[Senate Hearing 111-274]
[From the U.S. Government Publishing Office]
S. Hrg. 111-274
CREATING A CONSUMER FINANCIAL PROTECTION AGENCY: A CORNERSTONE OF
AMERICA'S NEW ECONOMIC FOUNDATION
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
ON
THE CREATION OF A CONSUMER FINANCIAL PROTECTION AGENCY TO BE THE
CORNERSTONE OF AMERICA'S NEW ECONOMIC FOUNDATION
__________
JULY 14, 2009
__________
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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
Edward Silverman, Staff Director
William D. Duhnke, Republican Staff Director
Amy S. Friend, Chief Counsel
Jonathan N. Miller, Professional Staff Member
Kara Stein, Legislative Assistant
Randall Fasnacht, GAO Detailee
Mark Oesterle, Republican Chief Counsel
Andrew J. Olmem, Jr., Republican Counsel
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, JULY 14, 2009
Page
Opening statement of Chairman Dodd............................... 1
Prepared statement........................................... 57
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Johnson
Prepared statement....................................... 58
WITNESSES
Michael S. Barr, Assistant Secretary for Financial Institutions,
Department of the Treasury..................................... 6
Prepared statement........................................... 59
Responses to written questions of:
Chairman Dodd............................................ 141
Senator Johnson.......................................... 148
Senator Vitter........................................... 149
Richard Blumenthal, Attorney General, State of Connecticut....... 34
Prepared statement........................................... 66
Edward L. Yingling, President and Chief Executive Officer,
American
Bankers Association............................................ 36
Prepared statement........................................... 69
Responses to written questions of:
Chairman Dodd............................................ 153
Travis B. Plunkett, Legislative Director, Consumer Federation of
America........................................................ 38
Prepared statement........................................... 79
Responses to written questions of:
Chairman Dodd............................................ 154
Peter Wallison, Arthur F. Burns Fellow, American Enterprise
Institute...................................................... 39
Prepared statement........................................... 132
Sendhil Mullainathan, Professor of Economics, Harvard University. 41
Prepared statement........................................... 136
(iii)
CREATING A CONSUMER FINANCIAL PROTECTION AGENCY: A CORNERSTONE OF
AMERICA'S NEW ECONOMIC FOUNDATION
----------
TUESDAY, JULY 14, 2009
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:05 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. The Committee will come to order.
I would like to welcome all here this morning for this
morning's hearing on ``Creating a Consumer Financial Protection
Agency: A Cornerstone of America's New Economic Foundation.''
We want to thank you, Mr. Barr, for joining us, and our other
witnesses we will hear from after your testimony, and the
Members of the Committee who are here this morning. And,
obviously, my good friend and colleague Richard Shelby, former
Chairman of the Committee, will be making some opening comments
as well. So let me take a few minutes and share with you my
thoughts on this question and then turn to Richard for any
comments he has. And since only a few of us are here this
morning, Bob, if you have got any opening comments you would
like to make as well, I will turn to you, and then we will go
to you, Mr. Barr, for your testimony.
This morning we are taking an important step in our efforts
to modernize our financial regulatory system. The failure of
that system in recent years has left our economy in peril, as
we all know, and caused real pain for many hard-working
Americans who did nothing wrong themselves. And so I would like
to start by reminding everyone that the work we do here matters
to real people, men and women in my home State of Connecticut
and all across our Nation who work hard every day, play by the
rules, and want nothing more than to make a better life for
themselves and their families.
These families are the foundation, as all of us know, of
our economy and the reason that we are here in Washington
working on this historic and critically important legislation.
That is why the first piece of the Administration's
comprehensive plan to rebuild our regulatory regime and our
economy is something that I have championed as well, and that
is, an independent agency whose job it will be to ensure that
American consumers are treated fairly and honestly.
Think about the moments when Americans engaged with
financial service providers. Now, I am not talking about big-
time investors or financial experts. We know those people have
a level of sophistication. I am talking about just ordinary
citizens, working people trying to secure a stable future for
themselves and their families. They are opening checking
accounts. They are taking out loans. They are building their
credit. They are trying to build a foundation upon which their
families' economic security can rest for years to come. These
can be among the most important and stressful moments a family
can face.
Think of younger people who have carefully saved up for
that down payment on a home. It might be a modest house, but it
will be their first home, a starter home. Before they can move
into their new home, however, they must sign on the dotted line
for that first mortgage, with its pages and pages of complex
and confusing disclosures. Who is looking out for them in that
process?
Think of a factory worker who drives 30 miles to and from
work every day and that old car that is about to give out. He
or she needs another one to make it through the winter, but
wages are stagnant and the family budget is stretched to the
max. He has got no choice but to go to navigate the complicated
world of an auto loan. Who is looking out for that person at
that moment?
Think of a single mother--and there are many in our
country--whose 17-year-old son or daughter has just gotten into
his or her first choice of going to college. She is overjoyed
for him or her, but worried about how she is going to pay for
that tuition, which grows every year astronomically. Financial
aid might not be enough, and she knows that as her son or
daughter begins the next chapter in their lives filled with
promise, they may be saddled with overwhelming debt. Who is
looking out for that family under those circumstances?
These moments are the reason that we have invested so much
of our time and money to rebuild our financial sector, even
though some of the very institutions that the taxpayers have
propped up are responsible for their own predicaments. These
moments are the reason why we serve on this Committee and why I
believe we have all come to the Senate to try and make a
difference in the lives of the people we represent. And these
moments are the reason that I and many of my colleagues were
enraged by the spectacular failure of consumer protection that
destroyed economic security for so many of our American
families.
In my home State of Connecticut and around the country,
working men and women who did nothing wrong have watched this
economy fall through the floor, taking with it their jobs,
their homes, their life savings, and the cherished promise of
the American middle class. These people are hurting. They are
angry and they are worried, and they are wondering whether
anyone is looking out for them.
Since the very first hearings before this Committee on
modernizing our financial regulatory structure, I have said
that consumer protection should be a top priority in our
deliberations. Stronger consumer protection could have stopped
the crisis before it started, in my view. And where were the
regulators in all of this?
We know now that for 14 years, despite a clear directive
from the U.S. Congress, the Federal Reserve Board took no
action to ban abusive home mortgages. Gaping holes in the
regulatory fabric allowed mortgage brokers and bankers to make
and sell predatory loans to Wall Street that turned into toxic
securities and brought our economy to its knees.
That is why many of us call for the creation of an
independent consumer protection agency whose sole focus is the
financial well-being of consumers, an agency whose goal it is
to put an end to lending practices that have ripped off far too
many American families, and the Administration has sent us a
very bold and I believe thoughtful plan for that agency.
You would think financial services companies would support
protections that ensure the financial well-being of their
consumers. An independent consumer protection agency can and
should be very good for business, not just for consumers. It
can and should protect the financial well-being of American
consumers so that businesses can rely on a healthy customer
base as they seek to build long-term profitability. It can and
should eliminate the regulatory overlap and bureaucracy that
comes from the current Balkanized system of consumer protection
regulation. It can and should level the playing field by
applying a meaningful set of standards, not only to the highly
regulated banks but also to their nonbank competitors that have
slipped under the regulatory radar screen.
Financial services companies that want to make an honest
living should welcome this effort to create a level playing
field. Indeed, the good lenders--and there are many--are the
most disadvantaged when fly-by-night brokers and fly-by-night
finance companies set up shop down the street. Then we see bad
lending pushing out the good.
No Senator on this Committee, Democrat or Republican, wants
to stifle product innovation, limit consumer choice, or create
regulation that is unnecessary or unduly burdensome. And I
welcome the constructive input from those in the financial
services sector--who share our commitment, by the way, to
making sure that American families get a fair shake. We all
want financial services companies to thrive and succeed, but
they are going to have to make their money, in my view, the
old-fashioned way: by developing innovative products, pricing
competitively, providing excellent consumer service, and
engaging in fair competition on the open market.
The days of profiting from misleading or predatory
practices need to be over with completely. The path to recovery
of our financial services companies and our economy is based on
the financial health of American consumers. I believe that very
deeply. We need a system that rewards products and firms that
create wealth for American families, not one that rewards
financial engineering that generates profits for financial
firms by passing on hidden risks to investors and borrowers.
The fact that the consumer protection agency is the first
legislative item the Administration has sent to Congress since
it released its white paper on regulatory reform last month
tells me that our President's priorities are in the right
place. Nevertheless, with the backing of the Administration,
with the support of many in the financial community who
understand the importance of this reform, and, most of all,
with a mandate from the American families I have discussed who
count on a fair and secure financial system, I believe that we
will push forward and succeed.
I thank all of you for being with us here today as we move
forward on this issue. Let me say, as I have said many times
already in discussions both informally and formally, Richard
Shelby, my partner in all of this, he and I are determined to
work together on this to get this right. This is not one where
we bring a lot of ideology to this debate but, rather, what
works, what makes sense, what will restore the confidence and
optimism of people all across this country--and, for that
matter, around the world, who look to the United States as a
safe and secure place and an innovative place to come and park
their hard-earned dollars and hard-earned money.
And so, with that, I thank again everyone for being here,
and let me turn to Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
The Committee today, as the Chairman has already said, will
examine the Administration's proposal to establish a stand-
alone consumer protection agency. Well-regulated and
transparent financial markets have been and must continue to be
one of the central goals of our financial regulatory system.
The purpose of our markets is to benefit consumers by giving
them ways to save, invest, and conduct transactions.
Consumers are not likely to participate in our markets,
however, unless they know they are protected against fraud and
unfair dealings. In addition, consumers are more likely to use
financial products if they have the information they need to
make good financial decisions.
By creating confidence in our markets, consumer protection
promotes consumer participation, which in turn provides
additional benefits by increasing the size, vitality, and
resilience of our financial system. Good consumer protection,
therefore, makes good economic sense.
Since the start of the ongoing financial crisis, I have
stated that we should approach regulatory reform in a thorough
and deliberate manner. I believe this Committee should examine
what caused this financial crisis, develop solutions to the
problems identified by that examination, and then consider the
practical consequences of any reform measures.
This morning, we begin our examination of the
Administration's proposal. This is our first chance to review
the Administration's findings regarding the problems they have
identified and the solutions that they seek. As part of our
consideration, I believe it would be very useful, if not
necessary, for the Administration to submit for the record the
data and the evidence they used to craft a regulatory
restructuring proposal. It might be very helpful to us here.
In addition, the fact that the Administration has produced
a legislative draft gives us a chance to consider some of the
practical questions associated with the proposal. For example,
how will this new agency interact with the other banking
regulators? Who will have the final discretion over things like
capital treatment for alternative mortgage products or other
consumer credit products? What authority would the
Administration leave to State banking regulators?
What if there is a disagreement between a prudential
supervisor and the new consumer protection agency? What if a
prudential supervisor fails to operate in a manner consistent
with the consumer protection agency's guidelines? Will a
prudential supervisor be allowed to overrule the consumer
protection agency?
Will certain types of financial products be banned? What
standards would be used to make the decision to remove products
from the marketplace?
Beyond the practical issues regarding the program, I want
to highlight some conceptual issues that I believe we must
recognize as we consider financial consumer protection reform.
First, I believe that we must clearly acknowledge and
accept that risk cannot be eliminated from our financial
markets? It is risk taking that generates return. It would be
both false and irresponsible to lead the American people to
believe that an enhanced regulator can provide them with risk-
free opportunities.
Second, I believe that we must also acknowledge that the
risk associated with financial products are largely depending
on the circumstances surrounding a particular transaction and
the consumer. Some have tried to make oversimplistic analogies
comparing defective consumer products to certain financial
products. This is inaccurate, and I believe it is highly
inappropriate.
For example, a defective electrical device is dangerous
under every circumstance where it is used. We know that. But
that is not the case for financial products. A plain-vanilla
30-year fixed mortgage is not inherently safer, some argue,
than a shorter adjustable rate product? In fact, a 30-year
fixed mortgage could involve high costs and provide less value
to the consumer. We have to look at the circumstances.
Consumers need the relevant information and the means to
understand it so they can purchase products and engage in the
transactions that best fit their needs and circumstances. This
point bears on what I believe is finally the most important
issue associated with consumer protection reform. Who is best
able to decide about the value and the necessity of any
particular financial product or service?
Some, including those in the Administration, have decided
that consumers will not act in their own best interests and,
therefore, it is necessary that we remove or greatly restrict
products that in some situations might cause financial harm.
Implied in this belief is the notion that some people, such as
the Government bureaucrats, can make informed decisions about
the value of products and services while others, such as the
American consumer, cannot. In other words, ``Yes, we can,'' has
become ``No, you can't.''
While I can accept the view that in some cases consumers do
not have the necessary information or understanding to make
sound financial decisions, I do not accept the premise that the
remedy is to deny consumers decision-making power altogether. I
think this would be a very significant and paternalistic
departure from the notions of liberty and personal
responsibility that have previously guided all our regulatory
efforts. Quite frankly, I find it a bit disturbing and somewhat
offensive that the concept of the ``intellectually deficient
consumer'' has now found a voice in our legislative process.
To the extent that there is any merit to this theory, I
believe it would be better to provide those with deficiencies
the means to address them rather than seizing from them their
right to make free and informed choices. And while I look
forward to hearing from our witnesses, I am greatly concerned
over many aspects of the President's plan, not to mention its
underlying premise.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
And with that, we will turn to you, Mr. Barr, for your
opening statement and any supporting material or data you think
would be valuable for the Committee to have at this point. Why
don't you go ahead? Try and keep your remarks down, if you can,
to 5 or 10 minutes or so.
STATEMENT OF MICHAEL S. BARR, ASSISTANT SECRETARY FOR FINANCIAL
INSTITUTIONS, DEPARTMENT OF THE TREASURY
Mr. Barr. Certainly. Thank you very much, Chairman Dodd,
thank you very much, Ranking Member Shelby. It is a pleasure to
be back here to talk with you about the Administration's
proposal for a Consumer Financial Protection Agency, a strong
financial regulatory agency charged with just one job: looking
out for consumers across the financial services landscape.
The need could not be clearer. Today's consumer protection
system is fundamentally broken. It has just experienced a
massive failure. This failure cost millions of responsible
consumers their homes, their savings, and their dignity. And it
contributed to the near collapse of our financial system.
There are voices today saying that the status quo is fine
or good enough, that we should just keep the bank regulators in
charge of protecting consumers, that we just need some patches
to our broken system. They even claim consumers are better off
with the current approach. It is not surprising that we are
hearing these voices.
As Secretary Geithner observed last week, the President's
proposals would reduce the ability of financial institutions to
choose their own regulator and to continue financial practices
that were lucrative for a time, but that ultimately proved so
damaging to households and our economy. Entrenched interests
resist change always. Major reform always brings out fear
mongering. But responsible financial institutions and providers
have nothing to fear.
We all aspire to the same objectives for consumer
protection regulation: independence, accountability,
effectiveness, and balance. The question is how to achieve
them. A successful regulatory structure for consumer protection
requires a focused mission, marketwide coverage, and
consolidated authority.
Today's system has none of these qualities. It fragments
jurisdiction for consumer protection over many regulators, most
of which have higher priorities than protecting consumers.
Nonbanks avoid Federal supervision; no Federal consumer
compliance examiner lands at their doorsteps. Banks can choose
the least restrictive supervisor among several different
banking agencies with respect to consumer protection.
Fragmentation of rule writing, supervision, and enforcement
leads to finger-pointing in place of action and makes the
action that is taken less effective.
The President's proposal for one agency, for one
marketplace with one mission--to protect consumers--will change
that. The Consumer Financial Protection Agency will create a
level playing field for all providers, regardless of their
charter or corporate form. It will ensure high and uniform
standards across the financial services marketplace. It will
end profits based on misleading sales pitches and hidden fee
traps, along the lines of those that Senator Shelby and
Chairman Dodd worked together to end in the credit card market.
But there will be plenty of profits made on a level playing
field where banks and nonbanks can compete fairly on the basis
of price and quality.
If we create one Federal regulator with consolidated
authority, we will be able to leave behind regulatory arbitrage
and interagency finger-pointing. And we will be assured of
accountability.
Our proposal ensures, not limits, consumer choice; it
preserves, not stifles, innovation; it strengthens, not
weakens, depository institutions; it will reduce, not increase,
regulatory costs; and it will increase, not reduce, national
regulatory uniformity.
Successful consumer protection regulation requires mission
focus, marketwide coverage, and it requires expertise and
effectiveness through a consolidated supervisory entity.
Consumer protection requires a mission focus for
accountability, expertise, and effectiveness.
A new supervisor must have marketwide jurisdiction to
ensure consistent and high standards for everyone.
And an effective regulator requires authority for
regulation, supervision, and enforcement to be consolidated. A
regulator without the full kit of tools is frequently forced to
choose between acting with minimal effect and not acting at
all. We need to end the finger-pointing. The rule writer that
does not supervise providers lacks information it needs to
determine when to write or revise rules and how best to do so.
The supervisor that does not write rules lacks a marketwide
perspective or adequate incentives to act. Splitting
authorities is a recipe for inertia, inefficiency, and lack of
accountability.
The present system of consumer protection is not designed
to be independent or accountable, effective, or balanced. It is
designed to fail. It is simply incapable of earning and keeping
the trust of the American people.
Today's system does not meet a single one of the
requirements I just laid out. The system fragments jurisdiction
and authority for consumer protection over many agencies, most
of which have higher priorities than protecting consumers.
Nonbanks avoid Federal supervision; banks can choose the least
restrictive supervisor; and fragmentation of rule writing,
supervision, and enforcement leads to finger-pointing in place
of action.
This structure is a welcome mat for bad actors and
irresponsible practices. Responsible banks and credit unions
are forced to choose between keeping market share and treating
consumers fairly. The least common denominator sets the
standard, standards inevitably erode, and consumers pay the
price.
Mr. Chairman, if you look at the range of problems that
have been occurring in the marketplace through this fragmented
jurisdiction, I think that it is clear that the American public
cannot afford more of the same. The problems that we had in the
mortgage market--exploding ARMs, rising loan balances, credit
card tricks such as double-cycle billing and late fee traps,
the extent of failures in the past--are just unacceptable for
us in the future, and the system we have had that led to this
is structurally flawed. It is not capable of being fixed
through tinkering around the edges. The problem is the
structure itself.
That problem has only one effective solution: the creation
of one agency for one marketplace with one mission--to protect
consumers of financial products and services, and the authority
to achieve that mission.
It is time for a level playing field for financial services
competition based on strong rules, not based on exploiting
consumer confusion. It is time for an agency that consumers--
and their elected representatives--can hold fully accountable.
The Administration's legislation fulfills these needs.
Thank you for this opportunity to discuss our proposal, and
I would be happy to answer any questions.
Chairman Dodd. Well, thank you very much, and I did not
give you a proper introduction to begin with, and I apologize.
Mr. Barr is the Assistant Secretary for Financial Institutions
at the Department of Treasury, and I should have made the
formal introduction, so forgive me for not doing so.
Mr. Barr. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much for your testimony. As I
said at the outset, if you have any additional data that you
think would be helpful for the Committee in its consideration,
we would appreciate your submitting that to us as well. And I
will ask the clerk to put us on a 5-minute clock, if you would
here, and we will try and stay to that time.
Let me, if I can, be sort of the devil's advocate with you
because I anticipate these sorts of questions will be raised by
my colleagues as well. I know you have spent a lot of time in
your testimony on this point, but I think it is worth
reiterating. Why do you think a separate consumer protection
agency is necessary? And why wouldn't we just simply beef up
the existing regulatory bodies? Let us even assume we end up
consolidating a number of these regulatory bodies so they are
far more efficient, we stop the regulatory arbitrage that is
going on too often, the shopping, the charter shopping that we
talked about. Why not just beef them up, give them additional
personnel, and tell them they ought to be doing a better job?
In effect, aren't they supposed to be consumer protection
agencies in their own right? And so why in the world would you
go around and create a whole new one? And wouldn't you, in
fact, be then minimizing the importance of these other bodies
if they end up deferring that consumer protection function to
one agency and they are not doing the job they were supposed to
be doing in addition to their regulatory functions?
Mr. Barr. Thank you, Mr. Chairman. I think we have had a
long experiment with having the prudential supervisors over
banks responsible for consumer protection supervision, having
another agency--the Federal Reserve--responsible for rule
writing, having yet another agency--the Federal Trade
Commission--responsible for after-the-fact enforcement in the
nonbanking sector. And I think what we have seen and what the
American public has just experienced is a massive failure of
that system. And it was a massive failure of that system
because of the very structure of the system.
There were good people at the Federal Reserve, for example,
who wanted to effectuate strong consumer protections. You might
even say there were heroic people at the Federal Reserve who
wanted to effectuate consumer protection. Ned Gramlich, who was
a dear friend of mine, the Vice Chair of the Federal Reserve,
wanted to get consumer protection done, and the very structure
of the Federal Reserve, its very focus on what it viewed as
prudential supervision, its inability to move quickly on
consumer protection blocked reform in the mortgage market that
could have helped avert this crisis.
So I think we have had a long and disastrous experience
with having bank agencies with a mixed mission, with no one
focused on protecting consumers, with no one able to set rules
and supervise across the financial services marketplace, with
no one able to say there is going to be a level playing field
with high standards for everybody. And what we saw is the
market tipped to bad practices. We saw it tip to bad practices
in credit cards, practices which you and Mr. Shelby so
effectively blocked in the credit card bill this spring. We saw
it shift, tilt to bad practices in the mortgage market in ways
that were disastrous for the American people. And I just don't
think we can afford that experiment any longer. We have to have
a fresh start with a new agency whose sole mission is standing
up for the American people.
Chairman Dodd. Let me continue my role as the devil's
advocate. One of the arguments we are going to hear is this
will restrict the availability of credit to consumers, restrict
their choices; that a way that the financial institutions will
respond to this is just start saying no to a lot of people who
otherwise might have a chance to get that car loan, get that
started house; and so if you want us to make sure we are not
going to make any mistakes at all, not take any risks at all,
then we just won't provide that kind of extension of credit to
an awful lot of people out there.
How do we respond to the question that consumer credit and
consumer choices are going to be severely limited if, in fact,
you get so heavy-handed with a consumer protection agency that
the very people you are designing it to help here are actually
going to be hurt by this idea?
Mr. Barr. Mr. Chairman, I think that is exactly the thing
to be focused on, and in our legislative draft, we suggest that
the agency be required to assess not just the benefits of its
rules, but the costs of its rules; that it be required not just
to look at questions of consumer protection but also questions
of access; that it be required to evaluate its major rule
writing every 5 years to ensure that it is keeping up with
changes in the marketplace at a minimum; that it be required to
be held accountable through notice and comment rulemaking, even
when it is not going to do a rule, to let the public and
financial institutions comment on how it is doing its job.
I think it has got to weigh the costs and the benefits. It
has got to be a balanced entity. But what we want to see is a
level playing field, access for everyone based on high
standards. We want consumers to be able to choose whatever
product they want, whatever credit card they want, whatever
mortgage loan they want, whatever payday loan they want. We
want them to be able to choose loans, to choose products, to
choose services. We want the consumer to be empowered to do
that. We want it to be done on a level playing field with high
standards. So what they are choosing is based on transparency
and honesty and integrity in the process.
Chairman Dodd. Two final questions for you. I made the
point in my opening statement that I thought if this were done
well and right--as I plan to do so--that it is not only going
to be beneficial to consumers, but the one argument we do not
hear is that it is very beneficial to business, very beneficial
to the financial institutions themselves to have a consumer
protection agency, number one.
And, number two, a witness who will appear in the second
panel, Mr. Wallison from the American Enterprise Institute,
says in his statement here, ``If we are looking for a primary
cause of today's financial crisis, it is here,'' referring to
the Community Reinvestment Act.
Why don't you respond to the issue of whether or not you
believe the Community Reinvestment Act was the primary cause of
the financial crisis as well?
Mr. Barr. Thank you, Mr. Chairman. Let me first say I agree
with you that the Consumer Financial Protection Agency is good
for banks as well as for consumers. If banks are competing on
the basis of price and quality, that is good for them. If banks
and credit unions and their communities can compete on a level
playing field so we do not have a situation where a community
bank wants to do the right thing but an independent mortgage
company is stealing all market share with a policy that
consumers cannot understand, we don't want that in the future.
We want a level playing field based on fair competition, based
on transparency to consumers.
With respect to the Community Reinvestment Act, I think the
empirical evidence here, Mr. Chairman, is quite strong. I
looked at this when I was researching at the University of
Michigan. The Federal Reserve economists have looked at this
question. The Federal Reserve found that about 6 percent of
subprime mortgage loans were made by CRA-regulated institutions
with respect to low-income communities or low-income borrowers.
Six percent is unlikely to have driven, highly unlikely to have
driven the subprime mortgage crisis.
If you look at the timing of our subprime mortgage crisis
in the mid-2000's, it is hard to imagine that that was caused
by changes in CRA regulations a decade earlier in 1995. If you
look at the performance of CRA lending with respect to
equivalent subprime loans, comparable performance levels. So I
think the empirical evidence just does not support that claim.
Chairman Dodd. They have very strong underwriting standards
with CRA. The Community Reinvestment Act required very strong
underwriting standards to be met by the borrowers. Is that
true?
Mr. Barr. That is correct.
Chairman Dodd. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Secretary Barr, the proposed Consumer Financial Protection
Agency embodies the notions of behaviorally informed regulation
that you wrote about in an article published in October of last
year. The premise of that article, as I understood it, was
that--and I will quote--``Individuals consistently make choices
that they themselves agree diminish their own well-being in
significant ways.'' That was in the article.
This dim view of the capabilities of the average American
contrast with the author's belief, as we understood it, that
bureaucrats are capable of discerning what financial products
and services would maximize the well-being of individuals that
they don't even know.
Why do you believe that bureaucrats working for a Consumer
Financial Protection Agency would be able to make better
decisions than American consumers themselves?
Mr. Barr. Thank you, Mr. Chairman. I appreciate the
opportunity to make clear that that is not my view. In the
first case----
Senator Shelby. Was that in this article?
Mr. Barr. The quote is in the article, but the material
that followed that you articulated was not in the article. So
the material that followed is the point that I would say is not
my view. I would say it in two particular respects.
One is I think the common human failing that we identified
in the article are not about us versus them. They are common
human failings that all of us have. All of us make mistakes in
our daily lives. I get overdraft----
Senator Shelby. We learn from those mistakes, don't we?
Mr. Barr. We do learn from those mistakes, and sometimes
those mistakes are quite costly. But we all make them, is the
only point I--I wasn't trying to say--I am not speaking for
you, sir, but I know I make those mistakes all the time.
Senator Shelby. I probably make more. Go ahead.
Mr. Barr. So just to be clear on that.
