E. Wilmarth, Jr., Hearing before the Subcomm. on Financial 
Institutions and Consumer Credit of the House Comm. on Financial 
Services (Apr. 26, 2007).
---------------------------------------------------------------------------
    I served on the Federal Reserve Board's Consumer Advisory Council 
from 2002 through 2004 and saw firsthand how resistant Federal banking 
regulators were to instituting basic consumer protections during the 
run-up to the current crisis. Repeatedly over that period, I and other 
members of that Council warned the Federal Reserve's staff and 
Governors about rising foreclosures and other dangers associated with 
reckless subprime loans. We urged the Board to exercise its powers 
under HOEPA to strengthen protections for subprime and nontraditional 
mortgages, but to no avail. During my tenure on the Council, the late 
Governor Gramlich told me during a break at one of the Council's public 
meetings that there was not enough support on the Board to expand 
HOEPA's protections. These experiences confirmed my belief that banking 
regulators often dismiss the consumer protection piece of their 
mission.
    Some critics argue that removing consumer protection 
responsibilities from Federal banking regulators and housing them in 
their own dedicated agency would undercut the safety and soundness of 
banks. As the current crisis shows, however, entrusting consumer 
protection to the Federal banking agencies is no guarantee of bank 
safety and soundness. Indeed, having a separate Federal watchdog for 
consumer credit would help place healthy, countercyclical constraints 
on the tendency of Federal banking regulators to sacrifice long-term 
safety for short-term profits at the top of the credit cycle. It would 
also encourage forward-looking regulation as new problems arise, 
instead of laggard, backward-looking regulation of the type recently 
issued by the Federal Reserve.
    Congress could institute mechanisms to avoid agency conflicts or to 
resolve them if they occur. Such mechanisms could include formal or 
informal consultation with Federal banking regulators or judicial 
dispute resolution.

2. A Separate Federal Consumer Credit Agency Offers Other Strong 
        Advantages
    A wide range of experts across the political spectrum, from the 
Treasury Department under former Secretary Paulson to the Congressional 
Oversight Panel, have recommended housing consumer credit protection in 
its own separate agency.\64\ A separate Federal agency dedicated to 
consumer protection for all consumer credit would offer several 
distinct advantages. First, it would consolidate industry-wide 
enforcement in one agency, which would mean that all providers of 
credit would be subject to the same level of enforcement. Under the 
current regime, even though the Federal Reserve Board administers most 
Federal consumer credit laws, compliance examinations and enforcement 
are divided among Federal banking regulators and sometimes other 
agencies. Other Federal consumer protection laws--such as Section 5 of 
the Federal Trade Commission Act and the Community Reinvestment Act--
are individually implemented by the four Federal banking regulators 
with respect to their regulated entities. Each agency can make its own 
choice about the extent to which it enforces or does not enforce the 
law. Ending this fragmentation of enforcement would discourage lenders 
from switching charters in search of the easiest regulator.
---------------------------------------------------------------------------
    \64\ The Department of the Treasury, Blueprint for a Modernized 
Financial Regulatory Structure 170-74 (March 2008) (proposing a Conduct 
of Business Regulatory Agency), available at www.treasury.gov;  
Congressional Oversight Panel, Special Report on Regulatory Reform 30-
37 (Jan. 2009), available at http://cop.senate.gov/documents/cop-
012909-report-regulatoryreform.pdf. The Committee on Capital Markets 
Regulation recommended an independent consumer protection agency as one 
alternative. Committee on Capital Markets Regulation, Recommendations 
for Reorganizing the U.S. Financial Regulatory Structure 5 (Jan. 14, 
2009), available at http://www.capmktsreg.org. While the Government 
Accountability Office has not taken a position, last month it advised 
that ``[c]onsumer protection should be viewed from the perspective of 
the consumer rather than through the various and sometimes divergent 
perspectives of the multitude of Federal regulators that currently have 
responsibilities in this area.'' General Accountability Office, 
Financial Regulation: a Framework for Crafting and Assessing Proposals 
to Modernize the Outdated U.S. Financial Regulatory System 18 (GAO-09-
349T Feb. 4, 2009), available at www.gao.gov. See also Heidi Mandanis 
Schooner, Consuming Debt: Structuring the Federal Response to Abuses in 
Consumer Credit, 18 Loyola Consumer L. Rev.  43, 77-78, 82 (2005) 
(``while there are benefits to combining prudential regulation and 
consumer protection, serious doubt remains as to whether it is the best 
arrangement''; ``[t]he most sensible approach to correcting the 
structural defect in the current regime would be to eliminate entirely 
the Federal banking regulators' role in consumer protection'').
---------------------------------------------------------------------------
    Transferring consumer credit laws to one agency whose sole mission 
is consumer protection would also provide regulators with a complete 
overview of the entire consumer credit market, its structure, and 
emerging issues. Right now, consumer credit regulation suffers from a 
silo mentality because it is parceled out among so many agencies. 
Consolidating consumer credit oversight would overcome this silo 
mentality. In addition, consolidation would have the benefit of 
concentrating expertise for consumer credit products in one agency.