So these are mistakes that I make, at least, and that other
people make and that are common mistakes, and our idea in the
legislation is not to prevent people from making mistakes. It
is to make it easier for them to avoid mistakes. Just easier
for them to avoid mistakes.
So if you have a product that people cannot understand,
then we need to figure out a way of making it easier for them
to understand.
Senator Shelby. I agree with that.
Mr. Barr. And, Mr. Shelby, I know you worked very hard on
the credit card legislation to make sure that credit card
products and services are offered in a transparent way, and to
let people know the consequences of their financial decisions
for the cost of making those choices, and that is exactly the
kind of approach that is embodied in this legislation.
Senator Shelby. Is your premise basically trying to take
risk out of a marketplace? And if there is no risk, there is no
marketplace, is there?
Mr. Barr. Sir, I think that risk and innovation are central
to our financial system.
Senator Shelby. We benefit from it, don't we?
Mr. Barr. We at times benefit from it and at times have
costs from it, and on balance, financial innovation and risk
taking are central to our system. What we are talking about
here is not eliminating risk, certainly not eliminating
financial innovation. Quite the contrary. I think those are
central concepts. But we have to see that happen on a level
playing field with high standards so that people are competing
based on price and quality and not consumer confusion.
Senator Shelby. The board of the consumer--the composition
of the board, the proposal of the Consumer Financial Protection
Agency would include the Director of the National Bank
Supervisors and four members of the President's choosing. There
is no limit on the number of members who are from the same
political party. This contrasts, as you well know, with the
limits on the composition of both the Securities and Exchange
Commission and the Consumer Product Safety Commission.
Why did you choose such a politically biased construct at
this point knowing that would raise red flags for some?
Mr. Barr. Senator Shelby, I would not describe it as
politically biased in any way. In fact, it is designed to be
not political, so there is not an identification of parties
with respect to those matters. And the board----
Senator Shelby. You do not say that, but that is what the
result would be.
Mr. Barr. And if you look, for example, Mr. Shelby, at the
Federal Reserve Board, we see a balanced range of individuals
on the Federal Reserve Board without a particular requirement
of party identification.
Senator Shelby. I would like to just restate a request I
made in my opening statement. I am sure the Administration used
a great deal of detailed data--you know, you had to--and
analysis that led to this proposal, because we would do this,
too. Would you please provide that data and your analysis of
that data to the Committee--not just to me, but the Chairman
and all of us, staff on both sides--so that we can use it in
our effort to evaluate your proposal? In other words, look at
your data, evaluate it, weigh it, because we might agree with
it. We might not. Would you do that?
Mr. Barr. We would be happy to work with the Committee to
provide whatever information would be available and useful to
you.
Senator Shelby. You state, Mr. Secretary, repeatedly that
the status quo is not acceptable because things are changing
every day in the marketplace, as we know, and the need for a
new independent consumer protection regime could not be
clearer. In addition, you state that, ``Banks can choose the
least restrictive supervisor among several banking
supervisors.'' Yet the Administration leaves in place in their
overall proposal exactly that fragmented system for prudential
supervision, four or five regulators.
Why is it that we must and why would you propose only one
agency responsible for consumer protection, but four Federal
banking agencies is entirely appropriate for safety and
soundness regulation of our system? Why would you do that if
you are going to have the other? If we had one prudential
banking regulator, you could draw the analogy, but I don't know
how you do it here.
Mr. Barr. Thank you, Mr. Chairman. Our view was that in the
context of prudential supervision and the arbitrage that we had
seen on the prudential side, that we could effectively deal
with that problem by merging the OCC and the OTS into a new
national bank supervisor, and eliminating the thrift charter,
eliminating the remaining distinctions between State member
banks, State nonmember banks, and national banks, and requiring
a series of protections against charter conversion in the event
that there were pending enforcement matters, pending problems
at any of the institutions.
It is not, I would agree, a perfect answer to that
question, and in the context of the Consumer Financial
Protection Agency, the problems that we saw were so pervasive,
the basic structural problems so severe, the extent of mission
conflict and mission confusion so strong, that we felt the only
real answer there was a Consumer Financial Protection Agency.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Mr. Secretary, in a panel that will follow you, Mr.
Yingling, who is the representative of the American Bankers
Association, has a series of critiques, and I would like to go
through some of them with you and see what your responses are.
First of all, he talks about how community banks are likely
to have greatly increased fees to fund a system that falls
disproportionately and unfairly on them, as they were not part
of the present crisis.
Second, he talks about this agency having the power to
compel the use of certain products that the agency would
define.
Third, he talks about two lessons that he believes are
fundamental building blocks of any reform of consumer
protection oversight: One is that the uniform regulation and
supervision of consumer protection performance should be
applied to nonbanks as rigorously as it has been applied to the
banking industry; and two, that regulatory policymakers for
consumer protection should not be divorced from the
responsibility for financial institution safety and soundness.
And he talks about how the failure of nonbank regulation was
the most severe under the current system.
So looking at those as some of the main points of critique
of the legislation, how do you respond to those?
Mr. Barr. Thank you, Senator Menendez. I would be happy to
address those four concerns.
First, with respect to community banks, community banks
have endured a system under which they are forced to compete
with independent mortgage companies and other unregulated
lenders in the system. They have been forced essentially by
market pressure to offer products and services that, if you are
in their community and you talk to community bankers, they
would rather not have offered. They would rather not have
gotten engaged in pay option ARMs. But because or the unlevel
playing field in supervision and regulation, the market tilted
to bad practices, and market pressure drove the market to a
place that was bad for community banks and it was bad for
consumers.
What we are saying here is there is going to be a level
playing field for community banks, for big banks, for
independent mortgage brokers, for anybody else in the
marketplace. One regulator is going to set the standards,
everybody can compete equally, on an equal footing.
Senator Menendez. Are you saying that the proposed
legislation that the Administration advocates is going to reach
to those previously unregulated entities?
Mr. Barr. Absolutely, sir. One of the key features of this
legislation is that nonbank providers for the first time are
going to get subject to supervision and examination and
enforcement with the same tools available to bank regulators.
So the legislation would say the new Consumer Financial
Protection Agency would apply these strong consumer standards
across the board so that no one competes on the basis of an
unlevel playing field or hiding the ball.
Second, with respect to the point about compelling the use
of products, the agency here is offering a lighter touch form
of regulation than banning or restricting products or services.
What the legislation provides is if the agency sees a problem
in the marketplace where some products and services are more
confusing based on more difficult terms for consumers, instead
of saying you can't offer that product at all--right?--which in
some instances an agency would want to say, Oh, we want to ban
that kind of product or service, in this instance the agency
has a different tool, a more flexible and more nuanced tool.
They can say, Look, if you want to offer a pay option ARM, you
have to show a consumer first what a 30-year fixed-rate
mortgage would look like or what a regular adjustable rate
mortgage looks like, what a 5-1 ARM without hidden features or
terms looks like, so they can compare and make their own
judgment, make their own choice, but make it based on something
that they can understand and that is comparable across the
marketplace.
Third, with respect to nonbanks, let me just reiterate
nonbanks will be subject to the same high standards, the same
rules, the same supervision, the same examination, the same
enforcement as banks for the first time ever.
And, last, with respect to the link to safety and
soundness, again, I think we have had a system. We just
experienced what it is like to have massive failure in a system
in which bank supervisors do safety and soundness and also do
consumer protection. And what happened is they did not do
safety and soundness in a good way, and they did not do
consumer protection in a good way. We had a massive failure in
our system. And we need to reform it. We need to give them a
single--the bank regulators need to have a single mission
focused on safety and soundness, and we need a new consumer
protection agency whose sole mission is consumer protection.
Agencies can then have one job. They can be held accountable
for doing that job. And you all can go out and talk to them and
say, ``This is your job. Why aren't you doing it?''
Senator Menendez. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Corker.
Senator Corker. Mr. Chairman, thank you, and thanks for
having this hearing. Mr. Secretary, thank you for your service.
I am going to digress just for 1 second. I think you may be
the overall architect, if you will, of much of what has been
put forth as it relates to regulatory changes, and I have been
somewhat curious that the GSEs were not addressed, and if we
could just spend about 30 seconds on that. Obviously, the
largest liabilities that we as a country have, other than
Medicare and Social Security, are within those GSEs, and yet at
a time when you in essence own them, we are not in any way
looking at changing their status or moving them along into a
different direction. I am just wondering why you all chose not
to address that.
Mr. Barr. Thank you, Senator Corker. In the Treasury
Department's report, we highlighted the fundamental need that
you articulated just now to reform those institutions, and we
promised to come back to the Congress at the time of the
President's budget submission in February with a reform
proposal, and really our judgment was just about sequencing of
what we could get done with you.
We think it is a high priority to get done. We will be
proposing legislation to you with respect to reform of the
Government-sponsored enterprises, looking at our mortgage
finance system as a whole. And between now and then, we will be
holding a series of public meetings as well as engaging in our
own internal deliberations to focus exactly on that question.
You are right. We need to address it.
Senator Corker. When is ``then''? When is ``then,'' when
you are going to be proposing this----
Mr. Barr. Oh, I am sorry. At the time of the President's
budget submission, which is in February of the coming year.
Senator Corker. So would you urge us to wait on regulatory
reform until after that point so that we can address it all?
Mr. Barr. Our judgment, again, Senator Corker, I do not
have--you all are obviously keepers of your own calendar, and I
would not want to suggest anything with respect to that. Our
own judgment in terms of the sequencing is that we could move
forward expeditiously on the financial reforms measure we have
put in place, that we have suggested that you put in place, and
next turn to the Government-sponsored enterprises in February.
I do not think we can afford to wait for 6 or 7 months to
do that. I think we need to act now and put in place these
essential measures for the financial system.
Senator Corker. So sort of a developing theme, I think,
within the Administration, not necessarily with yourself, is
that we have a lot of smart people who work with us that know
better than the average citizen what ought to happen in so many
areas, and it is just a theme that continues to evolve. So as I
look at this agency--and I no doubt believe that consumer
protection ought to take place. For the first time--and a lot
of people have sort of compared this to consumer product
safety, but, in essence, you all are advocating that you design
products for the financial industry. That is a major departure
from anything that has happened in any other category of the
economy that I am aware of. But you guys would be designing
products that all institutions had to conform to, which is very
different than product safety. They usually test products that
are designed by others afterwards to see that they are safe.
I am just wondering, what is it that drives you all to that
extreme?
Mr. Barr. Senator Corker, thank you for the opportunity to
clarify again that that is not at all what we have in mind. So
under this Consumer Financial Protection Agency, financial
institutions can continue to offer any product or service that
they want. The point of having a simple product offering is to
say if you are going to offer a complex product like a pay
option ARM, you also have to offer a straightforward product
that exists in the marketplace--a 30-year fixed-rate mortgage
with straightforward pricing and terms; a 5-1 or 7-1 ARM with
straightforward pricing and terms.
So I think that if you look at the language that we have
proposed, the factors that the agency is supposed to take into
account, this is not designed to dictate all the products and
services. It is not designed to----
Senator Corker. But it does dictate some, right? Because
you are dictating by virtue of what you just said.
Mr. Barr. It says certain products or services that are
standard products and services, if you are going to offer
exotic products and services, you also have to show the
consumer what it would cost to take out a straightforward
product that exists in the marketplace.
Senator Corker. So if Senator Warner, who has been a
tremendous entrepreneur, wanted to create a niche product to
serve the public, he would not be able to offer that niche
product unless he offered all of these other standard products,
which if he were a new boutique kind of company that was trying
to meet the need of a small part of our population that needed
that service, he would be unable to do that under your
legislation unless he offered all of these other types. Is that
correct?
Mr. Barr. Senator, if you look at the areas in which this
might apply, we are talking about, let's say, again, in the
mortgage context, if an entrepreneur wanted to offer a pay
option ARM, they would need to show the consumer what a 30-year
fixed-rate or regular ARM would look like in terms of cost so
the consumer can compare and make their own choices. They would
still be able to offer these other products and services in
whatever way they would like, but they would need to have a
point of comparison that shows what the costs and risks are in
relation to that standard.
Senator Corker. I have a number of questions, and I guess
we may have another round. I do not know if that is true or
not. So what you are saying is this new entity under your
proposal is not going to lay out basic requirements for certain
types of products. You are not going to do that. Yes or no?
Mr. Barr. Senator, with respect to what a standard product
is, you would be able to say a 30-year fixed-rate or a regular
ARM is a standard product, and if you wanted to offer other
products, that is fine; but you have got to compare it to this
product, too. You would not be saying----
Senator Corker. And you have to offer that product----
Mr. Barr. You have to offer the standard product if you are
going to offer the exotic product.
Senator Corker. OK. Well, I think my time is up, but I
think what you have just said, again, is that smaller
innovative companies that want to enter a market, which is what
our country is about as it relates to innovation--that is why
we are the leader that we are in the world. You are basically
saying that these entities, unless they offer other standard
products, would not be able to be in business. That is a large
departure from where we have been as a country, and I want to
revisit that with you. And I thank you for your service and
your testimony.
Chairman Dodd. Thank you, Senator, very much.
Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chair, and thank
you for your testimony and for your presentation of this
agency. It certainly has been a long time since we have had an
agency that was dedicated to consumers in the financial world,
and we have certainly seen many practices that have damaged the
financial foundations of our working families. And so I
certainly applaud the Administration for bringing this forward.
In your testimony and in follow-up questions, you talked
about a level playing field. I wanted to ask about one aspect
of that. If a State, for example, decided that it wanted to ban
yield spread premiums or incentives to brokers to basically
sell a more complicated product, a more expensive product,
wanted to ban those or make them perhaps transparent, at least
to be displayed to the consumer so the consumer understands
where the broker is receiving their compensation, would they be
able to do that under this legislation? And would it apply to
all folks who offer or only for State-chartered institutions?
Mr. Barr. Thank you very much, Senator Merkley. So under
our proposal, if a State wanted to have higher standards than
exist under Federal law, they would be able to apply those
standards. Under our proposal, the broad preemption provisions
that had previously applied to national banks and their
subsidiaries would not apply in that circumstance, so the
higher standard would be available for institutions operating
in that marketplace.
Senator Merkley. So this would eliminate the unfairness
that has arisen in part in the past where State-chartered
institutions might have been subject to higher standards
imposed by the State, but had federally chartered competitors
who were not subject to those standards?
Mr. Barr. That is correct.
Senator Merkley. Second, I wanted to ask you about a
phrase, there is a set of tests in the law for what can be
done, and to quote, ``The agency must have a reasonable basis
to conclude that the act or practices cause or are likely to
cause substantial injury to consumers which is not reasonably
avoidable by consumers, and such substantial injury is not
outweighed by countervailing benefits.'' So we have a
``substantial'' test, a ``not reasonably avoidable'' test, and
a ``not outweighed by countervailing benefits.''
Can you expand a little bit on those, and particularly this
``not reasonably avoidable''? And let me give you an example. I
have a constituent, an elderly constituent, who cashed in a
check that came in the mail that was from an established
financial institution that he did business with. He thought it
was related to simply a refund of an excess escrow fees or
something of that nature. And, in fact, what it was in the fine
print on the back was a high-interest loan--a very high-
interest loan. And then the bank turned around and asked him to
consolidate that loan with his other debt, and he ended up
converting basically a very sound financial situation in short
order into a situation that destroyed his equity in short
order.
But one could argue that he could reasonably have avoided
that by simply not depositing the check, that he could have
read all of the fine print on the back of the check and made
sure he understood it.
How does this test work in kind of the real world?
Mr. Barr. Thank you very much, Senator. The intent of the
provision is to ensure that when the agency is thinking about
the options available to it in regulating a particular product
or service or sector, that it first try methods such as
disclosure. So if we have a strong disclosure regime in place,
could a consumer in that circumstance reasonably avoid the
practice?
In the context, say, of credit cards, thinking back again
to the work that the Senate did in getting that bill passed,
the judgment was that double-cycle billing was not a practice
that a consumer could reasonably--with disclosure could
reasonably understand, and so the Senate decided that that
practice was a practice that should be banned.
So the basic idea of this legislation is to say, let us try
disclosure first. Let us see if there are ways to make
disclosure work. Let us try and have robust disclosure. If
disclosure can't work because the consumer can't reasonably
shape his or her conduct to be responsible based on that
disclosure because the information, the terms are so confusing
that consumers can't get enough information to actually
understand them, then it ought to think about other regulatory
tools, and in doing that, it needs to consider the costs as
well as the benefits.
Senator Merkley. So certainly a very clear set of
reasonable tests to be met, moving from disclosure forward.
Mr. Barr. That is correct.
Chairman Dodd. Thank you very much, Senator.
Senator Crapo.
Senator Crapo. Thank you, Mr. Chairman and Secretary Barr.
I want to return to the issue that Senator Corker had
raised with you just so that I understand it more clearly. As I
understand the proposal, the new agency would, in fact, have
authority and direction to create what are called plain-vanilla
or basic products and services. Do I understand that to mean
that in a number of different categories, the agency would
decide what the basic vanilla product is, like the basic 30-
year loan or the basic ARM and so forth?
Mr. Barr. The agency could decide to say a basket of loans
is a standard basket of loans, so a 30-year fixed-rate loan and
an ARM with straightforward pricing might be the standard loan
or set of loans. And then consumers would have the opportunity
to see what the costs of that loan were and compare it to the
costs of, say, a pay option ARM.
Senator Crapo. But conceivably, as we get more distinct and
varied types of products, we could see more distinct and varied
types of what we are calling plain-vanilla versions of those
products and we could have a pretty long list or vast array of
agency-established products, is that correct?
Mr. Barr. Senator, the intent and purpose of the provision
is not, precisely not to have a proliferation of product-level
decisions at a micro level but a basic set of standards that
people can use as a point of comparison in making their
decisions in choosing which product or service that they want.
They will have a standard, a comparative point to look across
the sector, as we did essentially with respect to the mortgage
market until quite recently.
Senator Crapo. I guess my point is, where does it end?
Theoretically, the agency could just create one vanilla
product, a 30-year loan, or a 15-year loan, or what have you,
but it seems to me that what I am understanding you to be
saying is that that is not what is contemplated and that there
is, in fact, going to be an agency-established product for more
than just a 30-year loan, but for other types of products and
services that are going to be marketed. Am I correct there?
Mr. Barr. Senator, you can have the agency engage in this
process in the mortgage sector. You might see it, say, in
credit cards. I would think you would want to look at areas in
which there is broad market participation, lots of consumers
are involved, and there is a way of anchoring decision making
in a comparable product. But I don't imagine it would be the
primary tool of the new agency. It is an additional tool that
it has, along with the other tools of disclosure and banning
unfair and deceptive acts and practices.
Senator Crapo. And am I correct that the proposal also
contemplates that the consumer would be required to acknowledge
in yet another notice or acknowledgment that they were offered
these basic products as well as any other products that were
offered?
Mr. Barr. Again, the agency has flexibility there, Senator.
So it could, instead of--it could have a requirement that the
consumer opt into an alternative product. It need not do it
that way. There is flexibility built into the agency's
structure so that it can choose that approach if it feels it is
warranted under the circumstances.
Senator Crapo. All right. Thank you. I would like to--
because of time, I want to shift gears very quickly here to the
issue of whether it is wise to separate safety and soundness
regulation from consumer protection. I am sure you are aware
that a number of authorities have indicated that there's a
great danger in doing so.
I see a couple of problems. One, proliferation of
regulatory agencies. I think we should be trying to consolidate
and streamline our regulatory system rather than adding yet
another regulatory layer. But also the fact that you could have
inconsistent regulations between the safety and soundness
regulators and the consumer protection regulators. And finally,
the fact that the safety and soundness regulators or the
prudential regulators will have access to information that
could be very relevant to consumer protection and vice-versa.
Why should we separate these two functions?
Mr. Barr. Thank you very much, Senator Crapo. I think that
the key here is that in the past, we have had a system in which
we had a joining of the safety and soundness function and the
consumer protection function in the banking sector and then no
supervision or examination at all in the nonbanking sector and
I think we have seen the results of that. We have had a system
that hasn't protected consumers and hasn't been good for the
safety and soundness of banks. It is very hard, I think, to say
that our current structure with respect to consumer protection
is good for consumers. It is very hard to say that it is good
for banks.
I don't think we will see inconsistent approaches because
the consumer regulator will have clear authority for the items
that the consumer regulator has to do. The prudential
supervisor has clear authority for what it has to do. And they
each have to do their jobs.
And third, with respect to information, there is a
requirement of information sharing between the prudential
supervisor and the consumer agency. The examiners are going to
share examination reports. The prudential supervisor sits on
the board of the consumer agency. The consumer agency and the
prudential supervisor both sit on the Financial Services
Oversight Council. So I do believe there will be quite good
coordination.
Senator Crapo. Well, thank you. I have heard that
explanation before, the fact that it didn't happen before,
therefore, we should change. I am not sure that that really is
a good reason to separate those two functions, but thank you
very much anyway.
Chairman Dodd. Thank you, Senator Crapo, very much.
Senator Tester.
Senator Tester. Yes, thank you, Mr. Chairman. Thank you,
Secretary Barr, for being here.
The proposal provides authority for the agency to collect
annual fees or assessments. How do you see this impacting
smaller financial institutions?
Mr. Barr. Thank you, Senator Tester. I believe that the new
agency will be able to use existing fees that are collected for
this purpose by the banking agencies----
Senator Tester. OK.
Mr. Barr. ----and it will not increase the overall level of
fees that are being collected in the system.
Senator Tester. So they are going to be pulling some of the
fees they are already paying to pay for the regulation that
already exists?
Mr. Barr. That is correct.
Senator Tester. So no increase in fees?
Mr. Barr. Well, under the legislation, there is broad
authority for the agency. We don't anticipate that it would
result in any increase in fees. It would likely result in a
reduction in fees because the agency is consolidating functions
across all the existing entities. There will be efficiencies of
scale and scope in doing that.
Senator Tester. All right. How do you see the States
fitting into the Consumer Financial Protection Agency?
Mr. Barr. The States would have a quite important role.
States have been at the forefront in many ways of consumer
protection. States would be able to enforce Federal law. States
would have a strong role with respect to their own examination
and supervision processes.
Senator Tester. Would they be able to go beyond the
Federal?
Mr. Barr. And States would be able to set higher rules if
they believe that the Federal standards weren't sufficient.
Senator Tester. All right. There can be debate on why we
have regulation. I can tell you, safety and soundness and
consumer protection, I mean, if you don't have--it is all
consumer protection in the end, as far as I am concerned. I
think that is fundamentally, from my perspective, why
regulation is set up. You may disagree. But in your statement,
and it is in the written statement and you verbalized it again,
you talked about how screwed up the current system is, and I
agree and I think everybody in this Committee understands that
it is severely flawed right now. And I appreciate the
Administration coming forward with their proposal.
But the question is, does the proposal, this part of the
proposal, other parts of the proposal, does it really fix the
problem, because we do have a fragmented system and you can
shop for regulators and all that stuff. Does it fix it?
Mr. Barr. In our judgment, sir, it does. I think it would
prevent the kind of regulatory arbitrage that we saw in the
past.
Senator Tester. OK----
Mr. Barr. It sets high standards across the playing field
that apply to everybody.
Senator Tester. Correct me if I am wrong, but as far as
consolidation of agencies so things don't fall through the
cracks, the proposal is for the OCC and the OTS to be combined.
Any others?
Mr. Barr. Yes, sir. I think if you look across the range of
the proposals that we put in place, we would merge the OCC and
the OTS into a new national bank supervisor.
Senator Tester. Right.
Mr. Barr. We would prevent kind of shopping for regulators
by firms that are in enforcement trouble. We would eliminate
all the exceptions to the Bank Holding Company Act, the
loopholes in the past that have permitted firms to escape
consolidated supervised regulation at the Federal level. We
would remove the Fed Light restrictions from the Gramm-Leach-
Bliley Act so that the Federal Reserve can act as a
consolidated supervisor. And each of those measures is designed
to ensure that the kind of regulatory arbitrage we saw on the
prudential side does not occur in the future.
Senator Tester. OK. One of the things that has concerned me
and I have expressed in this Committee many times is that
community banks, credit unions, for the most part, have been
pretty good actors in this whole thing. They haven't created
the problem. And yet when it gets down to the nuts and bolts of
regulation, they are being clamped as much as the Wall Street
bankers that I think in a lot of cases should be doing time for
what they have done.
So in this proposal, what can you tell me--Consumer
Financial Protection Agency aside, what can you tell me that
will make it so that this doesn't happen again or has a lot
less possibility of happening again?
Mr. Barr. Senator Tester, we have a very strong proposal in
our report and will soon be sending up legislation with respect
to consolidated supervision of very large financial firms, what
are called under our proposal Tier 1 financial holding
companies. They will be subject to stringent supervision on a
consolidated basis. They will have higher capital standards.
They will have higher requirements with respect to liquidity.
And the basic goal of that system is to create large cushions
in the system so that when failures happen, if failures happen,
there is a lot more give----
Senator Tester. Are we doing the same thing to the
community banks that you just talked about to the Wall Street
banks?
Mr. Barr. The communities are not getting extra
requirements----
Senator Tester. Are we requiring higher capital standards?
Are we doing some of the other stuff you talked about? What I
am hearing that is happening on the ground because of what the
bad actors did above them, if you want to call them above them,
is they are getting pinched on capital standards across the
board.
Mr. Barr. Sir, I think I want to separate, Senator Tester,
what may be happening in the field with respect to examination
today and what the proposals are for the future, and under our
legislative proposal, we are focusing on raising capital in the
system and raising it even more so and higher with respect to
Tier 1 financial holding companies so that any incentive to be
large is taken away.
Senator Tester. All right. OK. Thank you very much. Thank
you.
Chairman Dodd. Thank you, Senator Tester.
Let me just comment here. I think Senator Tester has raised
a good point. I think all of us would tell you up here, and I
am sure you are aware of this, as well, that from our community
bankers and, for the most part, the credit unions in our State
acted very responsibly through all of this and what they worry
about is being saddled with a lot of the cost that comes down.
That will not be warmly received, I can tell you right now,
just looking at it.
We need to make that case over and over again. There is a
distinction in performance. We have a tendency to talk about
banks in a generic context and don't draw the distinctions
between those who acted responsibly and those who didn't. And
so as we look at these proposals and ideas, we ought to keep
that very much in mind. I can just guarantee you, there will be
no willingness up here to levy kind of additional fees and
costs on the community banking system of the country that is
feeling a lot of pressure already.
Mr. Barr. Absolutely, Mr. Chairman.
Chairman Dodd. Senator Warner.
Senator Warner. Thank you, Mr. Chairman.
Thank you, Mr. Secretary, for your testimony. Let me start
by simply saying I concur that there have been failures in the
systems and that we need to figure out how to do a better job
on consumer protection. I do have some questions about the
approach the Administration is taking. I want to go back to
some of the comments that Senator Corker and Senator Merkley
made.
I am still struggling with kind of what the underlying
theory here is. Is the underlying theory that the goal is
enhanced disclosure in comparison, or as you raised, that there
are times when disclosure in comparison may not be enough as
was evidenced by the Fed's action on double-cycle billing? Take
me through again what the basis is here. Are we going to look
for some bright-line prohibitions or do we feel like a
disclosure regime alone is enough?
Mr. Barr. Thank you, Senator Warner. I think that in the
first instance, we need an independent, single-focused mission
Consumer Financial Protection Agency. So the first principle
would be clear mission, clear accountability, clear
responsibility by one agency. That agency will have different
tools that it needs to use in different market contexts. Some
of those tools--the bulk of those tools will be disclosure.
Disclosure can often solve many of the problems in our
financial services marketplace, because if you clearly disclose
a product or services, then consumers can choose the product or
service they want. That is the best answer in many
circumstances.
In some circumstances, you want that agency to do more. You
want it, for example, to say to a consumer, not just here is
the information about the transaction, but here is the
consequence of this decision or that decision. So one of the
things that this Committee and the Congress did in the credit
card bill was say to credit card companies, you need to let
consumers know how much it would cost them if they only paid
the minimum on their credit card balance. That is an additional
item beyond the traditional disclosure that in some contexts
can make a big difference to consumers.
In other contexts, you need a standard point of comparison
to make that disclosure meaningful, so not just the pay-option
ARM costs X, but that is what it costs in relation to, say, a
standard 30-year mortgage or in the kinds of pay-option ARM, a
5-1 ARM with straightforward terms. So points of comparison can
matter a lot, too.
And then in the last instance, you have the ability to ban
terms in products or services where they are unfair and
deceptive and these other tools don't work.
Senator Warner. But you would see this agency having that
ability to ban certain products?
Mr. Barr. Again, as----
Senator Warner. In a preclearance way or after the product
has already been out in the marketplace?
Mr. Barr. There is no preclearance requirement under this
legislation. It is not like other legislation the Committee may
have considered in the past. There is no preclearance procedure
with respect to all products and services. There is a
requirement of disclosure.
Senator Warner. But let us assume you have a product. It
has been disclosed. You have got a comparison basis. In effect,
the Federal agency has fostered that that is appropriate. But
we are still allowing, then, the 50 independent Attorneys
General to go out and raise the bar higher, correct?
Mr. Barr. Yes. So under the legislation, the traditional
preemption by national banks would not be available and States
could set higher rules for products and services. But with
respect to the unfair acts and practices, the agency could step
in and say, if you are offering a credit card with double-cycle
billing, that is unfair. We can't disclose our way around it.
So that particular term----
Senator Warner. I guess what I just want to make sure I
understand, you are saying that a product, that if the Federal
agency had determined disclosure alone was enough, it then
comes out into the marketplace and an Attorney General decides,
no, disclosure is not enough. We want to actually ban this
product in State X. They can go ahead and initiate that action,
and if it is successful at a State level, what does the
financial institution--there is no kind of pass, that once you
have passed the disclosure requirement at the Federal level,
that you have got an ability then to go into the marketplace
and offer this because you can still have the State Attorney
General raise a separate action, is that correct?
Mr. Barr. No, sir. So the State Attorney General can only
enforce State law that exists or Federal law that exists. If a
State legislature decided to set a higher standard in a
particular area, it would be free to do that as States are free
in many areas of consumer life to set higher standards to
that----
Senator Warner. I know my time is up. Just one quick other
comment. I am not sure I fully got your answer there, but I am
interested in this area on the nonbank supervision, the
question of going after financial products. Do you envision at
some point the Administration coming forward on these
noncurrently covered financial institutions? Are you going to
look at their product mix underneath this legislation? Will you
also envision at some point laying out some kind of safety and
soundness oversight, prudential oversight, as well, for a
series of nonbank financial institutions?
Mr. Barr. Senator Warner, this only applies to consumer
financial protections. So in our proposal, consumer financial
protection issues would be at this one agency and the consumer
issues would be able to be examined across the financial
services sector. But there is no proposal to have broad Federal
prudential----
Senator Warner. No prudential regulation on the whole
nonbank sector of the----
Mr. Barr. Not with respect to, say, an independent mortgage
company. Certainly with respect to, if you are a--within a bank
holding company, the Federal Reserve would have consolidated
supervision of all the entities within a bank holding company
and it would be required to ensure that all the elements of the
holding company are not undermining safety and soundness. So in
that respect, yes, but not a broad new authority with respect
to prudential supervision outside the bank holding company
context.
Senator Warner. Thank you, Mr. Chairman. I hope we get
another round.
Chairman Dodd. Thank you, Senator Warner.
Senator Johnson.
Senator Johnson. Mr. Barr, one of the objectives of the
CFPA is to fill regulatory gaps, a goal I share. If a State
does not examine a mortgage broker, would this agency? If a
State does not examine a check casher, would this agency?
Mr. Barr. The agency, Senator Johnson, would have the
authority to set uniform rules to examine and supervise
mortgage brokers. It could also do that with respect to other
financial services providers, including check cashers, with a
goal again of having high standards across the financial
services marketplace and a level playing field for competition,
so banks and community banks and credit unions are not at a
competitive disadvantage.
Senator Johnson. According to the draft bill submitted by
the Administration, the CFPA would have the authority to
oversee financial advisors who provide financial and other
related advisory services. Since the bill appears to exclude
from the CFPA's jurisdiction all products and services
regulated by the SEC, the CFTC, and State insurance
departments, will you please clarify who this language is
intended to impact.
Mr. Barr. Thank you, Senator. The basic language there is
designed to deal with scams that have come up around the
corners of the marketplace, where institutions that are not
generally subject to any regulation offer what they call
financial advice to consumers. It is primarily not aimed at
State-regulated financial advisors, where there already is a
system in place at the State level for regulating those
institutions.
Senator Johnson. Could an unintended consequence of
products be the consolidation of markets?
Mr. Barr. I think, Senator Johnson, that we will see lots
of financial innovation in the future, lots of choice in the
future in financial products. This agency will enable choice
cross the financial services sector, enable financial
innovation across the financial services sector based on a
level playing field with high standards.
Senator Johnson. I can probably say that most mortgages are
originated within the terms of 30-year fixed-rate mortgages.
These products work for most of my constituents. That said,
sometimes there are other products that are not plain vanilla
that work for a consumer. Your proposal seems to create many
hurdles for both banks that offer these types of products and
consumers that use them. Do you think your proposal creates a
disincentive for institutions to offer different products? Do
you think that fewer products will reduce consumer choice?
Could this indirectly increase the cost of credit?
Mr. Barr. Thank you, Senator. Our judgment is that the new
agency will have the ability to set high standard across the
financial services marketplace, including for mortgages, that
we will continue to see innovation in the mortgage sector, but
that if firms want to offer products that are difficult for
consumers to understand, there will be a higher burden on them
to explain those products and services. And I think that we
have seen the consequences of a system in which there is
inadequate supervision of those kinds of practices.
So I do think we are going to see a rebalancing, if you
will, where it is a much lighter regulatory burden even than we
have today with respect to straightforward products. So you can
do things like combine the Truth in Lending Form and the Real
Estate Settlement Practices Form into one simple Mortgage
Disclosure Form everybody can use. That is easy under the new
approach, very hard under the current approach. It is a way of
reducing regulatory burden for banks, improving disclosure for
consumers. We can see a lot of that happening in this space
with the new agency.
Senator Johnson. My time is up.
Chairman Dodd. Thank you very much, Senator.
Senator Bayh.
Senator Bayh. Thank you, Mr. Chairman.
Thank you, Mr. Barr, for your service. I know you guys have
a lot on your plate over at Treasury, so I am grateful for your
time this morning and your focus on this important issue.
Can you outline for the Committee, what were some of the
abuses that have been brought to light by the current crisis
that this proposal intends to prevent?
Mr. Barr. Thank you, Senator Bayh. I think one key area
where we saw abuse was in mortgage broker conduct. We saw
brokers who were offered incentives to get consumers to take
out loans that were more costly than the ones they qualified
for----
Senator Bayh. And you forgive me for interrupting you. I
agree with that wholeheartedly. That has been fairly well
documented. How about in areas beyond mortgage lending?
Mr. Barr. I think, again, in the credit card context, this
Committee has discussed problems with unfair practices in
credit cards, problems we have seen with respect to bank
overdraft fees, which are not disclosed as credit problems,
problems in the payday lending sector, where there have been
significant failings, problems in the auto loan sector, where
disclosures have been inadequate and abuses have occurred. I
think if you look really across the consumer financial services
marketplace, at credit products, at payment products, and the
like, bank products, there have been a series of failures of
our existing regime to take account of the needs of consumers.
And I am sure you hear the complaints from your constituents on
these matters.
Senator Bayh. Certainly in the credit card area we did, and
that is one of the reasons the Committee and the Congress acted
in that area. So it is your judgment, Mr. Barr--and I agree
with your assessment of many of the practices you have outlined
there--it is your judgment that the problem can't be addressed
by simply proscribing some of those things or tightening
existing enforcement and regulation to prevent a recurrence or
to require greater disclosure in the future?
Mr. Barr. That is our judgment, sir. I think if you look
across the history of this matter, we don't want to fix one
problem only to ignore and miss the next problem. We need an
agency that is looking out for consumers all the time.
Senator Bayh. Let me ask you about the responsibility that
consumers have, because an enlightened, vigilant consumer is
really their best protection. It is hard to regulate against
all these sorts of things. So what responsibilities do
consumers bear under this regime?
Mr. Barr. I think consumers bear the responsibility to act
responsibly based on the best information they have, and it is
the job of the financial services industry to compete based on
price and quality and not based on confusing consumers. But in
our current system, the incentives to have hidden features are
very large. We have seen that across the financial services
marketplace. And so if you have an agency that can set rules of
the road, everybody can compete based on transparent pricing
and services. Consumers win. Financial services firms win. It
is good for the economy. It is good for the country. So that is
the kind of system we want to see going forward.
Senator Bayh. Several of my colleagues have touched upon
the importance of disclosure, and you have touched upon the
importance of prohibiting abusive practices. I think we all
agree on that. But disclosure only works if consumers do their
part, too, and that is why I asked the question. We need to
build in incentives for them to actually take advantage of the
information that is being offered, process it, and then bear
some responsibility for their own outcome, because if there is
not some responsibility on the individual, the system is not
going to work too well.
Mr. Barr. I think that is absolutely right. Consumers need
to behave responsibly and we need to make the path available to
them to do so.
Senator Bayh. Thank you, Mr. Barr.
Mr. Barr. Thank you.
Chairman Dodd. Thank you very much, Senator.
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman, and we appreciate
your being here, Under Secretary Barr. Sorry I couldn't be here
the whole time. We have the Judiciary hearings. That is why I
am in the back here.
But I am very much for a Consumer Financial Protection
Agency. In fact, Senator Durbin, Senator Kennedy, and I
introduced legislation quite along the lines of this a while
back and I am glad that the Chairman has made this an important
hearing, an important part of our bill, and I am glad that the
White House has supported it.
The bottom line is that the present regulatory structure
has been an abject failure. I worked with the Fed on, for
instance, credit card interest rates for 15 years. The progress
was slow, it was muted, and way behind what the credit card
issuers would come out with. And so to have an agency whose
sole focus is on protecting consumers when the Fed has so many
other responsibilities, and we are considering giving them even
more responsibility, makes sense. Having the FTC do it, again,
they are all across the board.
And look, let us face it, the kinds of deceptive practices
that, for instance, occurred in the mortgage industry brought
down the whole economy, and it is amazing to me that people say
we don't need stronger regulation given that that has happened.
It is just amazing.
And as for this idea, and I want to ask you about this,
stifling innovation--some of the critics have said this--yes,
it will. It will stifle innovation, clever ways to dupe the
consumer, to sell people mortgages that they shouldn't have, to
issue people more credit card debt than they can pay for. You
bet, it is going to stifle that kind of innovation. But will it
stifle a new product, as long as it is fully disclosed, that
the consumer or mortgagor needs? No.
So please, we have had such a sorry history in the
regulation of consumer financial products--sorry history,
despite the efforts of you, Mr. Chairman, and others on this
Committee on both sides of the aisle--that I would argue that
if we don't include this in our financial regulation bill,
there will be a gaping hole.
But I want to ask you the question about innovation, Mr.
Barr. What about the argument that this new agency will stifle
innovation of new products and things?
Mr. Barr. Senator Schumer, I think that the agency will
enable financial innovation to occur based on a level playing
field with high standards. It will prevent the kind of
competition that we have seen in the past based on--competition
based on who can provide the most confusing terms and the most
hidden fees.
Senator Schumer. Right.
Mr. Barr. But competition based on financial innovation for
price and quality, transparency to consumers, that kind of
financial innovation we will see more of, not less.
Senator Schumer. Right. Let me ask you this. What about the
FTC? Some have said, well, the FTC can do these kinds of
things. Has the FTC done at all a decent job in regulating
financial products in the last decade?
Mr. Barr. Senator, I think that the FTC is a good agency
with many good people in it. I think that it has not had the
tools to do this kind of action. It is structurally not set up
to supervise or examine the nonbank sector. It can only act
long after the fact with enforcement when it is too late----
Senator Schumer. Right.
Mr. Barr. and that is just not enough. It can't act at all
with respect to banks, and so we have a fractured system where
everybody can point fingers and nobody gets the job done.
Senator Schumer. Right. And let me just ask one more
question of you, and that is this. Right now, one of the things
that hamstrung us was the fact that there were unregulated
areas. In other words, if a bank issued a mortgage, there was
some degree of regulation--I would say not enough, but some.
But if a mortgage broker got from a nonbank financial
institution financing, there was virtually no regulation at the
Federal level, and when you talked to the Fed about it, which I
did, they would say, well, we don't have jurisdiction. Isn't
another reason to have this financial product regulator, which
regulates the product and not the specific institution that
issues the product, a way when the next new innovation comes up
that there won't be a hole in the regulatory structure, because
right now, we regulate by the type of institution, not the type
of product issued?
Mr. Barr. Senator Schumer, that is exactly right. This
institution, this new agency will have the authority to examine
and supervise any financial institution. It won't be limited to
banks. It won't be limited to nonbanks. It can supervise and
examine and set rules across the financial services industry.
So if you are a community bank and a credit union, you are not
going to be put in a place of competing with an unregulated
mortgage company ever again.
Senator Schumer. It will, as you say, create a level
playing field across the board based on the product.
I thank you, Mr. Chairman.
Chairman Dodd. Senator Schumer, thank you very much.
Senator Shelby has a comment he wants to make. I know Bob
had a quick question. I am trying to get to the second panel if
we can, as well, so I don't want to limit my colleagues here
who want to raise another question or two here, but I do want
to get to the second panel.
Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman. I will try to be
fast. I do have a number of questions for the Secretary that I
would like to be made part of the record.
Chairman Dodd. And I have, as well, and I will submit those
for the record.
Senator Shelby. Mr. Secretary, you were one of the authors,
and we have talked about this this morning, of the article that
appeared, published by the New American Foundation,
``Behaviorally Informed Financial Service Regulation,'' right?
Mr. Barr. Yes, sir.
Senator Shelby. OK. Among other things in that article, I
just want to quote from this, and this will be as quickly as I
can say. It says, ``We explore a different approach based on
insights from behavioral economics on the one hand and an
understanding of individual organization on the other. At the
core of our analysis is the interaction between individual
psychology and market competition. This is in contrast to the
classic model, which relies on the interaction between rational
choice and market competition. In the classic model, absent
market failures, because rational agents choose well, firms
compete to provide products and improve welfare. Because
rational agents process information well, firms compete to
provide information that improves decision quality.
``By contrast, in our model,'' and some of this is in this
proposal, as I understand it, ``individuals depart from
neoclassical assumptions in important ways. The introduction of
richer psychology complicates the impact of competition. Now
firms compete based on how actual individuals will respond to
products in the marketplace and actual competitive outcomes may
not always and in all contexts closely align with the improved
decisional choice and increase consumer welfare.''
This is a real departure from, as you said in your paper,
from the model that we have relied on for a long time. I am not
saying that model is pure and perfect, because it is not, but
this is a heck of a departure, is it not?
Mr. Barr. And, Senator Shelby, in that article, we are
highlighting different models of thinking about human decision
making----
Senator Shelby. Sure.
Mr. Barr. and in most circumstances, competitive outcomes
are going to lead to welfare enhancement. But in some
circumstances where individuals are consistently prone to
failure, it won't, and then the question is should the
Government do something about that. Many times, the answer is
no. It is sort of a trivial difference in outcomes. It would
cost more to get engaged than it would to not get engaged and
so you want the Government to do nothing.
In some contexts, though, the failures are so deep that you
think some kind of step needs to happen, whether that is
through disclosure or through providing information about the
consequences of financial decision making, or in some
particular circumstances saying a particular term should be
banned, as this Committee did with respect to double-cycle
billing.
Senator Shelby. I understand, I think, where you are going,
or trying to go. I hope you don't go too far here, or we don't.
But on the other hand, an informed consumer--an informed
consumer--that has relevant information will generally make a
rational decision in the marketplace.
Mr. Barr. I think that is absolutely right. So I think that
in most circumstances, most of the time, disclosure is going to
get you most of the way there. And then the question is, in
what context is that not enough? And again, as the Committee
did with respect to credit cards, some practices you can't
disclosure your way around. They are too complicated. Consumers
can't--a responsible consumer trying to do the right thing
couldn't actually figure out how to behave responsibly in that
context.
Senator Shelby. Wait a minute. But you are really saying
that you don't trust the consumer to make decisions for
themselves, in a sense.
Mr. Barr. No, I think consumers are--I trust consumers
tremendously. What I don't trust is that if we set up the
marketplace so that the incentives are to confuse consumers,
that is the kind of competition we will get. We will get
competition around confusing consumers. If we set up the
marketplace so the rules are you compete to get consumers to
your product because you have a better product, that is the
marketplace we will get.
Senator Shelby. But according to Senator Corker's question,
as I understood it earlier, you are going to ration the
products that you can offer.
Mr. Barr. No, sir. There would be no product rationing
under this----
Senator Shelby. You are not going to ration----
Mr. Barr. No product rationing under this approach at all.
Consumer choice, individual freedom are at the heart of this.
The key provisions of this Act would enhance the ability of
consumers to make decisions that make sense for their own
lives.
Senator Shelby. Well, I hope we are going to have a lot of
hearings on this, Mr. Chairman.
Chairman Dodd. Yes. Jack, you have a question you would
like to raise?
Senator Reed. Thank you very much, Mr. Chairman, and thank
you, Secretary Barr.
Can you walk through how the proposal establishes primary
and secondary enforcement, rulemaking, and examination
responsibilities?
Mr. Barr. Yes, Senator Reed. A core principle of our
proposal is that supervision, examination, and rule writing
should be joined together with respect to banks and nonbank
institutions so there can be uniform rules of the road, real
supervision and enforcement across the financial services
sector.
We leave backstop authority at the bank agencies and at the
FTC in case something falls through the cracks, in case
something gets picked up in an exam and they need to refer it
over to the new agency. But the idea is not to have any
duplication, to have real core focus on consumer issues in one
place with real responsibility and accountability to the
Congress and the American people.
Senator Reed. Can you comment about the alternative
approach which some have suggested, which is essentially the
bank regulators take the lead and then the CFPA would be sort
of the backup?
Mr. Barr. Senator Reed, I think we have seen a system in
the past where rule writing was at the Federal Reserve and
supervision was spread around in the bank agencies and the
system was fundamentally broken. The rule writer had a
conflicting mission. The supervisory entities had conflicting
missions. None of them thought consumer protection was at the
top of what they would do. They would regulate banks based on
reputation risk and litigation risk with respect to consumer
issues, looking out for the interest of the bank and not
consumers. I think we can't have that approach going forward.
Senator Reed. Let me raise another issue and that is the
funding. Your proposal, how would the CFPA be funded?
Mr. Barr. We look forward to working with the Congress on
determining the right approach to funding issues. I know that
is an area of great concern to the Congress. We need to ensure
that the funding is stable and strong. Under our approach,
there would be a mix of appropriated funds as well as the
transfer of fees from the bank regulatory agencies with respect
to consumer protection functions and fees in the area where
such fees have not been collected in the past in the nonbanking
sector. So we have a mix of appropriations and fees funding the
agency. We would be happy to work with the Congress on that
approach.
Senator Reed. Mr. Secretary, a final question. There is at
present the tension in the banking regulators between safety
and soundness and consumer protection. Some would argue that
consumer protection was always subservient to that, and that
led--was one of the factors that led. How in this new approach
do we balance the safety and soundness issue with the
regulators who are responsible for it and the consumer
protection issues?
Mr. Barr. Each agency would have responsibility for the
mission assigned to it. The consumer protection agency would
need to be sure that, say, disclosures are clear about a
product or service, and the bank supervisory agency would have
authority with respect to prudential supervision, underwriting
standards, capital requirements, sort of core prudential
supervisory matters. So a clear assignment of authority, clear
assignment of responsibility and accountability to the Congress
and to the American people for achieving those aims.
Senator Reed. Thank you very much. Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, very much.
Bob, did you have a quick question on this?
Senator Corker. Out of respect for everybody's time and
knowing you want to move on, instead of asking questions, I
will just make one statement. You have not alluded to student
loans, auto loans. I know we have talked about mortgages. All
of those are areas under your proposed legislation that you all
would set up basic products. And while I said not necessarily
on the front end, I just want to say, in listening to your
testimony and answers, this is an example of all examples of
this Administration being Big Brother, and I think the American
people are recoiling from this. I think this is a tremendous
overreach and very disturbing to listen to.
I hope that as you move along, we will be able to work
together to do something that is not an overreach, where the
Federal Government is telling citizens the types of products
they should and shouldn't buy, and telling companies what they
should and shouldn't offer. This is way out of bounds and I
look forward to working with you to get it in bounds.
Chairman Dodd. Senator Warner, do you have a quick
question?
Senator Warner. I just want to make sure we try to get it
right and I have still got a series of questions, but I will
reserve those until another time.
Chairman Dodd. I thank my colleagues. Let me just say, that
is our intention, obviously, to get this right. I think your
testimony has been very valuable this morning. Maybe Senator
Schumer hit the note in a way. We don't want to forget what has
happened over the last several years. It is unprecedented. You
have got to go back to the generation of our grandparents to
talk about a time similar to the ones we have been through. We
have got 15 million homes underwater today--15 million--and
every likelihood of those foreclosures continuing at a rate
that is unprecedented, certainly in modern times, and the
obvious implications of that are spread far beyond just home
mortgages to other aspects of our economy.
And so the notion--when we lost sight of the--three great
things done by the Depression Era Congress and Administrations
were the establishment of the Securities and Exchange
Commission, the establishment of the Federal Deposit Insurance
Corporation, and Glass-Steagall, in my view. Those three things
gave us virtually 60 years almost of unprecedented stability.
When we began to wander away from having oversight of our
financial institutions, we began to mix commerce and banking to
the point where we thought we were going to have firewalls to
protect people but did not do so, as well as not having
adequate insurance under the Federal Deposit Insurance
Corporation. We began to see the problems, and I can point to
other aspects to all of this.
And so getting back to the notion that when that consumer--
and the consumer, in my view, is the shareholder, it is the
policy holder on an insurance policy, it is the borrower
whether it is a mortgage or a car loan or a student loan--when
we lose sight of that individual, if we don't take into view
that individual's concerns and begin to look just top-down and
not bottom-up, then you begin to lose sight of what this is all
about to people. These are highly complicated areas.
Now, I think the issues raised about mandating or dictating
or somehow driving certain product lines is something that we
have got to be careful how we engage in that. Bob Corker has
raised an interesting point and one that we ought to examine
thoroughly. But the idea that we are going to have sort of
disregard for what is going on, too often, in too many cases is
where consumer issues have been lost in this process here.
The idea that when people walk in and they are being
marketed--60 percent--according to the Wall Street Journal, 60
percent of the subprime mortgages went to people who otherwise
qualified for a conventional mortgage, a lot cheaper product
than that subprime mortgage. That is an outrage. That is people
marketing products that they knew very well that that borrower
could not afford, never at the fully indexed rate, and were
going to be in trouble. And having a process which protects
people against that kind of behavior, I think is critical.
Now, how we do this and shake this up obviously is a
challenge to the Committee, working with the Administration and
others. But my view is we have got to take this issue on and
find a mechanism here that certainly fills that gap that has
existed for far too long and created for the first time in 60
years the kind of break that occurred that we are all
struggling with today.
So I appreciate your testimony. We will have additional
questions for you to submit, but I want to get to the second
panel here if we can, very quickly.
Senator Shelby. Mr. Chairman, can I have one word?
Chairman Dodd. One word.
Senator Shelby. If I could, maybe one or two. We appreciate
you coming here today, but even you admit in your studies, and
this is an outgrowth of some of those studies, that this is a
radical departure from the way we have regulated things before.
We have tried to let the market work, let the consumer, an
informed consumer, make decisions, not a bureaucrat make the
decisions. And there are a lot of flaws in these proposals and
that is why we are holding hearings, political and otherwise.
But to move away fast and furious from a classical model of
regulation, we had better be really careful. What we ultimately
will do probably is really ration credit to people who need it
the most.
Chairman Dodd. Let me just say, and then we will give you a
chance to quickly respond, we have been faced with a radical
situation in our country. This is unprecedented. I respect that
the classical model has fallen apart and the people who have
paid the price for it are consumers. That home owner or that
potential home owner, that person out there today who is losing
their home, they are losing their jobs, they are losing their
retirement, they are losing their health care, to them, this is
pretty radical. This is not an abstract problem for them, it is
a real one. And when you get 10,000 people a day losing their
homes and 20,000 people a day losing their jobs, that is
radical, believe me.
And so I am not looking for radical solutions here that
don't meet the problem. But if we don't understand the depth of
this problem, the anger of the people of this country of what
they are going through and the demand that we start paying
attention to what happens to them every single day they walk
into an institution to borrow money, to buy a policy, to invest
in a corporation because they want to increase their stability,
then we are losing something here. So we need to get this
right.
Do you have any comments you want to make quickly as we end
up?
Mr. Barr. Thank you, Mr. Chairman. The Administration's
proposal would represent a fundamental break from the past. I
think it is clear that our system of financial regulation
failed the American people and we need to have a new
foundation, a firm foundation that protects consumers, and that
is what this proposal does.
Thank you very much to you, Mr. Chairman, to Mr. Shelby,
and to the Committee as a whole for hearing from me.
Chairman Dodd. We will stay in touch. As Bob Corker said
and others said, we want to work with you. We have got a lot of
work to do, but we appreciate you being here.