3. Agency Responsibilities and Oversight
    In assigning consumer credit protection to its own separate agency, 
it is necessary to ask whether the agency should adopt a supervisory 
model based on routine examinations akin to banking regulation or an 
enforcement model akin to that used by the Security and Exchange 
Commission or the Federal Trade Commission.
    Banking regulators are supposed to examine all of their regulated 
entities for consumer compliance on a routine basis. Requiring regular 
examinations of all credit providers and related entities, from 
depository institutions and nonbank lenders to mortgage brokers and 
payday lenders, would be extremely costly and not the best use of tax 
dollars.
    Given the large number of participants in the consumer credit 
market, it would make more sense to adopt an enforcement model similar 
to that used by the Securities and Exchange Commission.\65\ Under that 
model, market participants would be required to register with the 
agency and obtain licenses. Regular reporting would provide the agency 
with a steady flow of needed information to pinpoint possible 
violations and identify new problems. Under its broad statutory 
mandate, the agency would issue binding rules and interpretations to 
prohibit unfair and deceptive acts and practices. The agency's research 
arm would conduct empirical tests of the effects of new financial 
products and proposed regulations. Finally, the agency should have 
strong enforcement authority, including the power to conduct special 
examinations and issue subpoenas; the power to take agency enforcement 
action and levy restitution and sanctions; and criminal and civil 
enforcement authority.
---------------------------------------------------------------------------
    \65\ A consumer complaint model alone, such as that employed by the 
FTC, would not provide an oversight agency with enough information or 
authority to keep abreast of the rapid pace of financial innovation.
---------------------------------------------------------------------------
4. Should Congress Create a New Agency or Transfer All Consumer Credit 
        Oversight to the Federal Trade Commission?
    In removing consumer credit oversight from Federal banking 
regulators and transferring it to a dedicated agency, Congress must 
decide where to house it. There are two obvious choices. One would be 
to create a new agency for consumer credit oversight. The other would 
be to transfer this responsibility to the Federal Trade Commission.
    Each approach has advantages and disadvantages. Unlike the FTC, a 
brand new agency would be solely responsible for consumer credit 
products and would not be distracted by other duties, such as policing 
antitrust violations or the marketing of home appliances, over-the-
counter drugs, dietary supplements, computer software, and other 
products, that fall under the FTC's purview.
    A new agency would also have the benefit of starting on a clean 
slate. If, as I recommend, the model for consumer protection is based 
on the SEC's registration and reporting scheme, the FTC would have to 
transform itself away from its current consumer complaint enforcement 
model. The FTC, like any other agency, has a bias toward the status quo 
that could make it hard to implement a new enforcement model and 
otherwise change the way the agency functions. A new agency would not 
suffer under this handicap.
    On the other hand, creating a new Federal agency would be costly 
and entail substantial startup time. The FTC already has the 
institutional expertise and single-minded commitment to consumer 
protection to regulate consumer credit industry-wide. This is 
particularly true within the FTC's Division of Financial Practices and 
the Division of Privacy and Identity Protection, which fall in the 
FTC's Bureau of Consumer Protection. In 2008, the Division of Financial 
Practices specifically ramped up its staff and in-house training in 
anticipation of heightened enforcement activity.
    Of course, for the FTC to succeed as the consumer protection 
enforcer, the agency would need dramatic increases in funding. A new 
agency would also need a substantial commitment of resources to 
properly do its job. Presumably, some of this cost could be defrayed by 
transferring resources from the consumer compliance operations of 
Federal banking regulators.
    Consolidating oversight in one Federal agency--whether that agency 
is new or the FTC--poses a final concern about agency capture and 
inaction. The FTC, for example, had a vigorous enforcement record 
regarding mortgage abuses during the Clinton Administration but a 
lackluster record during the George W. Bush Administration until 
recently. Whether consumer credit protection is consolidated in a new 
agency or the FTC, the best antidote to agency inaction is outside 
enforcement. Accordingly, Congress should give parallel enforcement 
authority for Federal consumer credit laws to State regulators and 
private causes of action (including carefully crafted assignee 
liability) to injured consumers. Congress could also set target 
consumer protection goals, such as maximum default rates, and require 
the implementing agency to report to Congress on its performance. 
Finally, that agency should be funded through congressional 
appropriations instead of assessments on regulated entities to assure 
that the agency remains independent.