Senator Shelby. A lot of work.
Chairman Dodd. Very good.
Mr. Barr. Thank you.
Chairman Dodd. Let me go to our second panel, and we
appreciate their patience, but I hope it has been worthwhile to
be here with us. The introductions are going to be brief, so I
don't have long introductions.
Let me first of all introduce my Attorney General. Dick
Blumenthal is here with us. Richard has been our Attorney
General for a long time and done a fabulous job, served in the
Connecticut House of Representatives, the State Senate, a
Sergeant in the U.S. Marine Corps Reserves, distinguished
record, and I think the greatest Attorney General in the United
States of America. I say that every time I get to introduce
him. He does a great job.
Ed Yingling is an old friend and a person we respect
immensely. Ed is the President and CEO of the American Bankers
Association. All of us here have worked with Ed Yingling for
many, many years and have a high regard for him and his
abilities.
Travis Plunkett is the Legislative Director for the
Consumer Federation of America and has appeared before this
Committee on numerous occasions involving any number of issues,
most recently on the credit card efforts, and I want to thank
publicly Travis and the Consumer Federation of America for the
tremendous job they did in promoting and advocating the
legislative success we had with the credit card bill.
Peter Wallison, I have already drawn into the debate,
having quoted from his testimony, but we thank you very much,
Peter. I hope you didn't mind me mentioning your quote on CRA.
Peter is the Arthur F. Burns Fellow in Financial Policy Studies
at the American Enterprise Institute. I often quote Arthur
Burns about the race to the bottom, he used to talk about, in
regulatory processes.
And Mr. Sendhil Mullainathan is a Professor of Economics at
Harvard University, and we thank you very much, Professor, for
being with us.
Let me begin with the Attorney General and thank him for
his testimony in advance and for your incredible career of
public service to our State and the country.
STATEMENT OF RICHARD BLUMENTHAL, ATTORNEY GENERAL, STATE OF
CONNECTICUT
Mr. Blumenthal. Thank you, Senator. I am very, very honored
by those kind words, especially from someone who has led
consumer protection efforts in the country, most recently in
the credit reform bill, and I want to thank you very sincerely
for all that you have done in other areas of consumer
protection and the leadership that you will no doubt provide
the Committee in this area, which as you have said marks what
seems to be a radical departure from past practices in a time
that demands radical solutions.
It is a fundamental break with the past that is very well
justified by recent history. This proposal would create a new
agency, a very strong financial products watchdog and guardian,
similar to the one that now exists at the Federal level in the
Federal Trade Commission for other kinds of products, the
Consumer Product Safety Commission for certain kinds of other
goods and services, and essentially would restore the historic
State-Federal alliance that existed for so many years so
productively in combating financial fraud and abuse.
This financial State partnership was riven and destroyed by
excessive resort to Federal preemption, which displaced State
enforcement and replaced that collegiality between Federal and
State officials with conflict and tension that need not have
existed. In fact, that conflict was one of the reasons why we
saw the kinds of abuses that led to the financial meltdown.
That meltdown was foreseeable. Indeed, it was foreseen. I
used the word ``regulatory black hole'' to characterize hedge
funds and many of the other inventive and innovative financial
instruments that very few people understood even as they used
them, and the excessive risk taking, often with other people's
money, that was enabled by that regulatory black hole.
And so I think that the genius of this proposal, or its
great advantage, is to restore the alliance between consumer
protectors at the Federal and State level.
The doctrine of Federal preemption has essentially led to
the Federal Government abandoning the battlefield and then
foreclosing the States from fighting on that battlefield. It
has in so many areas prevented States, in fact, in many of
those same areas that Secretary Barr answered to Senator
Warner's question--payday loans, tax preparer anticipation
refund loans, credit card issues, mortgage abuses--and I
describe in my testimony--I am not going to read the testimony
but just briefly say that in many of those areas where these
abuses developed, our opponent was most frequently the Office
of the Comptroller of the Currency.
I litigated more against the OCC than I did against any
other single institution. And the most recent Supreme Court
decision, Cuomo v. Clearinghouse Association, which restores
some of our authority under the National Bank Act, was really
against the OCC.
And so it isn't only that Federal authority has been
fragmented, that the culture has been wanting, that the FTC has
lacked the tools and resources, it is the hostility, the overt
antagonism and adversarial posture of the Federal Government as
against the States in consumer protection. And if it does
nothing else--and it does a lot else--this proposal will help
restore that alliance between State Attorneys General and the
Federal Government.
I believe very strongly that this proposal is a good idea.
There are details, as many Senators have already remarked, that
need to be refined and perhaps changed. But in concept, the
idea of having one central point accountable, fully accountable
to those consumers out there who don't know where to call--and
right now call my office--is a very, very important concept.
The accountability to this body of the Consumer Financial
Products Commission or Agency will be a tremendous advantage.
And let me just close by saying I couldn't agree more,
based on 18 years as Attorney General, that consumers
ultimately have to be their own protectors. But anybody who
right now reads most of these documents, and I am trained to
read them, will find them extraordinarily perplexing and
confusing, not just in the fine print but in their concepts.
And so this agency, as job number one, ought to not only fill
that regulatory black hole, but provide for clear, truthful,
accurate disclosure, and that is one of the essential missions
that has been completely absent.
I agree completely that the prudential responsibilities of
the Fed and other existing agencies probably conflict, or at
least create divided loyalties so far as consumer protection is
concerned, another reason why we can't use either the FTC or
the Federal Reserve to carry these important responsibilities,
because consumer protection, especially in disclosure, is a
mission that really requires, in financial products, a separate
and distinct agency that has that accountability and will
replace the current culture, the current mindset of conflict
with the States and resistance to aggressive and vigorous
consumer protection.
Thank you very much.
Chairman Dodd. Thank you very much, General. Thank you
very, very much.
Let me just also note that the Attorney General's son is
with us today. We are delighted to have him in the room, by the
way. We thank him for being with us.
Mr. Blumenthal. Thank you.
Chairman Dodd. Thank you.
Ed Yingling. Ed, thank you very much. You have been before
this Committee on countless occasions over the years. We have a
high regard and respect for you.
STATEMENT OF EDWARD L. YINGLING, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, AMERICAN BANKERS ASSOCIATION
Mr. Yingling. Thank you, Mr. Chairman. I appreciate your
introduction. It may be my high-water mark this morning, but I
really appreciate it. Thank you, Senator Shelby and Members of
the Committee.
It would be expected that your Committee would look at this
proposal from the point of view of consumers, who should be
paramount in your consideration. However, the ABA believes that
this proposal is not, unfortunately, the best approach for
consumers and will actually undermine consumer choice,
competition, and the availability of credit.
But I would also ask you to look at this issue from an
additional point of view. While banks of all sizes would be
negatively impacted, think of your local community banks and
credit unions, for that matter. These banks never made one
subprime loan, yet these community banks have found the
Administration proposing a potentially massive new regulatory
burden. While the shadow banking industry, which includes those
most responsible for the crisis, is covered by the new agency,
their regulatory and enforcement burden is, based on history,
likely to be much less.
The proposed new agency will rely first on State
enforcement, and yet we all know that the budgets for such
State enforcement are completely inadequate to do the job.
Therefore, innocent community banks will have greatly increased
fees to fund a system that falls disproportionately and
unfairly on them.
The agency would have vast and unprecedented authority to
regulate in detail all bank consumer products. The agency is
even instructed to create its own products and mandate that
banks offer them. And Senator Corker, this is the part that was
missing from your discussion with the Secretary. The agency is
urged to give the products it designs regulatory preference
over the bank's own products. The agency is even encouraged to
require a statement by the consumer acknowledging that the
consumer was offered and turned down the Government's product
first, and every nongovernment product would be subject to more
regulation than the Government product. Community banks,
whether it fits their business model or not, would be required
to offer Government-designed products, which would be given
preference over their own products.
On disclosure, the proposal goes beyond simplification,
which is needed, to require that all bank communication with
consumers be, quote, ``reasonable.'' This is a term that is so
vague that no banker and no lawyer would know what to do with
it. But not to worry. The proposal offers to allow thousands of
banks and thousands of nonbanks to preclear communications with
the agency. So before a community bank runs an ad in the local
newspaper or sends a customer a letter, it would need to
preclear it with the new agency.
All this cost, regulation, conflicting requirements, and
uncertainty would be placed on community banks that in no way
contributed to the crisis.
The fundamental flaw in the proposal is that consumer
regulation and safety and soundness regulation are two sides of
the same coin. You cannot separate a business from its
products. The simple example is check-hold periods. Customers
would like the shortest possible hold, but this desire needs to
be balanced with complex operational issues in check clearing
and with the threat of fraud, which costs banks and ultimately
consumers billions of dollars.
The breadth of this proposal is, in many respects,
shocking. Every financial consumer law Congress has ever
enacted and every existing regulation is rendered to a large
degree moot, mere floors. No one will know for years what the
new rules are and what they mean. When developing products and
making loans, providers must rely on legal rules of the road,
but now everything will be changed, subject to vast and vague
powers of this new agency and anything States may want to add.
This problem is exacerbated by the use of new, untested
terminology, again such as the requirement that disclosures be
reasonable, whatever that means, which will take years to be
defined in regulation and court decisions. If industry has no
idea what the rules will be, what the terms will mean, and how
broad legal liability will be, there is no doubt what will
happen. Innovative products will be put on the shelf and credit
will be less available.
We agree that improvements need to be made. The great
majority of the problems occurred outside the highly regulated
traditional banks, but there are legitimate issues relating to
banks, as well. We want to work with Congress to address these
concerns and implement improvements, and in that regard, my
written testimony outlines concepts that should be considered.
I do want to put one fact back on the table that Secretary
Barr referred to, and that is as we look at this and as we look
at preemption, as we look at where the problems were, 94--this
is the Administration's own numbers--94 percent of the high-
cost mortgages occurred outside the traditional banking
industry in areas that are either unregulated, lightly
regulated, or in theory supposed to be regulated at the State
level.
Thank you, Mr. Chairman.
Senator Reed [presiding]. Thank you, Mr. Yingling.
Mr. Plunkett, please.
STATEMENT OF TRAVIS B. PLUNKETT, LEGISLATIVE DIRECTOR, CONSUMER
FEDERATION OF AMERICA
Mr. Plunkett. Mr. Chairman, Ranking Member Shelby, Members
of the Committee, it is good to be back with you. I am
testifying today on behalf of the Consumer Federation of
America and 23 consumer, community, civil rights, and labor
organizations. We strongly support the Administration's
proposal to create a Federal Consumer Protection Agency focused
on credit, banking, and payment products because it targets the
most significant underlying causes of the massive regulatory
failures that have led to harm for millions of Americans.
First, agencies did not make protecting consumers from
lending abuses a priority. In fact, they appeared to compete
against each other to keep standards low and reduce oversight
of financial institutions, ignoring many festering problems
that grew worse over time. If they did act, and they often
didn't, the process was cumbersome and time consuming. As a
result, they did not stop abusive lending practices in many
cases until it was too late. Finally, regulators were not truly
independent of the influence of the financial institutions they
regulated.
The extent and impact of these regulatory failures is
breathtaking. I offer 10 pages of detail on 12 separate
regulatory collapses in my testimony over the last decade that
have harmed consumers and increased their financial
vulnerability in the middle of a deep recession. This involves
not just the well-known blunders that we have heard about on
mortgage lending and credit card lending. I also offer lesser-
known but quite damaging cases of regulatory inaction, such as
the failure of regulators to stop banks from offering extremely
high-cost overdraft loans without consumer consent, the
permission that Internet payday lenders have gotten from
regulators to exploit gaps in Federal law, and the fact that
regulators have not stopped banks that impose unlawful freezes
on accounts containing Social Security and other protected
funds.
Meanwhile, the situation for consumers keeps getting worse
as a result of these regulatory failures and the economic
problems in our country. One in two consumers who get payday
loans default within the first year. Mortgage defaults and
credit card charge-offs are at record levels. Personal
bankruptcies have increased sharply, up by one-third in the
last year.
Combining safety and soundness supervision with its focus
on bank profitability in the same institutions, regulatory
institutions, as consumer protection magnified an ideological
predisposition or antiregulatory bias by Federal officials that
led to unwillingness to rein in abusive lending before it
triggered the housing and economic crisis. But we now know that
effective consumer protection leads to effective safety and
soundness. Structural flaws in the Federal regulatory system
compromised the independence of banking regulators and
encouraged them to overlook, ignore, and minimize their mission
to protect consumers.
The Administration's proposal would correct these
structural flaws. Key facets of this proposal include
streamlining the Federal bureaucracy by consolidating consumer
protection rulemaking for seven different agencies in almost 20
statutes; providing the agency with authority to address
unfair, abusive, and deceptive practices; ensuring that agency
rules would be a floor and not a ceiling and that States could
exceed and enforce these standards.
In response to this far-sighted proposal, the financial
services industry has launched an elaborate defense of the
status quo by minimizing the harm that the current disclosure-
only regime has caused Americans, making the usual threats that
improving consumer protection will increase costs and impede
access to credit, and offering recommendations for reform that
barely tinker with the existing failed regulatory regime. These
critics are hoping that this Committee will overlook the fact
that the deregulatory regime that they championed and largely
controlled has allowed deceptive, unsustainable, and abusive
loan products to flourish, which has helped cause an economic
crisis and a credit crunch. In other words, the regulatory
system that creditors helped create has not only led to direct
financial harm for millions of vulnerable Americans, but it has
reduced their access to and increased their costs on the credit
they are offered.
Only a substantial restructuring of the regulatory
apparatus through the creation of this kind of agency offers
the possibility of meaningful improvement for consumers in the
credit markets. The agency will be charged with spurring fair
practices, transparency, and positive innovation in the credit
markets, which should lead to a vibrant, competitive credit
marketplace for many years to come. We strongly urge the
Committee to support this proposal. Thank you.
Senator Reed. Thank you, Mr. Plunkett.
Mr. Wallison, please.
STATEMENT OF PETER WALLISON, ARTHUR F. BURNS FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. Wallison. Thank you, Mr. Chairman and Ranking Member
Shelby, Members of the Committee. I must say candidly that I
was shocked when I realized how this legislation will actually
work.
For me, it raised the following questions. Are consumers
protected when they cannot buy products and services that are
available to others? Is that what consumers want? Does it
matter what they want? These questions occur because the
Administration's proposal for a Consumer Financial Protection
Agency, the CFPA, results in the Government, I believe,
essentially deciding which Americans will have access to
certain financial products and which will not.
Traditionally, consumer protection in the United States has
focused on disclosure. It has always been assumed that with
adequate disclosure, all consumers at whatever level of
education or sophistication could make rational purchase
decisions. Consumer protection under these circumstances
focused on fraud and deception and could take account of
differences in consumer sophistication.
But the Administration's plan is based on an entirely
different idea. That idea is that many consumers should not be
allowed to have particular products or services because they
are not sophisticated, educated, and perhaps intelligent enough
to understand what they have been offered.
It is clear that in the Administration's plan, disclosure,
no matter how complete, is not enough. The white paper that the
Administration circulated before submitting its legislation
contains the following language: ``Even if disclosures are
fully tested and all communications are properly balanced,
product complexity itself can lead consumers to make costly
errors.''
As a result, under the proposed legislation, every provider
of a financial service, and that term, incidentally, includes
everything from banks to check cashing services, and from
furniture rental companies to Western Union, every one of these
institutions--not including, incidentally, securities firms or
insurance companies, which are also involved in financial
activity--is required to offer a plain-vanilla product or
service to be defined and approved by the CFPA that will be
simpler and entail, ``lower risks'' for consumers.
This raises, to me, the obvious question. Once the CFPA has
prescribed a simpler and lower-risk mortgage, who will be
eligible to buy the more complex product that is tailored to a
consumer's particular needs? In effect, this question places on
the provider the burden of deciding which of his customers is
qualified for the more complex or riskier product.
Going beyond the plain-vanilla product will entail risks
for the provider, who could face an enforcement proceeding and
a fine from the CFPA, action by a State Attorney General or a
State Consumer Protection Agency also to enforce the CFPA's
regulations, and a class action by disgruntled consumers who
claim they did not understand the risks associated with the
nonplain-vanilla product.
As the white paper states, the CFPA should be authorized to
use a variety of measures to help ensure that nonplain-vanilla
mortgages were obtained only by consumers who understood the
risks and could manage them. How would a provider determine
whether a product with more features than the plain-vanilla
product is suitable for a particular consumer? The white paper
suggests that the CFPA could, ``require providers to have
applicants fill out financial experience questionnaires.'' This
will be a humiliating experience for anyone, especially a
consumer whose credit record up to that point has been
completely unblemished. It is not a question of what he can
afford, but what he can understand, a much more difficult
question.
These elements are troubling enough, but this regime will
be bad for all consumers. Product innovation will be stymied.
Product variety will be diminished. Costs of credit will rise,
and many small credit providers, small stores, finance
companies, and others will have to leave the market. This will
reduce competition and in some cases eliminate the only sources
of credit for some consumers.
So those who will be able to get these more complex plain-
vanilla products--more products than are plain vanilla--who are
these people? Not ordinary Americans, in my view, whose lack of
demonstrable financial sophistication will make the risks of
selling to them very difficult for most providers. The more
complex products, the ones with useful features, will be
offered only to the more sophisticated and the better educated,
in other words, to the Nation's elites.
In this way and for the first time in our history, it will
be Government policy to deny products and services to a large
proportion of the population, not because the products and
services are inherently dangerous, like drugs or explosives,
but because this Administration apparently believes that no
amount of disclosure can make some Americans capable of
understanding what they are buying. Thank you.
Senator Reed. Thank you, Mr. Wallison.
Professor.
STATEMENT OF SENDHIL MULLAINATHAN, PROFESSOR OF ECONOMICS,
HARVARD UNIVERSITY
Mr. Mullainathan. Mr. Chairman, Ranking Member Shelby, and
Members of the Committee, thank you for providing me with an
opportunity to testify.
As an academic, my comments will lay out some of the ideas
and research behind consumer protection. By way of background,
my area of expertise is behavioral economics. It combines
economists' healthy respect for markets with psychologists'
recognition that people are not financial engines churning out
optimal decisions.
I will focus on making three points. First, the quality of
choice is a result of the context in which we choose. Some
contexts--many contexts allow people to choose well, but others
do not.
Second, when people choose well, markets work very well.
They provide healthy competition. But when people choose badly,
they can race to the bottom.
Third, one tool in the proposed legislation, ring fencing
so-called ``standard products,'' provides a way to promote
competition and prevent this race to the bottom.
So let me start with the psychology of choice. I am going
to try and use two examples that are pretty familiar to all of
you to illustrate decades of psychological research on how
people actually choose. I want you to think back to the last
time you painted a room in your house. You have thousands of
colors to choose from. Benjamin Moore alone offers 140 shades
of white. Yet, you sifted through this explosion of options and
were probably happy with your final choice.
Contrast this with the last time you bought an electronic
device, such as a digital camera. How do you choose between a
smaller, cheaper 8-megapixel camera and a bigger, more
expensive 12-megapixel camera? What is a megapixel? How many do
you need? Are 12 megapixels 50 percent more than 8 megapixels?
At the end of this process, you probably weren't really sure
whether you bought the right camera.
The distinction here is that choosing between things you
don't understand--megapixels is very different from choosing
between things you do understand--color.
Part of choosing a mortgage is like picking a color. What
monthly payment fits within your budget? Part of choosing a
mortgage, however, is like choosing a megapixel. How do you
choose between a fixed-rate mortgage at $1,000 a month and one
that begins at $900 a month but after 2 years changes to three
points above the 1-year LIBOR? What does LIBOR mean? How much
does it vary? Is three points above it reasonable? The provider
says, ``Hey, you can refinance this mortgage in 2 years.''
Should you worry about being able to get another loan in 2
years?
Note, this has nothing to do with elites or intellectuals.
This is true for all people. These features of the difficulty
of choice are the challenges of being human in choice context
that are really not your area of expertise. The problem is not
disclosure alone, it is about understanding. Sometimes
disclosure produces understanding, but sometimes it does not.
Financial technicalities simply do not resonate with the
concepts you use in everyday life. As a result, errors abound.
For example, a recent study shows that 40 percent of borrowers
with income less than $50,000 do not know the per period caps
on their ARMs. It wouldn't surprise me if, like megapixels,
they barely understood what a pro period cap is. Why should
they?
Now let me turn to competition. As I pointed out, when
people choose well, low road firms with short time horizons
cannot do much harm. The best they can do is offer a product
the consumer likes. In this case, markets work well and
innovation helps consumers. However, when people are choosing
badly, low road firms can confound both the consumer and high
road firms.
Next to the $1,000 fixed-rate mortgage, the $900 balloon
ARM has a superficial appeal. It is cheaper today. Nine-hundred
is smaller than $1,000. Its risks down the road are harder to
understand. The worse product can look like the better product.
The high road firm can be pulled down by the low road option.
Now to my final point. I feel one powerful tool in the
proposed legislation can be particularly useful in preventing
the race to the bottom. Ring fence the standard, well-
understood products and the more exotic ones. Regulate the
standard ones minimally, ensure disclosure, prevent fraud, but
regulate the more exotic ones stringently. The goal of this
regulation should be to ensure that customers understand not
just that the risks of these products be mechanically
disclosed. Marketing can be endlessly inventive in sidestepping
disclosure. The Consumer Financial Protection Agency needs
stronger tools for products beyond the fence.
Ring fencing, though, is far more market friendly than a
banner or mandate. It retains customers' ability to access
exotic products. The CFPA would simply ensure that there is a
door on the fence that requires conscious choice to go through.
No one should unknowingly end up on the other side of the
fence.
There are several precedents for this approach. I do not
think this is the first time in American history this has
happened. In fact, the SEC uses it as a way to regulate the
trading of options and derivatives. If any of you would like to
see this, try and buy an option. The Federal Reserve in July of
2008 placed some mortgages under far greater scrutiny. It is
also analogous to how we regulate drugs. If you want to buy
ibuprofen, you simply go and buy it. If you like a strong
antibiotic, there are more barriers in place.
Ring fencing, however, requires a variety of things to
work. First, there must be sufficient choice within the fence.
This cannot be a one-size-fits-all solution. The goal of this
is to maximize choice. It is not to create standard products
designed by the Government. That would be a failure.
Second, there must be a clear, transparent process for how
products enter the fence. This is necessary to encourage
innovation. Lenders who create a good product must have the
comfort that they can reap rewards from it. For this reason, it
is important that the legislation should instruct the CFPA to
develop and codify a transparent process by which products will
be declared within the fence.
To summarize, real people choose badly when faced with
technical features as financial choices sometimes require. To
prevent a race to the bottom, financial regulation must prevent
unfair competition from products with hard-to-understand risks.
Ring financial provides one way to accomplish this goal. When
effective, it provides a market-friendly alternative to bans
and mandates. Thank you.
Senator Reed. Thank you very much. Thank you, gentlemen,
for your testimony.
Let me take 5 minutes and then recognize Senator Shelby.
General, thank you not only for your testimony, but for
your service.
Mr. Blumenthal. Thank you, Senator.
Senator Reed. As a neighbor in Rhode Island, I am well
aware of what you have done for your State and for the Nation.
Mr. Yingling suggested that we should put our attention on
the nonbanking system, and yet your testimony suggests that
there are real problems within the banking system because
Federal regulators have essentially interfered with your
ability to regulate what might be Connecticut chartered
companies. Is that fair, and can you elaborate?
Mr. Blumenthal. What has happened, Senator, and that
question is a very good one, is that many nonbanking
institutions have, in effect, invoked the shield by aligning
themselves with national banks. In the gift card area, for
example, we have been prevented from stopping expiration dates
and dormancy fees on gift cards, from enforcing our State law,
because they have used national banks. On payday loans or tax
anticipation loans, again, the litigation is cited in my
testimony. These institutions have, in effect, allied
themselves with national banks to shield themselves from State
authority. Again and again, what we have seen is that there has
been a very knowing and purposeful resort to the national bank
shield to protect these State and even local institutions
because they have succeeded in invoking that Federal doctrine.
And so the proposal here to put a floor rather than ceiling
on the impact of Federal regulation, I think is a very
important one. It is hardly novel or new. It is essentially
what is done in antitrust and other forms of consumer
protection enforcement with the FTC and I think it would
eliminate the incentive for these local institutions to, in
effect, become part of or integrate their activities with the
national banks.
Senator Reed. Thank you, General.
Mr. Yingling, you have just laid out, I think, in your very
good testimony, as always, the notion, and one that I think we
all ascribe to, that safety and soundness and consumer
protection are sort of two sides of one coin. And yet we have
seen examples over the last several months where that doesn't
seem to be the case. Maybe safety and soundness is not the
word, but profitability seems to have come before consumer
protection in credit card cases and many other instances, which
leads, I think, to the thrust of what the Administration is
proposing, that you have an agency that is, in fact, devoted
not to this balance between safety and soundness and consumer
protection, but has a focus on consumer protection. Your
response?
Mr. Yingling. Well, first, they are two sides of the same
coin and I would just use the famous example now of the
mortgage crisis, where that was in many ways a consumer issue,
a terrible failure of regulation at both the Federal and State
level with respect to regulating these toxic mortgages. At the
same time, it is a tremendous safety and soundness question
because it has blown up our economy to a large degree in a
number of markets. Local banks that maybe never made a subprime
loan in their life are being dragged down because the local
economy is dragged down.
I think the main question we would have with respect to
separation is just to use example after example where we feel
that we are going to be caught in the middle. So take the
account opening process. That is a combination. So we are going
to have one examiner come in and say, in your account opening
process, you need to change this disclosure. It needs to be
clearer. You need to change this process. You need to change
the way you are training your tellers. We spend billions of
dollars training tellers on all kinds of compliance issues. The
safety and soundness examiner comes in and says, I completely
disagree with that. If you do it that way, you are going to
encourage fraud, and by the way, you are not complying with the
Bank Secrecy Act. What are we to do? All the legislation talks
about is consulting, but ultimately, both sides have the power
to say, you will do it our way. And there is just example after
example. Check hold periods are another example where we would
be caught in the middle.
Senator Reed. Right now, could a Federal regulator make
those same calls?
Mr. Yingling. One Federal regulator could make the same
calls.
Senator Reed. And that Federal regulator, it seems, based
on the record of the last several years, to make the call in
favor of not consumer protection, but to the ability of the
bank to continue to operate, reputational and other----
Mr. Yingling. I would not argue with you, Senator, that
there have not been failures and that things need to be done.
But it is not always profitability. If you look at the check
hold period, they have to balance what the consumers would
like, which is the money right away, with the fact that we have
a multibillion-dollar processing system that is evolving for
checks with the fact that we are subject to billions of dollars
in check fraud which is ultimately paid for by the consumers.
Senator Reed. Mr. Plunkett, if you could comment on this
discussion, I think it has been a good one.
Mr. Plunkett. The concern I have is that there are, until
the last year, virtually no examples of the current safety and
soundness structure putting consumer protection concerns first.
The reason we need to go this route is because safety and
soundness regulators, and we have to say this based on
experience over the last 30 years, the norm for them is to
consider the bottom line for the institutions that are
regulated, and there is just example after example.
I mentioned in my statement overdraft loans, where the
regulators appear to have dithered because primarily what is a
deceptive practice, that is offering a loan without telling the
consumer, charging the consumer fees without giving them a real
right to choose to accept those fees, it is a very profitable
line of business. So again and again, the norm for safety and
soundness regulators has been to ignore consumer protection. It
is all well and good to say, well, that should change, but I
don't think that that is how safety and soundness regulators
typically think.
Senator Reed. Thank you very much.
Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Mr. Wallison, in your written testimony, you quote Justice
Brandeis, who wrote, and I will quote, ``The greater dangers to
liberty lurk in insidious encroachment by men of zeal, well
meaning but without understanding.'' Elaborate on that, if you
would, because as I raised earlier the question to Secretary
Barr, this is a radical approach, different from our classical
approach to regulation, is it not?
Mr. Wallison. Yes, I think this is a very paternalistic
approach and quite different from anything we have had in the
past. In the past, we have always used disclosure, and
disclosure can be improved. There is no question----
Senator Shelby. Absolutely, it can.
Mr. Wallison. Actually, my AEI colleague, Alex Pollock, has
come up with a one-page disclosure form for a mortgage which
you would have to look at before you signed up for the
mortgage--not at the closing, but when you sign up for the
mortgage--and that would list all of the various risks and so
forth and the costs of the kind of mortgage that you are
taking. That is an improvement----
Senator Shelby. In plain English, right?
Mr. Wallison. In plain English, that is exactly right.
People can understand that. Instead, what we are proposing to
do here is really to say to providers, you are going to take
the risk of offering something more than this plain-vanilla
product. If you take this risk and it turns out that the
consumer is not pleased with it or we, the regulatory agency,
are not pleased with it, you are going to have to pay some very
substantial costs in the form of enforcement. This is a
completely different way of looking at consumer protection and
radical in my view, too.
Senator Shelby. Could this in a big way ration credit to
some people who need it the most?
Mr. Wallison. Well, exactly. The effect of this, of course,
is when a provider is confronted with the choice of whether to
offer only the plain-vanilla product or the more complex
product, he has to decide whether this particular consumer is
going to be able to understand the product. And as I quoted in
my testimony, the white paper says here that disclosure itself
may not be enough. For some people, complexity itself is going
to make it difficult for them to sign up for something that
they may not understand.
So the provider has to make this decision, and what the
provider is mostly going to do is say, I am sticking with the
plain-vanilla product because if I go any further with that,
with this particular consumer, I could get in trouble, and that
will reduce the products that are available to consumers, I am
afraid.
Senator Shelby. Financial institutions, as I understand the
proposal, will no longer be primarily concerned with discerning
and meeting the needs of their customers. Instead, they would
be concerned with gaining regulatory approval and avoiding
taking any steps that would lead to enforcement actions or,
obviously, costly litigation down the road. Do you agree with
that?
Mr. Wallison. Yes, of course. That is the thing that I
think the people in the Administration missed--that there is a
very important problem for providers, a very difficult problem
in fending off litigation and enforcement activities. They want
to comply with the law, and so they have to know exactly what
it is that they can do. If they are left in a position where
they have to make a decision about the ability of someone
sitting in front of them across the desk to understand
something, well, there is only one decision they can make and
that is to limit what they offer.
Senator Shelby. Mr. Yingling, the proposal states that the
agency would have to, quote, ``consider the potential benefits
and cost to consumers and covered persons.'' Consider and
potential are not very definite words, I would think. Shouldn't
the language require that the real benefits must outweigh real
costs to consumers and covered persons instead of that? The
agency could not meet its mandate, as I understand it, to
promote efficient markets if in the end the transaction is not
beneficial for both parties in the transaction. That is the way
the market works, does it not?
Mr. Yingling. Senator, that is basically the only general
standard in it. The authority of this agency is broader than
any agency, I would say, that has ever been proposed. If I
could, let me just read you the one section. This is Section
1037(1)(a). In general, the agency shall prescribe rules
imposing duties on a covered person. Now, a covered person is
anyone that offers consumer financial services. So the agency
shall prescribe rules imposing duties on a covered person as
the agency deems appropriate or necessary to ensure fair
dealing with consumers. That is it.
Every single law you have ever passed, every regulation on
the books is trumped by this. They are just floors. And the
standard you cited, I could go in the hall with a couple of
lawyers and in an hour come back with a paragraph, a
boilerplate paragraph with a couple of blanks in it that this
agency could put in every rule they write to meet that
standard.
This agency is empowered to do anything it wants, and I
don't know what that means your function is, because that
credit card bill you just worked so hard on is now nothing but
a floor, trumped by this section.
Senator Shelby. Thank you. Thank you, Mr. Chairman.
Senator Reed. Thank you, Senator Shelby.
Senator Warner, please.
Senator Warner. Thank you, Mr. Chairman.
I share some concerns about some of the Administration's
proposals, but I want to go back with Mr. Wallison. I am not
sure that I would concur that the sense that the Government is
going in certain cases to prohibit certain products as being
too dangerous, that that has not been due course of doing
business. I mean, we have done it recently. The Fed has done it
recently with double-cycle billing in the credit card area. We
have had longtime prohibitions against loan sharking. I used to
be in a pretty good business in the venture capital business,
but we had, as we have discussed, Peter, prescriptions that
said not everybody can invest in venture capital fund. You have
to be a qualified investor.
And I understand the notional difference between investing
and access to credit, although I would argue that some of the
products that we have created have been all about marginally
lowering the cost of risk, and there is some judgment of
marginally lowering the cost of risk versus the overall
societal downside risk we are taking. There has got to be some
balancing here.
So I know where you are going to come back at me on this,
but I do want you to come back at me in terms of saying, would
you say market all the time, no prohibitions at all on any
product mix, disclosure alone always trumps?
Mr. Wallison. No. Thank you for the question, Senator, but
that would not be my view. I think there are things that one
could--the Senate could, the Congress could--forbid, and
should, because some things can actually be abusive. But in
general, what we are doing with this legislation is putting
providers in a position where they have to make a judgment
about the ability of the person sitting across the desk from
them to understand all of the factors that go into a particular
product that is being offered.
And so what we are saying in this legislation essentially
is, here is the plain-vanilla product. If you offer this
product, you are not going to take many risks because it has
been approved by the CFPA and here are the disclosures that the
CFPA wants you to make about it. And the provider puts that
product in front of the customer and says, ``I think you should
take this product'' because the provider has made a judgment
that this customer probably can't understand or might not be
willing to understand the complexities of the other products
that the provider could offer to customers who are more
sophisticated and experienced.
So the result of that, I think, is going to be only one
thing, that many, many people who could understand, with
adequate disclosure, products that are going to be better for
them and their families will never have those products offered
to them.
Senator Warner. But in this example, I mean, in the normal
marketplace, if we put out a symbol that says ``buyer beware,''
buyer makes the wrong choice and the market absorbs the
consequences. But in this circumstance, at least we have seen
in recent action there perhaps was not a ``buyer beware'' on
some of these exotic financial mortgage products. I have got
members of my family that I argued diligently against, don't
take that product. You are going to get it. But they saw the
up-front sticker price and they bought it anyway. Not everybody
has got a wealthy brother to bail them out, although I guess we
do have a wealthy Uncle Sam that is now indirectly bailing out.
But if at the end of the day the ramifications of buyers
making bad choices around the credit markets is that we, the
taxpayers, are ultimately going to bail them out, don't we have
some responsibility to perhaps put some either ring fencing or
some parameters around this? I mean, are we in a different mix
of products when we are at the end of the day maybe having the
taxpayer be on the hook for bad choices made by consumers? Is
there----
Mr. Plunkett. Senator, buyer beware doesn't always work. As
you pointed out, it is not just the new credit card law. In
2005, Congress said payday loans and other high-cost loans are
not good for our service members and prohibited them. There is
actually a long line of recent Congressional and regulatory
measures that have acknowledged that the disclosure-only
approach doesn't work. Telling somebody that you are going to
deceive them and then deceiving them is not a good thing. So we
need to recognize the limits of this disclosure-only approach.
Mr. Wallison. This makes my case, I think, and that is
there is no way that a provider can offer a product that he is
not certain the person sitting across from him understands.
Mr. Yingling. I think----
Mr. Plunkett. But that occurs all the time in the
securities world. Suitability is embedded in the new
legislation that the House has passed on mortgage lending. It
is absolutely possible to make those determinations and it is
done in law.
Mr. Yingling. Some products should be banned. Some products
should have a ``buyer beware'' sign on them, and that is what
the Fed has done, in effect, with their new mortgage
regulations. If you cross a certain line, it has a ``buyer
beware'' sign on it.
What this proposal says is if you deviate in any fashion
from the plain-vanilla product, so I will use a different
example. I will use basic banking accounts, because that will
be part of this. So they design a basic banking account and if
the community bank in Nashville says, I have a great idea that
the students at Vanderbilt will love. I will add an Internet
feature. If Navy Federal Credit Union says, I have a great
feature I can add that will be good for sailors at sea, they
are no longer part of the plain-vanilla product.
Let me read you what this says. This is the thing that was
handed out at the White House, the report that went with this
legislation. For example, the CFPA could impose a strong
warning label on all alternative products, require providers to
have applicants fill out a financial experience questionnaire,
or require providers to obtain the applicants' written opt-in
to such products. Originators, talking about loans, of
alternative products should be subject to significantly higher
penalties for violations.
Why would that bank in Nashville, why would Navy Federal
Credit Union offer these changes to the basic vanilla product?
It is one thing to have warning labels. It is one thing to
outlaw products. It is another thing to say, if you don't offer
our product, you are subject to all kinds of new regulatory
restrictions. I am quoting them. This is their proposal.
Mr. Blumenthal. If I may try to bring together these two
points of view from the standpoint of----
Senator Warner. Let the record show, Mr. Chairman, that I
am not extending my time. The panel is.
[Laughter.]
Senator Reed. This is the General and it is the General's
preference, so go ahead.
Mr. Blumenthal. The highest I made it in the Marine Corps
Reserve was Sergeant, so----
Senator Reed. I am actually in a higher rank.
[Laughter.]
Mr. Blumenthal. If I can bring together these somewhat
differing abstract points of view from the standpoint of the
cop on the beat, and we are talking here about an enforcement
authority as much as a regulator, we may disagree on what
should be banned. I think there is some agreement that certain
products should be banned. We can disagree on where the floor
in enforcement should be.
But the question really for this Committee and for the
Congress is, should we have a point person, an authority that
is accountable for protecting consumers, whether they have a
wealthy relative or not, and assuring disclosure, uniform
disclosure nationwide in an age where--and this is one of our
great frustrations--the mortgage rescue scams, the tax
anticipation loans that charge 300 percent interest can
disappear into the Internet ether and we need Federal
enforcement. Otherwise, even with the best and most vigorous
State law enforcers, including Attorneys General, that system
will be ineffective.
And so I think it is more than which products should be
banned, and certainly some of these standards need to be
tightened. I accept very wholeheartedly Mr. Yingling's critique
of this first draft of the legislation. There need to be
stronger standards, perhaps. But do we need an authority that
will ally with the States in providing stronger enforcement? My
answer is yes.
Senator Warner. You wouldn't end up being where you have
got just the floor set at the Federal level. Could a financial
institution ever have felt like they have finally passed muster
and they aren't going to be then still subject to 50 additional
Attorneys General trying to come after their product, even if
they have passed muster at the Federal level?
Mr. Blumenthal. And I think one of the challenges, Senator,
and I will be very brief in my response, but I think you have
identified, as you did earlier in your questions, one of the
key questions, which is how to harmonize Federal and State
enforcement. But that is a tension inherent in our Federal
system. We go through it in the criminal system with many other
areas except where there is total Federal preemption, as in the
food and drug area. But if we are going to have State
enforcement, there needs to be harmonization. I think the SAFE
Act recognizes the potentials for harmonization. So do the
recent credit card reforms. I think we are moving in the
direction that keeps alive the Federal system, and I think they
can be harmonized.
Mr. Plunkett. Senator, I would just add that if the minimum
is high enough, then you will achieve uniformity because most
States won't see the need to exceed that minimum.
Senator Reed. Thank you.
Senator Corker.
Senator Corker. Mr. Chairman, thank you, and I thank each
of you as witnesses. It is always highly beneficial to us to
have people like you here and I thank you for that.
Mr. Wallison, I do want to thank you for your comments. I
agree with almost everything you have said, and we have met
many times. I appreciate certainly your testimony today.
Professor, I listened to the pixels and the ring fences and
very much appreciated what you had to say, also. I still was
unclear, though, as to whether you viewed disclosure--you were
talking about the psychology of people purchasing things in an
economy--whether you believe that disclosure is enough or
whether you believe, like this Administration, that they are
wise men that govern ignorant souls that need to be directed as
to what to buy and not buy. I still was unclear and I would
love some edification there.
Mr. Mullainathan. Thank you very much. I think it is useful
to set two extremes. I think by focusing on contrasts with
disclosure, we are failing to recognize that sometimes in this
sector we also engage in bans. We have done that with the
credit card bill and it will happen again.
So to me, the challenge is not about disclosure and moving
to do more than disclosure. The challenge is when we are
setting up an agency, are we going to handicap it by giving it
only two extreme options, disclose or ban. To me, that is
unfortunate. That is exactly a bad market solution because
there are products which have benefits for some consumers but
which are complicated for other consumers. As a result,
disclosure might not work. It may be hard to get some consumers
to understand fully the most exotic products, but we don't want
to ban them because they have genuine benefits for a variety of
other consumers.
I think that raises a--there is a set of products that fall
in that middle, and to me, ring fencing and the proposals in
the legislation--and I have to admit, maybe I am reading a
different draft. I don't see Government design or Government
standards in this draft. To me, what this does is it gives the
opportunity, and I think more clarity is needed in the bill and
I think moving forward that is where we would need clarity, but
it gives an opportunity to say, let us recognize the financial
services require some middle ground. Sometimes, we will want to
keep exotic products in the mix. Therefore, we won't want to
ban them. But we will need something more than disclosure,
because a lot of consumers, as with double-cycle billing, there
is no single form that is going to simply explain to consumers
the most exotic products.
And even if there were a single form, the reality of the
way you buy something is such that someone can give you that
single form and eight other pieces of paper on top of that
single form. I have rented cars many times, and I realized the
other day, they say, put an X here, an X here, an X here, put
your initials there, and sign here. I don't know what I am
signing for when I sign those things. I have never read the
disclosure on that form. Maybe some of you have.
But the point I am trying to make is that marketing is very
powerful. Disclosure for many customers for exotic products
won't necessarily work, but at the same time, I wouldn't want
to resort to a ban every time we encounter that situation. And
I think it is that middle ground that is trying to be attained
by this bill. Though, I understand the risks if that middle
ground is not done well, and I would think the challenge of
working and crafting this bill is to give the agency another
tool beyond either of these extremes.
Mr. Yingling. I will just say Section 1036 of the bill,
Standard Consumer Financial Products or Services, clearly
authorizes them to mandate products and to put restrictions on
products that are not mandated.
Senator Corker. Which brings me----
Mr. Plunkett. The idea is not to have a bureaucrat
designing a product, Ed. The idea is to, as we heard from the
Administration, make sure that as a class there are
alternatives.
Mr. Yingling. I can only deal with what the statute says
and what their proposal----
Senator Corker. I would like to interject here, if I could.
Mr. Yingling. Sorry, Senator.
Senator Corker. Thank you both for your vigorous help in
this.
So, Mr. Yingling, you have been before us before, and
obviously because of the group that you represent, people are
going to say that when you say that we can do this within the
confines that we now have, you are basically arguing for the
status quo. I know that is not what you are arguing for. But if
you would, tell us how within the present regulatory system
that we have we can ensure that there is consumer protection.
And, second, what kind of products do you think would go away
under this type of regime? Good products, by the way.
Mr. Yingling. Well, first we are not arguing for status
quo. The status quo has been a failure, and so we are arguing
for change.
One thing I would point out is there has been a significant
change in terms of the power of the agencies using UDAP. And if
you look at the credit card regulation--which you all trumped
with a stronger bill, but a lot of it was in that regulation--
this is a new era. The use of UDAP by the regulatory agencies
is much stronger, and we would recommend that a bill that was
passed by the House last year which grants that authority in a
coordinated fashion to all the regulatory agencies should be
adopted.
You are going to deal with a systemic oversight regulatory
that is controversial, but that systemic oversight regulator
should have the authority to look at these consumer issues in a
coordinated fashion.
One of the great obvious failures is why our Government did
not see--did see, to a large extent, but was not really charged
with saying look at the graphs in the growth of these kinds of
loans, let us investigate it, let us stop it. The systemic
regulator should be given that charge.
There should be a coordinated place in the Federal
Government where consumers can call in. You raised that point.
It is a very legitimate point. They do not know where to call.
There should be a coordinated place where they can call, and
then the statistics are kept, and that is referred for action
to the correct regulator.
There should be greater coordination at the Federal level
with the States. I think we have gotten into the habit of
having these court fights, and in reality we should be sitting
down at the table between the States and the Federal regulators
and figuring out how to do it. There are a number of things
that could be done.
In terms of products that would be innovative, every single
day in this country in some bank they are thinking of how to
adjust a mortgage product, adjust an automobile loan, adjust a
basic banking account. They are sitting around a table saying,
``Oh, if we could add this Internet feature, if we could add a
feature for senior citizens.'' They are constantly adjusting.
And some of those fail; some of those helped in their market;
some of them become great products that others start to offer.
And I can only deal with the language that they have offered.
All those are not plain-vanilla products. Any time you
deviated, you would not be a plain-vanilla product. And so if
that is not going to chill innovation, I do not know what is,
because you are subject to all kinds of extra rules if you
cannot make those deviations.
Senator Corker. Mr. Chairman, thank you, and, gentlemen, I
want to say that the comments you have made indicate to me that
while you want to see strong consumer protection, because that
is what you do, and you see abuses, that you, too, even see
this bill in its present form as an overreach and that we have
a lot of work to do to get it right.
Mr. Blumenthal. I would agree with everything you have just
said except perhaps with the term ``overreach.'' And I do not
mean to quibble or criticize. I agree with you wholeheartedly
that this bill is a first draft; it needs refinement, it needs
work. And I think with your help, with Senator Shelby's, and
with all the Senators who are here, particularly Senator Dodd,
we are going to reach the goal line. But I do think that a
point of accountability somewhere that your constituents can
call when they have a question or a problem and they need an
enforcer to protect them against a usurious interest rate or
any of the abuses we have been talking about here I think is
tremendously important.
Thank you.
Senator Reed. Thank you.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. Thank you all
for your testimony.
Mr. Yingling, I appreciate many of the comments you made. I
know you spent a lot of time in your testimony talking about
community banks, and I am concerned about the pressures we are
putting on them. But it was not just community banks. If it was
just community banks, we would not be in trouble. You know, we
have Bank of America, we have given it a lot of money; Citi, we
have given it a lot of money. So while I understand your focus
on community banks, the reality is that we have a range of
banks here, some which clearly acted in ways that were not, I
guess, in their interest and certainly not in our collective
interest because they created systemic risk, and that is why we
are giving them enormous amounts of money.
And while I think you have some legitimate concerns in your
testimony, I am concerned, as I have said in the past to the
association on other matters, is that, you know, I read the
elements of what you have listed here as improvements that can
be made. And, you know, my concern is that if the industry does
not get out there and be for significant changes, then it will
face a legislative action that it probably will not like at the
end of the day.
And so I hope that when you say that we are not for the
status quo and we are for change--but I read the changes and,
you know, centralized call centers and, you know, basically
saying that we should enable basic products, you know, when
even in your testimony you recognize some of those problems
become overly complex and difficult, as well as that they often
have consumers buying products or enhancements that are not
right for them, for which they pay too much, you know, is not
in my mind the type of reform we are going to need. I
appreciate what you talked about on OTS. That is, I think, a
good offer, but after that it seems very little to me.
So I would urge, you know, the association to be more
aggressive in what they are offering here in terms of a
legislative response. And I am concerned, you know, that--I
look at where we are at, and it seems to me that a lot of,
prior to the crisis, financial institutions changed their
charters to shop for lenient regulators. And it seems to me
that by imposing uniform regulations on consumers financial
products across all types of financial institutions, one of
your concerns, but listening to the Secretary pretty much sound
to me like we are talking about all types of financial
institutions no matter who regulates them, wouldn't the
Consumer Financial Protection Agency reduce the incentives to
shop for more lenient regulators, at least with respect to
consumer product legislation?
So I think that while we can tailor this a little better,
the reality is that we need this. So, you know, I am--I hope
the industry will be a little bit more forthcoming in terms of
real change so that we can strike the right balance at the end
of the day between having the financial products we all want to
see open to consumers but having the protections that are
critical at the end of the day. And it is in that spirit that,
you know, I certainly come to this with, and I hope others do
as well.
I just get, you know, a sense--you know, Mr. Plunkett, when
most Americans go apply for one of the hundreds of different
kinds of mortgages, they do not typically bring a financial
adviser along with them, do they?
Mr. Plunkett. No.
Senator Menendez. And when a mortgage broker or lender
talks to somebody about a 5-1 interest-only ARM or a negative
amortization loan, how many people do you think really
understand that?
Mr. Plunkett. I wouldn't--Senator, you make some very good
points here. What we have heard so far from the financial
services industry in terms of their ``reforms,'' I heard a
systemic regulator maybe, but I heard no discussion of
eliminating regulatory arbitrage. I heard no discussion of
consolidating the consumer protection approach in any fashion
to make it more effective. I heard no discussion of any
systemic approach to improving consumer protection regulation.
I heard the regulators are getting a little better, so we might
as well leave things as they are.
That is not going to work given the current situation. We
need something broader, and we need an agency that is focused
just on consumers.
Senator Menendez. So it just seems to me that when we go
down the list of questions of what the average consumer might
find themselves in, we see the incentives, for example, in the
mortgage crisis for lenders to move people into products that,
at the end of the day, may be very beneficial to them but not
very beneficial to the consumer. And when millions of people
enter into those transactions and then have consequences when
those first 5 years end and cannot meet their obligations, then
we have systemic challenges to our economy.
So it just seems to me why should we have the borrowers
simply fend for themselves? I believe all in personal
responsibility. I would love us to have greater financial
literacy commitments as a country from education, to
engagement, even our financial institutions to do so. But at
the end of the day, if we allow millions of people based upon
incentives that move individuals to try--entities to try to
move individuals to products that are good for the lender and/
or the broker but bad for the consumer and millions ultimately
make a mistake and then create the consequences that we have
today in the housing market, it affects all of us.
Mr. Plunkett. Well, Senator, I hope that when we heard
discussion today about choices, we were not hearing about
choices like the large number of minority consumers who were
steered into high-cost mortgage loans when they could have
afforded and would have qualified for a lower-cost loan. I hope
we are not talking about choices like what Congress has just
eliminated in the credit card bill, not just double-cycle
billing but interest rate increases on existing balances for no
apparent reason. I mean, that is called ``negative financial
engineering.'' That is not legitimate innovation. And that is
the kind of, unfortunately, choice in many credit areas that
has driven out positive credit, credit offered by some of the
small banks you mentioned or credit unions.
Senator Menendez. Well, Mr. Chairman, I hope that we will--
you know, I do have concerns about how we structure this in a
way that affects community banks that clearly have not been at
the forefront of our economic challenges. We need to look at
that.
I do get concerned about how we harmonize the State
regulator process with these efforts.
And, third, I do want to see--I think Mr. Yingling does
make a very valid comment that we have to apply--if we are
going to have this consumer protection agency, which I
generally support, it has to be applied across the spectrum of
financial service entities; otherwise, we would do a disservice
to the consumer, to the Nation, and certainly to the industry
as well. So I look forward to working toward those goals.
Senator Reed. Thank you, Senator Menendez.
Senator Shelby, you have a comment?
Senator Shelby. I have got a couple of scenarios here that
I think we ought to consider. In case one, a borrower obtains a
subprime loan, the only loan he could qualify for, and uses it
to buy property and then realizes a 75-percent gain on the
property 3 years later. This goes on.
In case two, a borrower obtains a subprime loan in another
market. This borrower has all the same credit and income
characteristics at the time he received the loan as the
borrower in the first scenario, but later loses his job, sees
the real estate market collapse, and then defaults.
I believe we need a system where we can accommodate both.
How do we do that? In other words, the first guy--and this goes
on--took a subprime loan and he made money out of it. Good for
him, good probably for the market. The second one, he had the
same qualifications, but things turned sour on him. He lost his
job, and then he could not make the payments and so forth.
How do we do this? Mr. Wallison, do you have any--how do we
balance this, I guess?
Mr. Wallison. I think, Senator Shelby, you are focusing on
exactly the problem here, which is trying to determine in
advance what a person understands. The first person you are
talking about--that consumer--may or may not have understood
all of the elements of this loan, but it worked for him. It
might not even have been the best loan he could have gotten,
but it still worked for him. In the second case, it did not
work for him.
I am looking at it, again--and I must do this because we
have to consider the way this works in practice--from the
standpoint of the provider. The provider is going to be very
much at risk if he offers a loan to the first or the second
person--the same loan----
Senator Shelby. That is right.
Mr. Wallison. Which goes beyond the plain-vanilla
structure. If he does, the second guy--who did not make any
money--is going to come back to him and complain about that or
complain to the CFPA about him. And providers have to worry
about this because they can be driven out of business very
easily.
Senator Shelby. By litigation.
Mr. Wallison. By an enforcement action or a litigation or
by a State Attorney General. So I think when the Committee is
looking at this, you have to look at it from the standpoint of
both the consumer and the provider, because the provider's
decisions on whether to make these loans will affect very much
what the consumer can get.
Senator Shelby. Thank you.
Mr. Mullainathan. If I may, I would like to add two
comments to that, if I----
Senator Reed. Quickly.
Mr. Mullainathan. Quickly. One comment is providers are in
the business already of detecting whether consumers understand
or not. It would be unfortunate if a consumer took out a loan
they could not repay. So one of the things providers do is
actually assess whether the person--a good provider, whether
the person understands the payments owed to them. So I do not
think this is novel business practice.