         RESPONSE TO WRITTEN QUESTION OF SENATOR VITTER
            FOR STEVE BARTLETT BY IRVING E. DANIELS

    Q.1. In my experience, TILA violations are small, technical 
violations related to the TILA mortgage disclosure. In the 
past, they have been used by the trial lawyers to file numerous 
class action law suits that were frivolous in nature, but very 
serious for the industry--and consumers that would ultimately 
bear the burden of any costs of litigation. Some of my 
colleagues may recall the infamous ``Rodash'' decision that was 
rendered in Florida in the mid-1990s. Mrs. Rodash was a 
sympathetic complainant who could not afford to repay the 
mortgage she took out. Her attorney claimed that the 
disclosures of the Federal Express charge and the taxes imposed 
by the State of Florida were disclosed on the wrong lines on 
the form. There was no doubt that she owed the money, but the 
attorney alleged that the charges were simply disclosed on the 
wrong line of the forms. The judge felt sorry for her and ruled 
in favor of Mrs. Rodash. The tolerance for error at that time 
was $10 and both the Federal Express charge and the Florida 
State taxes exceeded that $10 tolerance. The ``Rodash'' 
decision spawned more than 250 class action law suits and would 
have cost the mortgage industry more than $1.3 trillion in 
liability had Congress not intervened and passed retroactive 
legislation to right this wrong.
    The issue of mortgage disclosures is a thorny one.
    There are two Federal laws that govern the disclosures in 
the mortgage transactions--RESPA and TILA. Last year, HUD 
finalized a rule to revise the RESPA disclosures. Currently, 
the Fed is currently working on revamping the TILA disclosure. 
Neither HUD nor the Fed have worked to combine and coordinate 
their disclosures so the result is going to be that the 
consumer is going to get more disclosures that are even more 
confusing--and that will not conflict--than the disclosures 
they currently receive. I doubt that anyone in this room thinks 
that the pile of paper you get in the mortgage process is not 
confusing.
    So, now that the Feds are working to confuse consumers even 
more with their ``new and improved'' disclosures, we are going 
to turn the enforcement of this mess over to the State AGs. 
This will, undoubtedly, result in an enormous increase in 
litigation.
    This Committee has heard testimony recommending that it 
should work to close regulatory gaps. The TILA provisions 
inserted in the Omnibus spending bill allows State attorneys 
general to enforce consumer issues. Therefore, adding more 
duplication to a fragmented system. Why are we doing this? We 
have enough of a mess on our hands without creating a new one.

    A.1. The Financial Services Roundtable has regularly urged 
the agencies to work together in crafting regulations that 
overlap practices and activities in the economy. Most recently, 
The Roundtable, its Housing Policy Council and other industry 
groups spent considerable time explaining to Congress and to 
HUD and the Federal Reserve that the RESPA regulations HUD was 
creating would overlap the broader jurisdiction of the Federal 
Reserve and its TILA responsibilities. In addition, we pointed 
out that the TILA revision project of the Federal Reserve was 
underway at the time HUD staff was drafting. The staff of the 
Federal Reserve also commented directly to HUD on that same 
point.
    HUD issued its RESPA rules anyway without coordinating with 
the Federal Reserve. Now lenders are faced with the 
responsibility of making major changes in our RESPA practices, 
technology and training only to likely face the need to make 
additional ones in the same areas as the Federal Reserve 
announces its regulations under TILA. Most likely there will be 
irreconcilable conflicts between the two.
    To the Roundtable, it is a further demonstration of the 
harm that the regulatory silo effect can have in conducting 
business, and the confusion that it sews in the minds of 
consumers who, in the case we are discussing, will have yet 
more mortgage disclosures that will be confusing. We urge 
Congress to look closely at the Blueprint for regulatory reform 
that the Roundtable has published where we have proposed 
solutions to some of these issues. We strongly support agency 
coordination on issues such as mortgage term disclosures.
                                ------                                