Second, I think we have to ask the question who should bear
the risk of a consumer not understanding. I think part of the
risk should be borne by the consumer, but some of the risk
should be borne by the firm. So I think the question is, do we
leave the tilt of the balance all on the consumer or do we say
the firm bears some of the risk as well of a consumer not
understanding.
Thank you.
Senator Reed. Thank you very much.
Senator Merkley has joined us, but he has been very
gracious, and I just want to make two comments. I think the
testimony has been excellent. We have several challenges. The
two primary ones are ensuring there is a comprehensive form of
consumer protection, which has been proposed in one agency. And
then a second issue is the authority of that agency to conduct
the operations. Those I think are the two basic issues.
I think also, too, I would just point out for the record
that there is no private right of action included in this
proposal. So there might be complaints to regulators, but the
suggestion that this is going to set off a wave of private
claims it not included in the legislation.
Also, I think the presumption at least that I start out
with is that this agency will be subsuming the existing
legislation authority of the Fed, of the different regulators,
not have sort of an open-ended sort of role in crafting any
sort of ideas they want. Truth in Lending Act, HOEPA, all those
things now would shift--that legislation, that authority would
shift to the agency.
So I again want to thank you all, and I particularly want
to thank Senator Merkley, because I think we are ready to go.
Thank you, gentlemen.
The hearing is adjourned.
[Whereupon, at 12:10 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Good morning. Thank you all for being here today.
This morning, we are taking an important step in our efforts to
modernize our financial regulatory system. The failure of that system
in recent years has left our economy in peril and caused real pain for
hard-working Americans who did nothing wrong.
The important work we do on this Committee is often complex and
painstaking in its detail.
And so, I'd like to start by reminding everyone that the work we do
here, the details, matter to real people, the men and women in my home
State of Connecticut and across America who work hard, play by the
rules, and want nothing more than to make a better life for their
families.
These families are the foundation of our economy and the reason
we're here in Washington working on this historic and critically
important legislation.
That's why the first piece of the Administration's comprehensive
plan to rebuild our regulatory regime and our economy is something I
have championed: an independent agency whose job it will be to ensure
that American consumers are treated fairly and honestly.
Think about the moments when Americans engage with financial
service providers. I'm not talking about big-time investors or
financial experts, just ordinary working people trying to secure their
futures. They're opening checking accounts, taking out loans, building
their credit, trying to build a foundation upon which their family's
economic security can rest.
These can be among the most important and stressful moments a
family can face.
Think of a young couple. They've carefully saved up for a down
payment. It might be a modest house--but it'll be their home. Before
they can move into their new home, however, they must sign on the
dotted line for that first mortgage with its pages and pages of complex
and confusing disclosures.
Who's looking out for them?
Think of a factory worker who drives 30 miles to and from work
every day in an old car that's about to give out. He needs another one
to make it through the winter, but his wages are stagnant and the
family budget is stretched to the max. He's got no choice but to
navigate the complicated world of auto loans.
Who's looking out for him?
Think of a single mother whose 17-year-old son just got into his
top choice of colleges. She's overjoyed for him, but worried about how
she'll pay the tuition. Financial aid might not be enough, and she
knows that even as her son begins the next chapter in a life filled
with promise, he might be saddled with debt.
Who's looking out for them?
These moments are the reason we have invested so much time and
money to rebuild our financial sector even though some of the very same
institutions the taxpayers have propped up are responsible for their
own predicaments. These moments are the reason we serve on this
Committee.
And these moments are the reason I and many of my colleagues were
enraged at the spectacular failure of consumer protection that
destroyed the economic security of so many American families.
In my home State of Connecticut and around the country, working men
and women who did nothing wrong have watched this economy fall through
the floor--taking with it jobs, homes, life savings, and the cherished
promise of the American middle class.
These folks are hurting, they are angry, they are worried. And they
are wondering: Is anyone looking out for me?
Since the very first hearing before this Committee on modernizing
our financial regulatory structure, I have said that consumer
protection must be a top priority.
Stronger consumer protection could have stopped this crisis before
it started.
And where were the regulators? For 14 years, despite a clear
directive from Congress, the Federal Reserve Board took no action to
ban abusive home mortgages. Gaping holes in the regulatory fabric
allowed mortgage brokers and bankers to make and sell predatory loans
to Wall Street that turned into toxic securities and brought our
economy to its knees.
That is why I called for the creation of an independent consumer
protection agency whose sole focus is the financial well-being of
consumers; an agency whose goal is to put an end to unscrupulous
lenders and practices that have ripped off far too many American
families.
And I'm pleased that the Administration has sent us a bold and
thoughtful plan for that agency.
You would think financial services companies would support
protections that ensure the financial well-being of their customers--if
not out of concern for their own bottom-lines, then out of simple
common decency.
But now I read that various industry groups are planning a major PR
offensive in an effort to kill this consumer protection agency.
To those who helped create this mess and now plan to flood the
airwaves with misleading propaganda, I have just two words for you: Get
real.
The forces of the status quo can run as many ``Harry and Louise''
ads as they want. But Harry and Louise are exactly why we're moving
forward on this proposal.
We can't have a functioning economy if Harry and Louise can't
safely invest and borrow without fear of being cheated by greedy banks
and Wall Street firms. And we will not have a financial regulatory
modernization bill that doesn't provide the protections American
families need and deserve.
An independent consumer protection agency can, and should, be good
for business.
It can, and should, protect the financial well-being of American
consumers so that businesses can rely on a healthy customer base as
they seek to build long-term profitability.
It can, and should, eliminate the regulatory overlap and
bureaucracy that comes from the current balkanized system of consumer
protection regulation.
It can, and should, level the playing field by applying a
meaningful set of standards, not only to the highly regulated banks,
but also to their nonbank competitors that have slipped under the
regulatory radar screen.
Financial services companies that want to make an honest living
should welcome this effort to create a level playing field.
Indeed, the good lenders are the most disadvantaged when fly-by-
night brokers and finance companies set up shop down the street. Then
we see bad lending pushing out the good.
No Senator on this Committee wants to stifle product innovation,
limit consumer choice, or create regulation that is unnecessary or
unduly burdensome.
And I welcome constructive input from those in the financial
services sector who share our commitment to making sure that American
families get a fair shake.
But I do not view as constructive the opposition to the creation of
this agency by some industry groups in order to, as Bloomberg News
reported, ``protect their fees.''
We all want financial services companies to thrive and succeed, but
they will have to make their money the old fashioned way--by developing
innovative products, pricing competitively, providing excellent
customer service, and engaging in fair competition on the open market.
The days of profiting from misleading or predatory practices are
over.
The path to recovery of our financial services companies and our
economy is based on the financial health of American consumers.
We need a system that rewards products and firms that create wealth
for American families, not one that rewards financial engineering that
generates profits for financial firms by passing on hidden risks to
investors and borrowers.
The fact that the consumer protection agency is the first
legislative item the Administration has sent to Congress since it
released its white paper on regulatory reform last month tells me that
our President's priorities are in the right order.
I wish I could say the same for everyone in the industry.
Nevertheless, with the backing of the Administration, with the
support of many in the financial community who understand the
importance of this reform, and, most of all, with a mandate from the
American families who count on a fair and secure financial system, we
will push forward.
I thank you all for being here today. Now let's get to work.
______
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Thank you Mr. Chairman for holding today's hearing. This hearing
could be one of the most important held this month as the Committee
takes up legislation to modernize our financial regulatory system.
The current economic crisis has exposed regulatory gaps that
allowed institutions to offer products with minimal regulation and
oversight. Many of these products were not just ill-suited for
consumers, but were disastrous for American homeowners. There is a
clear need to address the failures of our current system when it comes
to protecting consumers. We need to find the correct balance between
consumer protection, innovation, and sustainable economic growth.
There is no doubt that the status quo is not acceptable. However,
as Congress considers proposals to improve the protection of consumers
from unfair, deceptive, and predatory practices, we must ask many
important questions. We need to know if it is the right thing to do to
separate consumer protection from functional regulation. We need to
know if a separate, independent consumer protection agency is better
than a consumer protection division within an existing regulatory
agency. We need to know who should be writing rules for consumer
products and who should be enforcing those rules. We need to know if
national standards or 51 set of rules made by each State are better for
consumers. Last, while the goal of any consumer protection agency is
clearly better protection of consumers, we need to know if it will also
preserve appropriate access to credit for the consumers it is designed
to protect.
The creation of a new agency is a daunting task under any
circumstances; even more so in this case, considering the role a
consumer protection agency would play in our Nation's economic
recovery. It is important we get this right. I look forward to hearing
from today's witnesses.
______
PREPARED STATEMENT OF MICHAEL S. BARR
Assistant Secretary for Financial Institutions,
Department of the Treasury
July 14, 2009
Thank you, Chairman Dodd and Ranking Member Shelby, for providing
me with this opportunity to testify about the Administration's proposal
to establish a new, strong financial regulatory agency charged with
just one job: looking out for consumers across the financial services
landscape.
The need could not be clearer. Today's consumer protection regime
just experienced massive failure. It could not stem a plague of abusive
and unaffordable mortgages and exploitative credit cards despite clear
warning signs. It cost millions of responsible consumers their homes,
their savings, and their dignity. And it contributed to the near
collapse of our financial system. We did not have just a financial
crisis; we had a consumer crisis. Americans are still paying the price,
and those forced into foreclosure or bankruptcy or put through other
wrenching dislocations will pay for years.
There are voices saying that the status quo is fine or good enough.
That we should keep the bank regulators in charge of protecting
consumers. That we just need some patches. They even claim consumers
are better off with the current approach.
It is not surprising we are hearing these voices. As Secretary
Geithner observed last week, the President's proposals would reduce the
ability of financial institutions to choose their regulator, to shape
the content of future regulation, and to continue financial practices
that were lucrative for a time, but that ultimately proved so damaging.
Entrenched interests always resist change. Major reform always brings
out fear mongering. But responsible financial institutions and
providers have nothing to fear.
We all aspire to the same objectives for consumer protection
regulation: independence, accountability, effectiveness, and balance.
The question is how to achieve them. A successful regulatory structure
for consumer protection requires mission focus, marketwide coverage,
and consolidated authority.
Today's system has none of these qualities. It fragments
jurisdiction and authority for consumer protection over many Federal
regulators, most of which have higher priorities than protecting
consumers. Nonbanks avoid Federal supervision; no Federal consumer
compliance examiner lands at their doorsteps. Banks can choose the
least restrictive supervisor among several different banking agencies.
Fragmentation of rule writing, supervision, and enforcement leads to
finger-pointing in place of action and makes actions taken less
effective.
The President's proposal for one agency for one marketplace with
one mission--protecting consumers--will resolve these problems. The
Consumer Financial Protection Agency will create a level playing field
for all providers, regardless of their charter or corporate form. It
will ensure high and uniform standards across the market. It will end
profits based on misleading sales pitches and hidden traps, but there
will be profits made on a level playing field where banks and nonbanks
can compete on the basis of price and quality.
If we create one Federal regulator with consolidated authority, we
will be able to leave behind regulatory arbitrage and interagency
finger-pointing. And we will be assured of accountability.
Our proposal ensures, not limits, consumer choice; preserves, not
stifles, innovation; strengthens, not weakens, depository institutions;
reduces, not increases, regulatory costs; and increases, not reduces,
national regulatory uniformity.
Successful consumer protection regulation requires mission focus,
marketwide coverage, and consolidated authority
Consumer protection regulation should be effective and balanced,
independent and accountable. It can be none of these without three
essential qualities: mission focus, marketwide coverage, and
consolidated authority.
First, consumer protection regulation requires mission focus. A
clear mission is the handmaiden of accountability. It is also the basis
for the expertise and effectiveness that are essential to maintaining
independence.
Second, the regulator must have marketwide jurisdiction. This
ensures consistent and high standards for everyone. And it prevents
providers from choosing a less restrictive regulator. Carving up
markets in artificial, noneconomic ways is a recipe for weak and
inconsistent consumer protection standards and captured regulators.
Third, authorities for regulation, supervision, and enforcement
must be consolidated. A regulator without the full kit of tools is
frequently forced to choose between acting without the right tool and
not acting at all. Moreover, if different regulators have different
authorities, each can point the finger at the other instead of acting,
and the sum of their actions will be less than the parts. The rule
writer that does not supervise providers lacks information it needs to
determine when to write or revise rules, and how best to do so. The
supervisor that does not write rules lacks a marketwide perspective or
adequate incentives to act. Splitting authorities is a recipe for
inertia, inefficiency, and unaccountability.
The present system of consumer protection regulation is designed for
failure
The present system of consumer protection regulation is not
designed to be independent or accountable, effective or balanced. It is
designed to fail. It is simply incapable of earning and keeping the
trust of responsible consumers and providers.
Today's system does not meet a single one of the requirements I
just laid out: mission focus, marketwide coverage, or consolidated
authority. It does not even come close. The system fragments
jurisdiction and authority for consumer protection over many Federal
regulators, most of which have higher priorities than protecting
consumers. Nonbanks avoid Federal supervision and banks can choose the
least restrictive supervisor among several different banking agencies.
Fragmentation of rule writing, supervision, and enforcement among
several agencies lead to finger-pointing in place of action and make
actions taken less effective.
This structure is a welcome mat for bad actors and irresponsible
practices. Responsible providers are forced to choose between keeping
market share and treating consumers fairly. The least common
denominator sets the standard, standards inevitably erode, and
consumers pay the price. Let me spell out these failures in more
detail.
Lack of mission focus: Protecting consumers is not the banking
agencies' priority. The primary mission of Federal banking agencies, in
law and in practice, is to ensure that banks act prudently so they
remain safe and sound. Ensuring that banks act transparently and fairly
with consumers is not their highest priority. Consumer protection
regulation and supervision was added to the agencies' responsibilities
relatively late in their histories, and it has never fit snugly in
their missions, structures, or agency cultures.
In fact, consumer protection supervision is generally conducted
through the prism of bank safety and soundness. The goal of such
supervision has too often been to protect banks or thrifts from
excessive litigation or reputation risk, rather than to protect
consumers. It was thought that supervising the banks for their
effective management of ``reputation risk'' and ``litigation risk''--
aspects of a safe and sound institution--would ensure the banks treated
their customers fairly. It didn't. It did not prevent our major banks
and thrifts from retroactively raising rates on credit cards as a
matter of policy, or from selling exploding mortgages to unwitting
consumers as a business expansion plan.
It should not have come as a surprise that the agencies' ``check-
the-box'' approach to consumer compliance supervision missed the forest
for the trees. Examiners are well trained to ascertain whether the
annual percentage rate on a loan is calculated as prescribed and
displayed with a large enough type size. Equally or more important
questions--Could this consumer reasonably have understood this
complicated loan? Is this risky loan remotely suitable for this
consumer?--are not a priority for an agency whose main job is to limit
risks to banks, not consumers.
Managing risks to the bank does not and cannot protect consumers
effectively. This approach judges a bank's conduct toward consumers by
its effect on the bank, not its effect on consumers. Consumer
protection regulation must be based first and foremost on a keen
awareness of the perspectives and interests of consumers, and a strong
motivation to understand how products and practices affect them--for
good and for bad. Agencies charged primarily with safeguarding banks
will lack this awareness or motivation.
Fragmented jurisdiction: There are two regulatory regimes for one
market, and nonbanks escape Federal supervision. There is one market
for residential mortgages, one market for consumer credit, and one
market for payment services--but two different and uncoordinated
regimes for these and other consumer financial products and services.
Banks are subject to an extensive supervisory regime, with lengthy and
intensive consumer compliance examinations on-site and off-site as well
as a legal obligation to respond to requests for internal information.
This regime, when it works, identifies and resolves weaknesses in
banks' consumer protection systems before they harm consumers. The
major failures of this regime were not for lack of examination hours or
paperwork burdens. Failures occurred for lack of asking the right
questions and taking the right perspective. These failures were rooted
in the absence of mission focus. A Federal regime of consumer
compliance supervision can be very effective in the right hands.
Nonbank providers, however, are not subject to any Federal
supervision. No Federal regulator sends consumer compliance examiners
to nonbank providers to review their files or interview their
salespeople. Nor does any Federal regulator regularly collects
information from them, except limited mortgage data.
Nonbank providers are subject only to after-the-fact, targeted
investigations and enforcement actions by the Federal Trade Commission
or State attorneys general. Supervision by the States of these
providers is limited, uneven, and not necessarily coordinated. In
general the same Federal consumer protection laws apply to this sector
as apply to banks, but lack of Federal supervision and inherent
limitations of the after-the-fact approach of investigations and
enforcement resources leave the sector much less closely regulated.
Lack of Federal supervision of nonbanks brings down standards
across the board. Capital and financing flow to the unsupervised sector
in part because it enjoys the advantages of weak consumer oversight.
Less responsible actors face good odds that the FTC and State agencies
lack the resources to detect and investigate them. This puts enormous
pressure on banks, thrifts, and credit unions to lower their standards
to compete--and on their regulators to let them.
This is precisely what happened in the mortgage market. Independent
mortgage companies and brokers grew apace with little oversight;
capital and financing flowed their way. The independents peddled
subprime and exotic mortgages--such as ``option ARMs'' with exploding
payments and rising loan balances--in misleading ways, to consumers
demonstrably unable to understand or handle their complex terms and
hidden, costly features. The FTC and the States took enforcement
actions, but their resources were no match for rapid market growth. And
they could not set rules of the road for the whole industry, or examine
institutions to uncover bad practices and prevent their spread.
To compete over time, banks and thrifts and their affiliates came
to offer the same risky products as their less regulated competitors
and relaxed their standards for underwriting and sales. About one half
of the subprime originations in 2005 and 2006--the shoddy originations
that set off the wave of foreclosures--were by banks and thrifts and
their affiliates. Lenders of all types paid their mortgage brokers and
loan officers more to bring in riskier and higher-priced loans, with
predictable results. Bank regulators were slow to recognize these
problems, and even slower to act. The consequences for homeowners were
devastating, and our economy is still paying the price.
Mortgages are the most dramatic example of the harm that regulatory
fragmentation causes consumers, but not the only one. Take the case of
short-term, small-dollar credit. Payday lenders have grown rapidly
outside the banking sector. They are not typically subject to State
examinations or information collections. On the other side of the bank-
nonbank divide, banks compete in the short-term, small-dollar credit
market with cash advances on credit cards and ``overdraft protection''
programs.
Each one of these three competing products is disclosed to the
consumer differently, and each has been associated with abusive or
unfair practices. There is a clear need for a consistent approach to
regulating short-term, small-dollar credit that protects consumers
while ensuring their access to responsible credit--but our fragmented
system cannot deliver.
The list goes on. A wide range of credit products are offered--from
payday loans to pawn shops, to auto loans and car title loans, many
from large national chains--with little supervision or enforcement.
Credit unions and community banks with straightforward credit products
struggle to compete with less scrupulous providers who appear to offer
a good deal and then pull a switch on the consumer.
Banks and thrifts can--and do--choose the most permissive
supervisor, further depressing standards. Just as capital flows from
the bank sector to the nonbank sector in search of less regulation,
banks and thrifts can freely choose their Federal supervisor on the
basis of which one has less restrictive oversight of consumer
compliance. We saw this choice in action during the mortgage boom.
But institutions do not actually have to switch supervisors to
bring down standards. The mere fact that institutions have a choice
exerts a subtle but pernicious drag on standards. It has little to do
with who runs the agency. It is simply that Government agencies, like
all other organizations, respond to incentives. The banking agencies,
naturally, seek to retain or even compete to gain ``market share.''
Incomplete and fragmented supervision delays and impedes responses
to emerging problems. When a consumer protection problem emerges, a new
regulation is not necessarily the first and best response. It takes
many months, even years, to adopt a new rule. And rules are often
fairly rigid, detailed, and technical, especially if the underlying
statute allows private suits. Supervisory guidance can be a much faster
and more flexible, principles-based method to prevent problems.
But guidance is a much weaker tool than it should be because of
incomplete and fragmented Federal supervisory authority. There is no
Federal supervision over nonbanks, and supervision of banks is divided
among several agencies. This means that any effort to use supervisory
guidance requires a massive and prolonged effort to bring many
different Federal bank regulators, and State regulators of bank and
nonbank institutions, to agreement on the precise wording of the
document.
It took the Federal banking agencies until June 2007 to reach final
consensus on supervisory guidance imposing even general standards on
the sale and underwriting of subprime mortgages--two years after
evidence of declining underwriting standards emerged publicly in a
regulator's survey of loan officers. By that time the subprime
explosion was nearly over. It took additional time for States to adopt
parallel guidance for independent mortgage companies. And it took a
third year for the Federal agencies to settle on a model disclosure of
subprime mortgages, by which point the subprime market had long ago
imploded.
Fragmented authorities: Rule writing is divided across agencies and
largely divorced from enforcement and supervision. Fragmented rule-
writing authority produces delays and inefficiencies. Separation of
rule writing from supervision and enforcement invites finger-pointing
in place of action and reduces the effectiveness of actions taken.
Rule-writing authority is fragmented, producing delays and
inefficiencies. While authority to write most Federal consumer
protection regulations is exclusively in the Federal Reserve, other
agencies have joint or concurrent authority to implement several
statutes. It is a recipe for delay and inefficiency.
For example, HUD and the Federal Reserve each implement a different
statute governing mortgage disclosure, the Real Estate Settlement
Procedure Act and Truth in Lending Act, respectively. The result is two
forms emphasizing different aspects of the same transaction and using
different language to describe some of the same aspects. It has been 11
years since the agencies recommended an integrated form. Even if they
succeed in adopting an integrated form, their ability to act jointly to
keep it up-to-date as the market changes will be limited at best.
As another example, Congress mandated joint or coordinated
rulemaking by six Federal agencies under the Fair and Accurate Credit
Transactions Act of 2003 to improve the accuracy of information
reported to credit bureaus and, to establish procedures for consumers
to file disputes with information furnishers. Those agencies published
final rules less than two weeks ago, on July 1, 2009. Clearly consumers
deserve faster action on issues as important in their financial lives
as accuracy of credit reports.
Rule writing is divorced from enforcement and supervision, causing
inertia and undermining effectiveness. The authority to write
regulations implementing the Federal consumer protection statutes is
largely divorced from the authority for supervision and enforcement.
This deprives the rule writer of critical information about the
marketplace that is essential to effective and balanced regulation.
That is one reason we did not have Federal regulations for the
subprime market. The Federal Reserve has authority to write regulations
under the Truth in Lending Act and Homeownership and Equity Protection
Act to ensure proper disclosure and prevent abusive lending. But it
cannot examine, obtain information from, or investigate independent
mortgage companies or mortgage brokers. So it is not surprising that
the agency was slow to recognize the need for new subprime regulations.
By the time it proposed rules, the subprime market had evaporated.
The separation of rule writing from supervision and enforcement
also leads to finger-pointing and inertia. Take the case of credit
cards. Some banks found they could boost fee and interest income with
complex and opaque terms and features that most consumers would not
notice or understand. These tricks enabled banks to advertise
seductively low annual percentage rates and grab market share. Other
banks found they could not compete if they offered fair credit cards
with more transparent pricing. So consumers got retroactive rate hikes,
rate hikes without notice, and low-rate balance transfer offers that
trapped them in high-rate purchase balances.
A major culprit, once again, was fragmented regulation: One agency
held the pen on regulations, another supervised most of the major card
issuers. Each looked to the other to act, and neither acted until
public outrage reached a crescendo. By then it was too late for
millions of debt-entrapped consumers.
There is only one solution to these deep structural flaws: One
regulator for one market with one mission--protecting
consumers--and the authority and resources to achieve it
These deep structural flaws cannot be solved by tinkering with the
consumer protection mandates or authorities of our existing agencies.
The structure itself is the problem. There are too many agencies with
consumer protection responsibilities, their authorities are too
divided, and their primary missions are too distant from consumer
protection.
These problems have only one effective solution: a single Federal
financial consumer protection agency. We need one agency for one
marketplace with one mission--to protect consumers of financial
products and services--and the authority to achieve that mission.
A new agency with a focused mission, comprehensive jurisdiction,
and broad authorities is the only way to ensure consumers and providers
high and consistent standards and a level playing field across the
whole marketplace without regard to the form of a product--or the type
of its provider. It is the only way to ensure independence,
accountability, effectiveness, and balance in consumer protection
regulation.
The CFPA will have one mission: To protect consumers. Mission focus
will not be a problem for this agency. It will have no other mission
that competes for attention or resources. And it will have the
resources it needs to fulfill this mission and maintain its
independence. The agency will have a stable funding stream in the form
of appropriations and fee assessments akin to those regulators impose
today.
A mission of protecting consumers requires weighing competing
considerations. Our proposal explicitly recognizes this complexity. It
charges the CFPA with requiring effective disclosures and preventing
abusive or unfair practices; and it also charges the CFPA with ensuring
markets are efficient and innovative and preserving consumers' access
to financial services. A statutory mandate to weigh these potentially
competing considerations will help ensure the CFPA's regulations are
balanced.
The banking agencies will be able to concentrate their attention on
bank safety and soundness. The Federal Reserve will be able to focus on
monetary policy, financial stability, and holding company supervision
without the major distractions it has experienced because it holds the
pen on most major consumer protection regulations.
The CFPA will have jurisdiction over the entire market. Our
proposal for comprehensive jurisdiction will ensure accountability. The
CFPA will not have the luxury of pointing the finger at someone else.
If a problem arises in the nonbank sector, the agency will be as
accountable as it will be for problems in the banking sector.
Comprehensive jurisdiction will also make regulatory arbitrage a
thing of the past. Providers will not have a choice of regulators. So,
by definition, they will not be able to choose a less restrictive
regulator. The CFPA will not have to fear losing ``market share''
because our legislation gives it authority over the whole market.
Ending arbitrage will prevent the vicious cycles that weaken standards
across the market.
Comprehensive jurisdiction will protect consumers no matter with
whom they do business, and level the playing field for all institutions
and providers. For the first time, a Federal agency would apply to
nonbank providers the tools of supervision that regulators now apply to
banks--including setting compliance standards, conducting compliance
examinations, reviewing files, obtaining data, issuing supervisory
guidance and entering into consent decrees or formal orders. With these
tools, the Agency would be able to identify problems before they
spread, stop them before they cause serious injury, and relieve
pressures on responsible providers to lower their standards.
The CFPA's marketwide perspective and authority will help it work
with the States to target Federal and State examination resources to
nonbank providers based on risks to consumers. The CFPA can set and
enforce national standards and supplement State efforts with its own
examiners and analytics. The agency will be able to use efficient
supervisory techniques in the nonbank sector such as risk-based
examinations. The CFPA will provide leadership to the States, improve
information sharing, and leverage State resources. The FTC will
continue to have full authority to investigate and stop financial
frauds.
The CFPA will have the full range of authorities: Rule writing,
supervision, and enforcement. CFPA's regulations will be based on a
deep understanding of markets, providers, and products gained from the
power to examine and collect information from the full range of bank
and nonbank financial service providers. Combining rule-writing
authorities with supervision and enforcement authorities in one agency
will ensure faster and more effective rules.
Where speed and flexibility are at a high premium, the CFPA will be
able to exploit the full potential of supervisory guidance to address
emerging concerns. Years-long delays to issue guidance because of
interagency wrangling will be a thing of the past.
For example, the CFPA will both implement the new Credit CARD Act
of 2009--to ban retroactive rate hikes and rate hikes without notice--
and supervise the credit card banks for compliance. So the agency will
have a feedback loop from the examiners of the banks to the staff who
write the regulations, allowing staff to determine quickly how well the
regulations are working in practice and whether they need to be
tightened or adjusted. It will also be able to improve credit card
practices with supervisory guidance.
The CFPA's rule-writing authority will be comprehensive and robust.
The CFPA will be able to write rules for all consumer financial
services and products and anyone who provides these products. (Its
authority will not extend to entities registered with the Securities
and Exchange Commission when these entities are acting within their
registered capacities.) The CFPA will assume existing statutory
authorities--such as the Truth in Lending Act and Equal Credit
Opportunity Act. New authorities we propose--to require transparent
disclosure, make it easier for consumers to choose simple products, and
ensure fair terms and conditions and fair dealing--will enable the
agency to fill gaps as markets change and to provide strong and
consistent regulation across all types of consumer financial service
providers.
For example, our proposal gives the CFPA the power to strengthen
mortgage regulation by requiring lenders and brokers to clearly
disclose major product risks, and offer simple, transparent products if
they decide to offer exotic, complex products. The CFPA will also be
able to impose duties on salespeople and mortgage brokers to offer
appropriate loans, take care with the financial advice they offer, and
meet a duty of best execution. And it will be able to prevent lenders
from paying higher commissions to brokers or salespeople (``yield
spread premiums'') for delivering loans with higher rates than
consumers qualify for. Lenders and consumers would finally have an
integrated mortgage disclosure.
Comprehensive standard-setting authority would improve other
markets, too. For example, the CFPA could adopt consistent regulations
for short-term loans--establishing disclosure requirements--whether
these loans come in the form of bank overdraft protection plans or
payday loans or car title loans from nonbank providers. The agency also
could adopt standards for licensing and monitoring check cashers and
pawn brokers.
The new CFPA will bring higher and more consistent standards;
stronger, faster responses to problems; the end of regulatory
arbitrage; a more level playing field for all providers; and more
efficient regulation. A dedicated consumer protection agency will help
restore the trust and confidence on which our financial system so
critically depends.
The CFPA will ensure, not limit, consumer choice; preserve, not stifle,
innovation; strengthen, not weaken, depository institutions;
and reduce, not increase, regulatory burden; and increase, not
reduce, uniformity
The CFPA will ensure, not limit, consumer choice. The agency will
have a mandate to promote simplicity. It will also be charged with
preserving efficient and innovative markets and consumer access to
financial services and products. The point is to make it easier for
consumers to choose simpler products while preserving their ability to
choose more complex products if they better suit consumers' needs.
For example, the CFPA will have the authority to require providers
that offer exotic, complex, and riskier products to offer at least one
standard, simple, less risky product. In the mortgage market, a lender
or broker that peddles mortgages with potentially exploding monthly
payments, hidden fees and prepayment penalties, and growing loan
balances--such as the ``pay option ARMs'' of recent years--might also
be required to offer consumers 30-year, fixed-rate mortgages or
conventional ARMs with straightforward terms.
The idea is not new. A division between ``traditional'' and
``nontraditional'' products is deeply embedded in our mortgage markets.
A similar consensus about standard and alternative products may emerge
in other product markets. The CFPA's rigorous study of consumer
understanding and product performance may help produce a consensus in a
given market about the appropriate dividing line.
This approach, to be sure, may not work in all contexts. Our draft
legislation requires the agency to consider its effect on consumer
access to financial services or products. In some cases the costs may
outweigh the benefits--that will be for the agency to determine. In
other cases, using this approach will obviate the need for costlier
restrictions on terms and practices that would limit consumer choices.
The CFPA will preserve, not stifle, innovation. The present
regulatory system clearly failed to strike the right balance between
financial innovation and efficiency, on the one hand, and stability and
protection, on the other. This imbalance was a major cause of the
financial crisis. Ensuring that consumers who want simple products can
get them, and that consumers who take complex products understand their
risks, will re-right the scales.
The benefits of innovation will continue to flow. By helping ensure
that significant risks are assumed only by knowing and willing
consumers, the CFPA will improve confidence in innovation and make it
sustainable rather than tied to quarterly results.
The CFPA will strengthen, not weaken, depository institutions.
Protecting consumer is not unsafe or unsound for banks. Protecting
consumers is good for banks. If we had protected consumers from banks
that sold risky mortgages like option ARMs in misleading ways, then we
would have made the banks more sound, not less.
We reject the notion that profits based on unfair practices are
sound. The opposite appears true. Massive credit card revenue, for
example, was not sustainable. It depended on unfair practices that bore
the seeds of their own demise. These practices led this Congress to
pass, and President Obama to sign, tough new restrictions on credit
cards.
Examiners in the field will resolve the rare conflict that arises
just as they do today. For larger banks, CFPA examiners could reside in
the bank just as consumer compliance examiners often do today, right
next door to safety and soundness examiners. They would regularly share
information--our draft legislation mandates the exchange of examination
reports--and coordinate approaches. Moreover, the CFPA could work with
the banking agencies to ensure bank consumer compliance examiners are
trained to understand safety and soundness, as they are today.
For the even rarer conflict that arises and cannot be resolved on
the ground, our proposal provides mechanisms for its resolution. A
safety and soundness regulator will have one of five board seats,
ensuring a strong voice within the agency for prudential concerns. In
addition, the agency must consult with safety and soundness regulators
before adopting rules. The Financial Services Oversight Council will
bring these agencies together on a regular basis.
The CFPA will reduce, not increase, regulatory costs. The CFPA is
not a new layer of regulation; it will consolidate existing regulators
and authorities. I have already discussed the tremendous benefits this
will bring to responsible providers by ensuring consistent standards
and a level playing field. And consolidating authority does not just
increase accountability for protecting consumers, it also increases
accountability for removing unnecessary regulatory burdens.
Consolidation will also bring direct efficiencies. The agency would
help to simplify and reduce regulatory burdens in areas where current
authorities overlap or conflict. For instance, the agency would ensure
we have a single Federal mortgage disclosure--eliminating confusing and
unnecessary paperwork.
Other efficiencies will flow from the CFPA's ability to choose the
best tool for the problem. The agency's authority to restrict terms and
conditions of contracts by regulation--as the Congress did in the
Credit CARD Act of 2009--will be just one of many authorities. With
comprehensive supervisory authority over the whole market, the agency
will also be able to use more flexible, potentially less costly tools
such as supervisory guidance.
The breadth and diversity of the authorities we propose will ensure
the agency can tailor its solution to the underlying problem with the
least cost to consumers and institutions. The agency will have ample
authority to harness the benefits of market discipline by improving the
quality of, and access to, information in the marketplace. The CFPA
will have authority to ensure that consumers receive relevant and
concrete information in a timely manner. These measures, and measures
that make it easier for consumers to choose simpler products, should
reduce the need for more burdensome regulations.
Imposing Federal supervisory authority on nonbank institutions for
the first time will increase compliance requirements on that sector.
But this is well worth the benefit of higher and more consistent
standards.
The CFPA will increase, not reduce, national regulatory uniformity.
The CFPA's rules and regulations will set a floor for the States, not a
ceiling. The contention that this will somehow increase variations in
State laws is a red herring. Our proposal does not alter the law of the
status quo: major Federal consumer protection statutes such as the
Truth in Lending Act and Homeownership and Equity Protection Act
explicitly make Federal regulations a floor, not a ceiling.
In fact, a strong Federal consumer protection regulator should be
able to increase regulatory uniformity. States sometimes adopt new
financial services laws because they perceive a lack of Federal will
and leadership. That is exactly what happened in the mortgage context,
where States filled a vacuum of predatory mortgage law with State
statutes and regulations. If the States believe an expert, independent
Federal agency is on the job and working with the States to protect
their consumers, the States will feel less need to adopt new laws.
Conclusion
We need consumer protection regulation that is independent and
accountable, effective and balanced. These goals are achievable, but
only if we address fundamental flaws in the structure of consumer
protection. The only real solution to these flaws is creating an agency
with a focused consumer protection mission; comprehensive jurisdiction
over all financial services providers, both banks and nonbanks; and the
full range of regulatory, enforcement, and supervisory authorities.
It is time for a level playing field for financial services
competition based on strong rules, not based on exploiting consumer
confusion. And it is time for an agency that consumers--and their
elected representatives--can hold fully accountable. The
Administration's legislation fulfills these needs. Thank you for this
opportunity to discuss our proposal, and I will be happy to answer any
questions.
______
PREPARED STATEMENT OF RICHARD BLUMENTHAL
Attorney General,
State of Connecticut
July 14, 2009
I appreciate the opportunity to strongly support the
Administration's proposal to create a Federal agency dedicated solely
to protecting consumer interests in financial products and markets, and
preserve and expand State consumer protection authority.
The new agency--a consumer financial guardian--promises to be a
powerful watchdog and protector, and a partner of State attorneys
general in fighting for our citizens. The proposal marks a giant step
toward restoring an historic Federal-State alliance in combating
financial fraud and abuse. This Federal-State partnership was riven by
excessive resort to Federal preemption--displacing State enforcement
and replacing Federal-State collegiality and cooperation with
relentless conflict.
The new agency is a necessary and appropriate response to exploding
complexity, scope, and scale of new financial instruments and markets--
and exponentially increasing impact on ordinary citizens. It fills a
deeply felt consumer need. Ever more slick and sophisticated
marketing--often misleading and deceptive--cannot be battled
successfully by States alone, or the existing Federal agencies.
Creating a new agency to fight consumer cons and abuse in alliance with
the States, the Federal Government can muster more potent and proactive
policing and prosecution.
A new consumer guardian--we need it, and now. New firepower, focus
and drive, all are vital. The new agency will be more an enforcer, than
a regulator. At the Federal level, the new agency would investigate law
breaking and enable and assist Department of Justice prosecutions, both
civil and criminal.
Unfortunately, some opponents of this agency have misrepresented
its purpose. The Financial Consumer Protection Agency will not
``regulate credit.'' It will not make choices for consumers or deny
them access to products and services. Instead, one of its main missions
will be to assure that consumers are informed in clear, layman's
language of the terms and conditions of credit cards, mortgages, and
loans. The point is to assure that consumers fully understand the
financial realities and consequences of financial obligations, credit
cards, or loans they are considering before they make commitments.
As even experienced lawyers and consumer protection advocates can
attest, anyone attempting to understand their credit card agreements
all too frequently faces incomprehensible, consuming small print with
huge consequences. This agency's purpose is to assure people have good
information so they can make good financial decisions. Once they use
that information and make decisions, they will have to live with the
consequences.
Federal Preemption Doctrine Disaster
For far too long, States have been forced to the sidelines,
standing helplessly, while credit card, mortgage, and financial rescue
companies used Federal preemption as a shield to stop State consumer
protection agencies from enforcing State laws against unfair and
unscrupulous practices. Connecticut consumers have been scammed by
fraudulent and unfair marketing schemes and products by companies who
create or affiliate with national banks solely to avoid State consumer
protection laws.
Worse, Federal agencies have been complicit--aiding and abetting
lawbreakers by supporting preemption claims when States sued to stop
these unfair practices and recover consumer losses. Federal agencies
went AWOL--not only disavowing their firepower but disarming State
enforcers. They forced States from the battlefield and then abandoned
it--in countless areas of consumer protection. They enabled and
encouraged use of preemption as an impregnable shield to protect
mortgage fraud, credit card abuses, securities scams, banking failure,
and many deceptive and misleading snake oil pitches.
The financial meltdown was foreseeable--and foreseen--by
enforcement authorities who warned of irresponsible and reprehensible
retreat and surrender in Federal law enforcement. There were warnings--
including mine--about a regulatory black hole concerning hedge funds,
derivatives, credit default swaps, excess leverage devices and other
practices. I used this term--regulatory black hole--to characterize
lack of oversight and scrutiny that enabled self dealing, excessive
risk-taking, and other abuses that sabotaged the system.
The national financial meltdown was directly due to massive Federal
law enforcement failure--lax or dysfunctional Federal oversight and
scrutiny of increasingly arcane, complex, opaque, risky practices and
products. Federal law placed all enforcement and regulatory authority
in an array of Federal agencies that were inept, underfunded,
complacent or complicit. The result was a void or vacuum unprecedented
since the Great Depression.
Robust State investigatory and enforcement authority no doubt would
have revealed unfair and illegal activities sooner and helped fill the
gap left by Federal inaction and inertia. Putting State cops on the
consumer protection beat would have sent a message--educating the
public, deterring wrongdoing, punishing lawbreakers.
Connecticut has been at the forefront of State efforts to protect
consumers from unfair and fraudulent financial transactions. And two
areas illustrate the obstacles that we and other States have faced
under the current system.
Tax preparers use the lure of instant cash to entice taxpayers--
mostly low income--to borrow money at extremely high interest rates,
using their tax refund to pay these loans. Recognizing that Connecticut
could not regulate such usurious lending by national banks, our State
sought to cap at 60 percent the interest charged on loans made through
a tax preparer' or other facilitator of the loan. The statute was
challenged by lenders who charge more than 300 percent annual interest
rate. As a former United States Attorney, I can tell you that organized
crime would offer a better deal. The Federal Second Circuit Court of
Appeals held that Connecticut law could not be applied to national
banks or their agents. Pacific Capital v. Connecticut, 542 F.3d 341 (2d
Cir. 2008). As a result, consumers continue to pay astronomical
interest rates for such refund anticipation loans.
Second, even as gift cards have become increasingly popular in
Connecticut and the country, consumers often see their cash value erode
over time because of hidden inactivity fees or short expiration dates.
In response, Connecticut prohibited both inactivity fees and expiration
dates. Mall operators and retail chain stores avoided such consumer
protection laws by merely contracting with national banks to issue gift
cards. The Second Circuit Court of Appeals held that State consumer
protection laws are preempted because the State measures affect a
national bank rule. It ruled that Visa gift cards had expiration dates
so the State could not prohibit them. SPGGC v. Blumenthal, 505 F.3d 183
(2d Cir. 2007). The result is pervasive consumer confusion because some
gift cards issued by national banks may expire, but others have no such
expiration dates.
Other States have faced similar preemption obstacles to protecting
consumers. My colleague in Minnesota began investigating Capital One's
credit card marketing practices under the State's consumer protection
laws. Capital One transferred all its credit card operations into a
national bank, successfully halting the investigation, because
Minnesota's consumer protection laws were preempted. Similarly, an
Illinois investigation into Wells Fargo Financial's steering of
minorities into high cost loans was stymied by Wells Fargo's transfer
of those assets into a national bank.
A Historic New Alliance
I speak for other States in my enthusiastic and energetic support
for section 1041 provisions of the Consumer Financial Protection Agency
Act of 2009 that establish Federal law as a minimum standard for
consumer protection, allowing States to enact laws and regulations ``if
the protection such statute, regulation, order, or interpretation
affords consumers is greater than the protection provided under this
title, as determined by the [Consumer Financial Protection] agency.''
In addition, the proposal amends various Federal preemption statutes to
unshackle the States, allowing enactment of consumer protections at the
State level that may become a model for Federal, nationwide standards.
This law exemplifies federalism at its best--State and Federal
authorities working in common rather than conflict, and making the
States laboratories for new, creative measures. Many of our most
prominent Federal consumer protection laws were first adopted by
States.
A Federal Consumer Financial Super Cop
I also support the establishment of the Consumer Financial
Protection Agency, a Federal office dedicated solely to protection of
ordinary citizens using the Federal savings and payment market.
Currently, consumer credit products are regulated by at least seven
different agencies whose primary focus is the proper operation of
markets and the safety and soundness of institutions. While consumer
protection is within their jurisdiction, it is far from their major
focus. Nor does any existing agency dedicate significant or sufficient
resources to this responsibility.
They pay scant attention to consumer complaints, often reviewing
such problems from an industry perspective rather than the consumer's.
Indeed, these agencies face divided loyalties or even conflicts of
interest--when high interest rates and astronomical credit card fees,
for example, may be good for the bottom line, but bad for consumers.
Given the understandable emphasis on safety and soundness, consumer
protection not surprisingly receives Short shrift.
The Consumer Financial Protection Agency would have broad authority
to promulgate and enforce rules to protect consumers from unfair and
deceptive practices and to ensure they understand terms and conditions.
These regulations will encourage, not stifle, the development of
financial products that well serve consumers. A vibrant, competitive
market that is fair and honest is essential to consumers' and the
Financial Industry's financial interests. Clear rules and consistent
enforcement are vital prerequisites for innovation and wealth creation.
To mix metaphors, what's needed is a more level playing field--
essentially rational rules of the roads. When intersections become
busy, they need to upgrade from stop signs to traffic lights to avoid
car crashes, collisions and pile ups. As the proposal recognizes, joint
proactive consumer protection enforcement by both Federal and State
agencies--without preemption or exclusive jurisdiction--best serves
consumer interests, especially as financial products and markets grow
in complexity and number.
State agencies--including State attorneys general and other
consumer protection agencies--are often the first line of defense for
consumers. Consumers are usually far more comfortable contacting their
State officials rather than nameless faraway Federal agencies. I have
seen firsthand the frustration of consumers when we have had to tell
them that my office is legally powerless to help because of Federal
preemption of State enforcement authority.
Under the proposal, States may enact and enforce consumer
protection laws that are consistent with Federal law. In addition,
State attorneys general may enforce Federal rules and regulations in
this area provided that the Federal Consumer Financial Protection
Agency is notified of such enforcement action and has the opportunity
to join or assume responsibility.
This notification process seeks Federal-State coordination without
necessarily allocating primacy to the Federal agency. State Attorneys
General welcome the Federal Government as an ally rather than an
adversary. Joint efforts can involve far more effective and more
efficient use of our resources.
Joint State and Federal enforcement efforts are neither new nor
novel. States regularly work with each other and the Federal Government
in recovering hundreds of millions of dollars in Medicaid and health
care fraud, enforcing our respective antitrust laws against
anticompetitive mergers and acquisitions or abuse of market power, and
applying consumer protections laws against deceptive or misleading
advertisements. I served for several years as chair of the National
Association of Attorneys General Antitrust Executive Committee which
included regular meetings with the heads of the Department of Justice
Antitrust Division and the Federal Trade Commission. Successful
collaborations once were common--against Microsoft for example--
especially when the Federal Government was an active antitrust
enforcer. There are plenty of successful models of joint action
involving, for example, the Federal Trade Commission and the United
States Department of Justice's Antitrust Division.
Separating regulatory authority from consumer protection authority
also has models at the State level. In Connecticut, for example, the
Department of Banking regulates the banking industry while the
Department of Consumer Protection through the Office of the Attorney
General has broad consumer fraud enforcement authority. That authority
extends to the banking industry. The Connecticut Supreme Court
specifically applied our unfair and deceptive trade practices act to
the banking industry. Mead v. Burns, 199 Conn. 651 (1986).
I appreciate the industry's concern about two sets of agencies with
enforcement authority. The industry justifiably wants predictability of
regulation to properly plan product development and promotion. This
bill will do so by creating a regulatory floor that applies nationwide.
Most valuable would be predictability of vigilant and vigorous
enforcement. The message must be that a revived and reinvigorated
Federal-State alliance will punish any company that profits from
illegal anticonsumer devices or unfair and deceptive practices. The
predictable outcome is that anyone who cons or scams consumers in
financial products will be prosecuted.
Part of the genius of our Federal system is that it creates
separate distinct sets of authority in Federal and State governments.
Individual State experiments in solving problems and lawmaking can be
models for Federal statutes as well as other States. Our United States
Constitution assures that States cannot adopt rules inconsistent or
conflicting with Federal authority.
Finally, I urge the Committee to consider authorizing private
rights of action against consumer fraud. Most State consumer protection
statutes permit such private legal actions enabling victims to bring
legal actions and recover damages, sometimes when State authorities may
not do so. These initiatives supplement and strengthen State consumer
protection enforcement efforts. They could similarly enhance and
enlarge Federal enforcement efforts.
I appreciate and applaud your and the Administration's dedication
to protecting consumers in financial transactions. I commend this
Committee's support of these efforts and offer my continuing
assistance--along with other State attorneys general.
Thank you.
______
PREPARED STATEMENT OF EDWARD L. YINGLING
President and Chief Executive Officer,
American Bankers Association
July 14, 2009
Chairman Dodd, Ranking Member Shelby, and Members of the Committee,
my name is Edward L. Yingling. I am President and CEO of the American
Bankers Association (ABA). The ABA brings together banks of all sizes
and charters into one association. ABA works to enhance the
competitiveness of the Nation's banking industry and strengthen
America's economy and communities. Its members--the majority of which
are banks with less than $125 million in assets--represent over 95
percent of the industry's $13.5 trillion in assets and employ over 2
million men and women.
ABA appreciates how this Committee has responded to the financial
crisis in a thoughtful, deliberative, and thorough manner. Changes are
certainly needed, but the pros and cons and unintended consequences
must be carefully evaluated before dramatic changes--affecting the
entire structure of financial regulation--are enacted. That is why
hearings like this one today are so important.
I am pleased to present the ABA's views today on the proposal to
create a new consumer regulatory body for financial services that would
operate separate and apart from any future prudential regulatory
structure. We believe that a separate consumer regulator should not be
enacted, and, in fact, is in direct contradiction with an integrated,
comprehensive approach that recognizes the reality that consumer
protection and safety and soundness are inextricably bound. Consumer
protection is not just about the financial product, it is also about
the financial integrity of the company offering the product. Simply
put, it is a mistake to separate the regulation of the banking business
from the regulation of banking products.
Financial integrity is at the core of good customer service. Banks
can only operate safely and soundly if they are treating customers
well. Banks are in the relationship business, and have an expectation
to serve the same customers for years to come. In fact, 73 percent of
banks (6,013) have been in existence for more than a quarter-century,
62 percent (5,090) more than half-century, and 31 percent (2,557) for
more than a century. These banks could not have been successful for so
many years if they did not pay close attention to how they serve
customers. Satisfied customers are the cornerstone of the successful
bank franchise. The proposal for a new consumer regulator, rather than
rewarding the good banks that had nothing to do with the current
problems, will add an extensive layer of new regulation that will take
resources that could be devoted to serving consumers and make it more
difficult for small community banks to compete.
The banking industry fully supports effective consumer protection.
We believe that Americans are best served by a financially sound
banking industry that safeguards customer deposits, lends those
deposits responsibly and processes payments efficiently. Traditional
FDIC-insured banks--more than any other financial institution class--
are dedicated to delivering consumer financial services right the first
time and have the compliance programs and top-down culture to prove it.
Certainly, there were deficiencies under the existing regulatory
structure. Creating a new consumer regulatory agency, however, is not
the solution to these problems. It would simply complicate our existing
financial regulatory structure by adding another extensive layer of
regulation. There is no shortage of laws designed to protect consumers.
Making improvements to enhance consumer protection under the existing
legal and regulatory structures--particularly aimed at filling the gaps
of regulation and supervision of nonbank financial providers--is likely
to be more successful, more quickly, than a separate consumer
regulator.
Certainly the Members of this Committee should look at this
consumer agency proposal from the point of view of consumers, who are
paramount. Later in this testimony, we will discuss how the proposal in
our opinion is not the best approach for consumers and will actually
undermine consumer choice, competition, and the availability of credit.
However, we would also ask you to look at this issue from another point
of view. While all banks would be negatively impacted, think of your
local community banks, and credit unions also for that matter. These
banks never made one subprime loan, and they have the trust and support
of their local consumers. As Members of this Committee have previously
noted, these community bankers are already overwhelmed with regulatory
costs that are slowly but surely strangling them.
Yet a few weeks ago, these community banks found the Administration
proposing a potentially massive new regulatory burden that will fall
disproportionately on them. The largest banks, which will certainly
bear a significant burden as well, do have economies of scale.
Nonbanks, the State regulated or unregulated financial entities that
include those who are most responsible for the crisis, are covered, at
least in part, by the new agency--and that is positive. However, based
on history, their regulatory and enforcement burden is likely to be
much less. In fact, according to the Administration proposal, the new
agency will rely first on State regulation and enforcement for these
entities, and yet we all know that the budgets for such State
regulation and enforcement are completely inadequate to do the job.
Community banks, on the other hand, are likely to have greatly
increased fees to fund a system that falls disproportionately and
unfairly on them.
In both the Administration's white paper and the legislative
language submitted by Treasury, it is now clear that the new agency
would have vast and unprecedented authority to regulate in detail all
bank consumer products and services. The agency is even empowered, in
fact encouraged, to create its own standardized products and services--
whatever it decides is ``plain vanilla''--and may compel banks to offer
them. Even further, the agency is given the power, and basically urged,
to give the products and services it designs regulatory preference over
the bank's own products and services. The agency is even encouraged to
require a Statement by the consumer acknowledging that the consumer
affirmatively was offered and turned down the Government's product
first.
The proposal goes beyond simplifying disclosures--which is needed--
to require that all bank communication with consumers be
``reasonable.'' This is a term so vague that no banker would know what
to do with it. But not to worry--the proposal offers to allow thousands
of banks, and thousands of nonbanks, to preclear all communications
with the agency.
All existing consumer laws, carefully crafted over the years by
Congress, are transferred to the new agency, but they are rendered
nothing more than floors. The new agency can do almost anything else it
wants. CRA enforcement is apparently to be increased on these community
banks, although they already strongly serve their communities. And that
is not to mention the inherent conflicts, discussed below, that will
occur between the prudential regulator and the consumer regulator, with
the bank caught in the middle. All this cost, regulation, conflicting
requirements, and uncertainty would be placed on community banks that
in no way contributed to the financial crisis.
We share the vision that greater transparency, simplicity,
accountability, fairness, and access can be achieved by establishing
common standards uniformly applied that reflect how consumers make
their choices among innovative products and services. But this vision
cannot be achieved by ignoring the experience of our recent financial
crisis and failing to directly address those deficiencies that led to
it. It is now widely understood that the current economic situation
originated primarily in the unregulated or less regulated nonbank
sector. For example, the Treasury's plan noted that 94 percent of high
cost mortgages were made outside the traditional banking system. Many
of these nonbank providers had no interest in building a long-term
relationship with customers but, rather, were only interested in
profiting from a quick transaction without regard to whether the
mortgage loan or other financial product ultimately performed as
promised. Thus, an important lesson learned is that certain
unsupervised nonbank financial service providers and their less
regulated financiers--the so-called ``shadow banking system''--
undermined the entire system by abusing consumer and investor trust.