   RESPONSE TO WRITTEN QUESTION OF SENATOR VITTER FROM ELLEN 
                            SEIDMAN

    Q.1. In my experience, TILA violations are small, technical 
violations related to the TILA mortgage disclosure. In the 
past, they have been used by the trial lawyers to file numerous 
class action law suits that were frivolous in nature, but very 
serious for the industry--and consumers that would ultimately 
bear the burden of any costs of litigation. Some of my 
colleagues may recall the infamous ``Rodash'' decision that was 
rendered in Florida in the mid-1990s. Mrs. Rodash was a 
sympathetic complainant who could not afford to repay the 
mortgage she took out. Her attorney claimed that the 
disclosures of the Federal Express charge and the taxes imposed 
by the State of Florida were disclosed on the wrong lines on 
the form. There was no doubt that she owed the money, but the 
attorney alleged that the charges were simply disclosed on the 
wrong line of the forms. The judge felt sorry for her and ruled 
in favor of Mrs. Rodash. The tolerance for error at that time 
was $10 and both the Federal Express charge and the Florida 
State taxes exceeded that $10 tolerance. The ``Rodash'' 
decision spawned more than 250 class action law suits and would 
have cost the mortgage industry more than $1.3 trillion in 
liability had Congress not intervened and passed retroactive 
legislation to right this wrong.
    The issue of mortgage disclosures is a thorny one.
    There are two Federal laws that govern the disclosures in 
the mortgage transactions--RESPA and TILA. Last year, HUD 
finalized a rule to revise the RESPA disclosures. Currently, 
the Fed is currently working on revamping the TILA disclosure. 
Neither HUD nor the Fed have worked to combine and coordinate 
their disclosures so the result is going to be that the 
consumer is going to get more disclosures that are even more 
confusing--and that will not conflict--than the disclosures 
they currently receive. I doubt that anyone in this room thinks 
that the pile of paper you get in the mortgage process is not 
confusing.
    So, now that the Feds are working to confuse consumers even 
more with their ``new and improved'' disclosures, we are going 
to turn the enforcement of this mess over to the State AGs. 
This will, undoubtedly, result in an enormous increase in 
litigation.
    This Committee has heard testimony recommending that it 
should work to close regulatory gaps. The TILA provisions 
inserted in the Omnibus spending bill allows State attorneys 
general to enforce consumer issues. Therefore, adding more 
duplication to a fragmented system. Why are we doing this? We 
have enough of a mess on our hands without creating a new one.

    A.1. I completely agree with the Senator that greater 
coordination between government agencies who are working to the 
same end is highly desirable; consumers have enough difficulty 
understanding mortgage documents without having to attempt to 
decipher documents that are written for different purposes with 
potentially different outcomes. With respect to the role of 
State attorneys general, in the current mortgage crisis, State 
attorneys general were early movers in uncovering, litigating, 
and recovering for plaintiffs damages from abusive mortgage 
practices. The Ameriquest and Countrywide cases stand out--
serious, non-duplicative cases that generated major changes in 
practice, albeit too late. There is no reason to believe the 
AGs would not hold themselves to a similar standard with 
respect to TILA litigation.
                                ------                                


RESPONSE TO WRITTEN QUESTION OF SENATOR VITTER FROM PATRICIA A. 
                             McCOY

    Q.1. In my experience, TILA violations are small, technical 
violations related to the TILA mortgage disclosure. In the 
past, they have been used by the trial lawyers to file numerous 
class action law suits that were frivolous in nature, but very 
serious for the industry--and consumers that would ultimately 
bear the burden of any costs of litigation. Some of my 
colleagues may recall the infamous ``Rodash'' decision that was 
rendered in Florida in the mid-1990s. Mrs. Rodash was a 
sympathetic complainant who could not afford to repay the 
mortgage she took out. Her attorney claimed that the 
disclosures of the Federal Express charge and the taxes imposed 
by the State of Florida were disclosed on the wrong lines on 
the form. There was no doubt that she owed the money, but the 
attorney alleged that the charges were simply disclosed on the 
wrong line of the forms. The judge felt sorry for her and ruled 
in favor of Mrs. Rodash. The tolerance for error at that time 
was $10 and both the Federal Express charge and the Florida 
State taxes exceeded that $10 tolerance. The ``Rodash'' 
decision spawned more than 250 class action law suits and would 
have cost the mortgage industry more than $1.3 trillion in 
liability had Congress not intervened and passed retroactive 
legislation to right this wrong.
    The issue of mortgage disclosures is a thorny one.
    There are two Federal laws that govern the disclosures in 
the mortgage transactions--RESPA and TILA. Last year, HUD 
finalized a rule to revise the RESPA disclosures. Currently, 
the Fed is currently working on revamping the TILA disclosure. 
Neither HUD nor the Fed have worked to combine and coordinate 
their disclosures so the result is going to be that the 
consumer is going to get more disclosures that are even more 
confusing--and that will not conflict--than the disclosures 
they currently receive. I doubt that anyone in this room thinks 
that the pile of paper you get in the mortgage process is not 
confusing.
    So, now that the Feds are working to confuse consumers even 
more with their ``new and improved'' disclosures, we are going 
to turn the enforcement of this mess over to the State AGs. 
This will, undoubtedly, result in an enormous increase in 
litigation.
    This Committee has heard testimony recommending that it 
should work to close regulatory gaps. The TILA provisions 
inserted in the Omnibus spending bill allows State attorneys 
general to enforce consumer issues. Therefore, adding more 
duplication to a fragmented system. Why are we doing this? We 
have enough of a mess on our hands without creating a new one.

    A.1. Did not respond by publication deadline.