A second lesson learned is that consumer protection and financial
system safety and soundness are two sides of the same coin. Poor
underwriting, and in some cases fraudulent underwriting, by mortgage
brokers, which failed to consider the individual's ability to repay,
set in motion an avalanche of loans that were destined to default. Good
underwriting is the essence of both good consumer protection and good
safety and soundness regulation. Loans that are based on the ability to
repay protect the institution from losses on the loans and protect
consumers from taking on more than they can handle. Thus, what is
likely to protect both the lender and the customer cannot be, nor
should be, separated.
These lessons lead to two fundamental building blocks of any reform
of consumer protection oversight.
Uniform regulation and uniform supervision of consumer
protection performance should be applied to nonbanks as
rigorously as it has been applied to the banking industry.
Regulatory policymakers for consumer protection should not
be divorced from responsibility for financial institution
safety and soundness.
Separating the safety of the institution from the safety of its
products means each agency has only half the story. Without building
upon these keystones, the hope for better transparency, simplicity,
accountability, fairness, and access will not be realized, and we will
have missed the opportunity to build a strong consumer protection
infrastructure across the financial services industry.
Unfortunately, the Consumer Financial Products Agency (CFPA)
proposal, in our opinion, contains a number of very serious flaws. The
proposal:
Severs the connection between consumer protection and
safety and soundness--forcing each side to attempt to work
independently and freeing each to contradict the valid goals of
the other--to the detriment of consumer choice and safety and
soundness.
Subjects banks to added enforcement, but leaves the ``first
line of defense'' for the supervision and examination of
nonbanks to the States, which suffer from a lack of resources
for meaningful enforcement. This is where the failure of
nonbank regulation was most severe under the current system.
Once again there would be perverse incentives for financial
products to flow out of the closely examined banking sector to
those who will skirt the meaning, and even the language, of
regulations.
Excludes competitor financial products from its reach--
including securities, money market funds, and insurance--thus
further belying the promise of uniform or systemic oversight
and creating incentives for development of products outside the
scope of the CFPA that may be risky for consumers.
Renders all the consumer laws created by Congress largely
moot, as the very broad power of the CFPA would authorize the
agency to go well beyond such laws in every instance.
Imposes Government designed one-size-fits-all products--so-
called ``plain-vanilla'' products--and places them in a
preferred position over products that are designed by the
private sector for an increasingly diverse customer base. These
Government products would be given regulatory preference over
the products designed by the individual banks, and consumers
could even be required to sign a notice that they have first
turned down the Government's product.
Requires communications with consumers to be
``reasonable,'' an incredibly vague and unworkable standard
that will cause tremendous uncertainty for years to come.
Basically ends uniform national standards, quickly creating
a patchwork of expensive and contradictory rules that will
create uncertainty, increase consumer costs, and lead to
constant litigation.
Saddles providers, and, indirectly, consumers with a new
regime of fees to fund yet another agency.
Will inhibit innovation and competition, limit consumer
choices, and lessen the availability of credit.
To be successful in the regulation, examination, and enforcement of
nonbanks, the agency will have to be very large and have a significant
budget. We believe a better course exists. ABA offers to work with the
Administration and the Congress to achieve meaningful regulatory reform
to improve consumer protection and preserve financial system integrity.
As the crisis has proven, a strong banking industry is indispensable to
a strong economy; and a sound banking system is the greatest single
protection of consumer access to financial services fairly delivered.
Traditional banking is back in style, but that does not mean
improvements cannot be made. We pledge to work with this Committee to
find the best solutions to assure that consumers have the protection
they deserve for any financial product.
I would like to further discuss several points today:
Consumer regulation should not be separated from safety and
soundness regulation.
The key focus of change should be on closing existing gaps
in supervisory oversight across the financial institution
marketplace, not on adding yet another vast layer.
The proposal would give the agency unprecedented authority
to control the products and services offered by banks and make
all current consumer laws mere floors.
The undermining of uniform national standards will increase
costs and cause litigation and tremendous uncertainty.
The question of how to pay for this new agency was left
very vague and raises significant issues.
The proposal will inhibit innovation and competition, limit
consumer choices, and dramatically lessen the availability of
credit.
The regulatory authority to address consumer concerns is
already there for highly regulated banks, particularly with the
new focus on unfair and deceptive practices. However,
improvements can be made, and ABA will work with the Committee
to make such improvements.
I will address each of these points in turn.
Consumer Regulation Should Not Be Separated From Safety and Soundness
Regulation
Consumer regulation and safety and soundness regulation are two
sides of the same coin. Neither one can be separated from the other
without negative consequences; nor should they be separated. An
integrated and comprehensive regulatory approach is the best method to
protect consumers and protect the safety and soundness of the financial
institution. While certainly improvements can be made, the current
regulatory structure applied to banks provides an appropriate framework
for effective regulation for both consumer protection and bank safety
and soundness. As I note throughout this testimony, that same framework
was virtually nonexistent for nonbank providers of financial products.
FDIC Chairman Sheila Bair, testifying recently before Congress,
summarized the synergies between both these elements:
The current bank regulation and supervision structure allows
the banking agencies to take a comprehensive view of financial
institutions from both a consumer protection and safety and
soundness perspective. Banking agencies' assessments of risks
to consumers are closely linked with and informed by a broader
understanding of other risks in financial institutions.
Conversely, assessments of other risks, including safety and
soundness, benefit from knowledge of basic principles, trends,
and emerging issues related to consumer protection. Separating
consumer protection regulation and supervision into different
organizations would reduce information that is necessary for
both entities to effectively perform their functions.
Separating consumer protection from safety and soundness would
result in similar problems. \1\
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\1\ Bair, Sheila C., ``Modernizing Bank Supervision and
Regulation'', testimony before the Committee on Banking, Housing, and
Urban Affairs, U.S. Senate, March 19, 2009.
Attempts to separate out consumer protection from safety and
soundness will lead to conflicts, duplication and inconsistent rules,
which will likely result in finger-pointing as inevitable problems
arise. What are banks to do when the consumer and safety and soundness
regulators disagree, as they inevitably will?
Almost every consumer bank product or service has both consumer
issues and safety and soundness issues that need to be balanced and
resolved. It is important to remember that one person's deposit funds
another person's loan. It makes little sense to regulate the terms,
conditions and prices of deposit products or loan products separately
from the business aspects of a bank's fundamental process--turning
deposits into loans.
As I mentioned at the outset, the very nature and application of
good underwriting standards is by definition both a consumer protection
and a safety and soundness issue. A second simple example is check hold
periods. Customers would like the shortest possible holds, but this
desire needs to be balanced with complex operational issues in check
clearing, and with the threat of fraud, which costs banks--and
ultimately consumers in the form of increased costs that are passed
on--billions of dollars.
Similarly, the Electronic Funds Transfer Act contains numerous
important consumer protections, developed and modified over the years
based on experience, new technologies, and new types of fraud.
Separating the consumer consideration from the safety and soundness,
antifraud, and systems considerations would certainly seem unworkable.
Banks also have extensive duties under ``know your customer''
regulations designed to fight money laundering and terrorism. These
critical regulations must be coordinated with consumer and safety and
soundness regulation. A simple example is in the account opening
process, which is subject to extensive consumer and ``know your
customer'' regulations. It would be unworkable to separate these as
well.
And what about employee training? Banks spend billions of dollars
training employees to comply with the heavy regulations to which banks
are subjected. Examiners examine banks for their training programs.
Front-line employees must have training in numerous consumer, safety
and soundness, and antimoney laundering regulations. ABA offers dozens
of courses in compliance for front-line employees. How would such
training be effectively coordinated between agencies with differing
views and objectives? Is the new agency going to examine banks and
nonbanks equally for compliance training? It cannot be left to the
States, where there is little precedent for extensive examining for
compliance training outside banking.
Rather than take to heart the lesson of the inseparability of
safety and soundness and consumer protection, the Administration's
proposal creates a different form of regulatory fragmentation along the
fault lines of the jurisdiction of a new bureaucracy. A look at the
proposal's enumeration of existing rule-making authorities to be
transferred--mostly from the Federal Reserve Board--to the CFPA reveals
an assortment of likely interagency conflicts that will generate future
regulatory gaps rather than bridge the current ones.
For instance, consumer privacy is placed in the CFPA, but identity
theft protection is left out. The Electronic Funds Transfer Act is
assigned to CFPA, but the rules for clearing electronic check images
that make funds available for customers to access with their debit
cards remains with the Federal Reserve. Truth in Lending Act rule-
making over mortgages is assigned to the CFPA, but flood insurance
coverage (FDPA) and private mortgage insurance (HOPA) laws protecting
consumers who obtain mortgages remain with the banking agencies. These
and other anomalies in the Administration proposal will set true
consumer protection reform on the back-burner as countless hours and
dollars are wasted grappling with the regulatory morass that will
result from this ill-advised structural reform. The 30-year investment
in coordinated supervision (FFIEC) will be washed away and replaced by
interagency conflicts that are hardwired in the new bureaucracy without
a means to resolve them.
Finally, we are very concerned about conflicts over CRA. The
banking industry has worked hard in serving its communities and in
complying with CRA. We agree that CRA has not led to material safety
and soundness concerns, and that bank CRA lending was prudent and safe
for consumers. That is not to say that there is no debate about the
correct balance between outreach and sound lending. However, that
debate--that tension--is resolved now in a straightforward manner
because the same agency is in charge of CRA and safety and soundness.
To separate the two is a recipe for conflicting regulatory demands,
with the bank caught in the middle.
In the above examples and in many other areas, two different
regulators--one focused on consumers and another focused on safety and
soundness--will almost certainly come up with two different and
conflicting rules and answers that, when added together, only create
new costs, overlap and duplication, as well as an untenable situation
for the financial institution.
The Key Focus of Change Should Be on Closing Existing Gaps in
Regulation, Not on Adding Yet Another Bureaucratic Layer
The biggest failures of the current regulatory system, including
consumer protection failures, have not been in the regulated banking
system, but in the unregulated or weakly regulated sectors. \2\ As
Members of Congress from both parties have noted, to the extent that
the system did work, it is because of prudential regulation and
oversight of banking firms. While improvements within the banking
regulatory process can certainly be made, the most pressing need is to
close the regulatory gaps outside the banking industry through better
supervision and regulation--both on the consumer protection and safety
and soundness sides of the coin.
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\2\ Before the recent crisis, a coalition of 46 State Attorneys
General recognized that based on consumer complaints received, as well
as investigations and enforcement actions undertaken by them, predatory
lending abuses were largely confined to the subprime mortgage lending
market and to nondepository institutions. Almost all of the leading
subprime lenders were mortgage companies and finance companies, not
banks or direct bank subsidiaries. We stress the past tense, because
their lack of financial robustness assured that they would not be
around to answer for their consumer protection misdeeds.
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Take the case of independent mortgage brokers and other nonbank
originators. Again, as the Administration's own proposal States, 94
percent of the high cost mortgages occurred outside the regulated
banking sector. And it is likely that an even higher percent of the
most abusive loans were made outside our sector. In contrast to banks,
these nonbank firms operate in a much less regulated environment,
generally without regulatory examination of their conduct, without
strong capital provisions, and with different reputational concerns.
They have not been subjected to the breadth of consumer protection laws
and regulations with which banks must comply. Equally important, a
supervisory system does not exist to examine them for compliance even
with the comparatively few laws that do apply to them. In addition,
independent brokers typically do not have long-term business
relationships with their customers. Instead, they originate a loan,
sell the loan to a third party, and collect a fee. This results in a
very different set of incentives and can and does work at cross-
purposes with safe and sound lending practices. Proposals are also
being offered with respect to credit derivatives, hedge funds, and
others, and the ABA supports closing these regulatory gaps.
In stark contrast to the weakness of oversight or examination of
consumer compliance issues for most other financial service providers,
bank regulators have an extraordinarily broad array of tools at their
disposal to assure both consumer protection and safety and soundness.
Banks are regularly examined for compliance with consumer regulations,
and regulators devote significant resources to supervision and training
in consumer compliance issues. \3\ These enforcement and supervisory
options are coordinated through the Federal Financial Institutions
Examination Council (FFIEC), \4\ which sets standards for both consumer
and safety and soundness examination. \5\ The need is for the same
banklike structure, supervision, and examination to be applied to
nonbank financial service providers.
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\3\ Bank regulators are just as concerned about consumer
protection as are law enforcement authorities, but the bank regulators
are better able to achieve their objectives through an enormous array
of enforcement and supervisory options that allow them to meet their
broader mandate for law enforcement as well as financial stability.
These range from the behind-the-scenes citation in an exam report as a
matter requiring attention to the public actions of issuing a cease-
and-desist or civil money penalty order or even closing a bank and
imposing lifetime bans from participating in banking activities. Bank
examiners can direct a bank to stop taking an action or to take some
different action. These tools are most appropriately and effectively
exercised by one regulator that is focused on achieving the balance
described above.
\4\ The FFIEC, represented by the Federal Reserve, OCC, FDIC, OTS,
and NCUA, is charged with prescribing ``uniform principles and
standards for the Federal examination of financial institutions''
designed to ``promote consistency in such examination and to insure
progressive and vigilant supervision.''
\5\ In addition, the FFIEC agencies have set forth common
standards for determining a bank's rating for consumer compliance
performance. This rating stands as an identifiable grade, separate and
apart from the CAMEL rating, so that boards of directors and regulators
can hold management directly accountable for the quality of their
institution's consumer compliance management programs and performance.
Moreover, the FFIEC's agency members have endorsed top-down consumer
compliance programs expected of banks that contain system controls,
monitoring of performance, self-evaluation, accountability to senior
management and the board, self-correcting processes, and staff
training.
The breadth of this supervisory authority is extensive. Consumer
compliance management plays a role in every operational aspect where a
bank comes into contact with customers--from the marketing of products,
through account opening and credit Administration, to handling personal
information and monitoring for financial crime. Further, banks hold
their employees accountable for meeting their obligations. Every bank
invests heavily in consumer compliance with dedicated compliance
professionals who take great pride and apply tremendous effort to
assure that consumers are being treated fairly.
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There obviously have been consumer concerns with respect to banks--
we certainly know of this Committee's concerns with credit card
practices--but if the great majority of abuses occurred outside the
banking industry (with toxic subprime mortgages, for example), why
would Congress create a new regulatory agency that will end up focusing
its resources predominately on banks and not nonbanks? We see that the
intention is to have regulations that cover most providers. However,
regulation without enforcement can be worse than no regulation in that
it gives rogue institutions a veneer of legitimacy. All evidence tells
us that the States will not have the resources to enforce all these
regulations. We have, frankly, little confidence that the CFPA will
apply equal examination and enforcement on nonbank lenders and others,
or that it will have the resources to do so. This concern is
exacerbated by the incredibly vague funding provisions in the
legislative language. How big is this agency to be? If it is not large,
it cannot conceivably enforce its regulations on the thousands of
institutions it is supposed to regulate. If it is big, how is it to be
paid for?
The Proposal Gives the CFPA Unprecedented Authority To Control the
Products and Services Offered by Banks
As Stated earlier, the proposal calls for an unprecedented
delegation of legislative authority to the agency to control the way
consumer products and services are designed, developed, marketed,
delivered, and priced by banks and other financial service providers.
In fact, the agency is encouraged to design products and services,
mandate that banks offer them, regulate the products not designed by
the agency more heavily than the Government product, and require
consumers to sign a document that they do not want the Government-
designed product. The agency can even heavily regulate compensation
systems under very open-ended authority. All communications to
consumers about products and services would have to be ``reasonable,''
a vague and unworkable standard if there ever was one. This would
appear to give the agency an incredible amount of control over banks'
and others' products without any real legislated standards. Simply put,
this would appear to be the most powerful agency ever created in that
it has almost unlimited power to regulate and even mandate the products
offered by the regulated.
It also would very much undermine incentives for innovation and
better customer choice. Certainly banks and nonbanks would be less
likely to create new products or consumer enhancements. Any deviations
from the Government-designed product would be subject to additional
regulation and clearances. Coupled with the prohibition that it is
unlawful ``to advertise, market, offer, [or] sell . . . a financial
product or service that is not in conformity with the [Act],'' the
Administration's proposed new structure places banks and nonbanks alike
at extreme risk when innovating and will chill efforts to respond to
consumer demand for beneficial products and services.
Proponents of the agency have regularly used the catch-phrase that
we regulate toasters to keep them from blowing up (through the Consumer
Product Safety Commission), but we don't regulate mortgages that can
blow up consumers' finances. There are a number of problems with this
analogy, including that mortgages are regulated and that, unlike a
toaster with electrical problems, a financial product may often be a
problem or not depending on to whom and how it is offered. More
fundamentally, unlike the proposed CFPA, the Consumer Product Safety
Commission is not set up to design a toaster; mandate that anyone
selling toasters offer the Government toaster; and furthermore, to
adjust regulation, disclosures, and liability to put the Government
toaster in a preferred position. Of course such a Government toaster
could not meet the multitude of preferences of single people on the
run, small families, large families, those with small kitchens, those
with large kitchens, those that just want toast, those that just want
toast and English muffins, and those that want a multifunctional
toaster oven, etc. And, of course, such a Government plain-vanilla
toaster with such built in advantages would discourage innovation in
the creation of new options for consumers and competition in the
offering of alternatives.
In many cases, the Government financial product might not fit with
the institution's business plan. Niche banks, which serve important
constituencies, such as small business owners or low income
communities, would be required to offer products that simply do not
fit. There will even be safety and soundness issues. For example, some
banks that maintain all their loans in portfolios do not, and should
not, hold 30-year fixed ``plain-vanilla'' mortgages.
Furthermore, the incredible authority given to the proposed agency
means that all the consumer laws enacted and modified by Congress over
the years, which have resulted in hundreds and hundreds of pages of
regulations, are to a large degree moot. They are mere floors; and, in
fact, floors with holes in them. This new agency can do pretty much
anything it wants in any of the areas specifically covered by the laws,
and any other area relating to consumer financial products for that
matter. In the final analysis, the basic premise of the
Administration's proposal is to invite Congress to abdicate its
legislative responsibilities to address the ever-evolving financial
marketplace and delegate plenary discretion to a seemingly all-knowing
and all-powerful agency.
For example, this Congress just passed an extensive, tough new law
on credit cards. Combined with the previous law, this creates a
comprehensive congressionally crafted set of rules governing cards. Yet
the proposed CFPA legislation would grant the agency authority to do
practically anything it wants in the credit card area with respect to
terms, delivery, disclosures, compensation and even mandated products,
as long as it does not do less than the new card law. One wonders why
Congress undertook such extensive reform of the credit card law if it
was going to give almost open-ended authority to the CFPA shortly
thereafter.
The Undermining of National Standards Will Increase Costs and Cause
Tremendous Litigation and Uncertainty
The Commerce Clause of the Constitution was designed to allow
products and services to flow freely across State lines. It is hard to
think of an area of our economy where this should be encouraged more
than in financial services, where the market for products from loans to
deposits is national in scope. With changes in technology--such as the
Internet--and the incredible mobility of our society, the free flow of
financial services is even more pronounced. Furthermore, the National
Bank Act, enacted during the Civil War, was created to provide for a
national bank system that would not be subject, in its basic bank
functions, to State laws. This national banking system, as part of the
dual banking system, has served us well. However, a national system
cannot function effectively if all national bank consumer products are
subject to 50 different State laws. As we have noted, the safety and
soundness regulator will not be able to do its job if it has no
authority over consumer laws, much less if that authority is held by
not only the Federal consumer regulator, but every State regulator,
legislature, and attorney general as well.
The multitude of rules--and do not underestimate how incredibly
complex they would be--would subject banks to tremendous legal costs in
order to comply, and also to deal with constant litigation. Every
product, form, and customer communication would have to be checked and
rechecked regularly for compliance with changing laws in all 50 States.
Customers will move to other States regularly, and the bank would have
to assume its customers could be in any State.
There are many areas where problems will arise. ATM cards could be
subject to different rules by State, resulting in their not being
useable in every State at great inconvenience to travelers, who could
be left stranded without funds. Online banking could be affected as
differing rules would apply, depending on where the customer is
located.
Costs to consumers would increase as banks try to address all the
different rules. Innovation would be discouraged as any changes would
have to be tested against all the different State rules. The European
Union is working to develop common rules in order to have greater
efficiencies and innovation, and yet the Administration's proposal
would go in exactly the opposite direction--toward balkanization. From
a consumer's standpoint, such regulatory complexity will be translated
to account or loan agreement legalese to rightfully protect the bank
from elaborate and conflicting requirements--all to the detriment of
simplifying consumer products and making transactions more transparent.
Proponents of the proposal talk about providing one page of simple
disclosures--a goal much to be sought; but how can such a goal be
achieved if there would have to be page after page of disclosures to
cover all the State law differences?
The Question of How To Pay for This New Agency Was Left Very Vague and
Raises Significant Issues
To discharge its powers consistently over both banks and nonbanks,
this new agency will have to be extraordinarily large. It will need to
regulate, and in many cases examine, not just banks and credit unions,
but finance companies, payday lenders, mortgage brokers, mortgage
bankers, appraisers, title insurers and many others--apparently even
pawn shops.
However, under the proposal, no one has any idea how large this
agency is to be. If it is small, its focus will inevitably be on the
already regulated banks, even though, as already noted, 94 percent of
the high cost mortgages came from outside banks. That would be
incredibly unfair and counterproductive. To do its job as advertised by
proponents, this agency would need to ensure that the thousands of
nonbanks under its jurisdiction are reporting, examined, and subject to
enforcement in the same way banks will be. While the States are
supposed to be a front line of defense, it is not credible to argue
that States will have the budgets to implement such reporting,
examination, and enforcement even to a minimal degree. Therefore, the
new agency will need to do it, or its whole rationale falls apart.
Where is this agency's budget to come from? Apparently, the budget
is to be based on fees on financial service products. The Consumer
Products Safety Commission, said to be the model for the CFPA, is not
funded by toy or appliance manufacturers, but rather by an
appropriation. However, if the CFPA is to accomplish its goals and to
effectively regulate nonbanks, it would need to be considerably bigger
than the Consumer Products Safety Commission. Banks are already heavily
burdened with funding their regulators, directly and indirectly (e.g.,
deposit insurance premiums fund the FDIC's regulatory costs). These
costs cannot simply be split apart to pay for the banks' part of the
consumer regulator, as the tremendous efficiencies that result from
combining safety and soundness and consumer regulation will be lost.
How is the agency to collect fees from nonbank providers? On what
basis? How is it going to know about new entrants, unless they are
required to register with the agency? As new types of providers spring
up, how are they to be incorporated? There will, in fact, have to be a
large bureaucracy just to collect the fees. Of course, these new costs,
basic economics tells us, will ultimately be passed on to the users of
the products, and so consumers will end up paying for this large new
agency.
Obviously, these are very difficult questions that were not
addressed in the Administration's proposal, but which should be
answered before proceeding. Given the incredibly broad authority and
ambitions of the proposal, it is impossible for Congress to judge what
it will, in fact, do without knowing the size it is going to be.
The Proposal Will Inhibit Innovation and Competition, Limit Consumer
Choices, and Dramatically Lessen the Availability of Credit
The proposal will, first, create tremendous uncertainty in the
financial community about what the rules will soon be. The entire body
of rules that has governed the development, design, sales, marketing,
and disclosure of all financial products would be subject to change,
and be expected to change dramatically in many instances. When
developing and offering products, firms rely on the basic rules of the
road, knowing that they are subject to careful changes from time-to-
time. Now there would be no certainty. This lack of certainty will
cause firms to pull back from developing new products and new delivery
systems. And it will chill lending, as firms will not know what the
rules may be when they try to collect the loan a few years out.
This problem should not be underestimated. Why design a new product
if you do not know what regulatory rules will be applied to it? Why
stretch to make a loan to a deserving consumer when it may be
determined after the fact that your stretch terms and disclosures were
unreasonable and the contract is therefore unenforceable. Everyone will
be on hold, to some degree, waiting for the development, which will
take years of regulatory action and judicial interpretation, of an
entirely new roadmap.
What makes this situation particularly difficult is that the
proposed legislation, and the narrative provided with it, contains
vague terminology that has little or no legal history. What on earth
does ``reasonable'' mean for disclosures and communications? The legal
concept of ``unfair and deceptive,'' developed over many years, is also
changed. It will take years for these new legal concepts to be defined
fully by the courts. In the meantime, lenders will have no idea what
their potential legal rights and liabilities will be.
Second, you have the huge cost for legal and other work for redoing
the basis on which products are offered today. The current design of
many products and disclosures is thrown into question by the concepts
of this proposal. This is a cost that, again, will ultimately be borne
in large part by consumers.
For example, credit card companies are in the process of spending
hundreds of millions of dollars to change their systems, their
disclosures, their risk models, and basic parts of the product to meet
the new regulations and law. If this proposal is enacted, given the
testimony of Treasury, it seems quite likely that additional
significant changes will be made in regulations. How is the financial
industry to plan for such uncertainty?
Third, the regime surrounding Government designed products will
undermine innovation and the availability of credit. As noted
previously, the Government designed products, given regulatory
advantages, will undermine the incentive to develop new products. If an
institution develops an idea that could enhance the basic product for
all consumers or a subset of consumers, adding it will cause the
product to no longer be ``Government approved'' and will subject it to
discriminatory regulation and legal uncertainty. Why bother? Ideas that
could give consumers benefits or lower costs will never see the light
of day.
The impact on lending will be profound. First, loan adjustments,
which are made constantly in today's world, to fit a borrower's needs
or allow the loan to be made simply will not happen. Those most hurt
will be lower income consumers. Furthermore, the very large uncertainty
and potential legal liabilities will cause less credit to be available,
at the very time when credit is already scarce. Our Government is in
danger of designing policies that are absolutely contradictory--
encouraging more credit to be available, while at the same time,
through the President's proposal, designing a legal morass that will
have a dramatic effect in lowering the availability of credit.
Improvements Can Be Made
ABA agrees that improvements can and should be made to protect
consumers. The great majority of the problems occur outside the highly
regulated traditional banks, but there are legitimate issues relating
to banks as well. The ABA is committed to working with Congress to
address these concerns and implement improvements. In that regard, let
me outline some concepts that should be considered.
Enhance capabilities to apply unfair and deceptive
practices: As you know, the Federal Reserve Board and the OTS
have long had a very powerful tool called unfair and deceptive
practices or UDAP. This had not been used as a broad regulatory
tool for banks prior to the extensive credit card rule.
However, use of this authority would address many of the issues
raised. The UDAP authority is already in place. The ABA
supports legislation the House passed last year to extend this
authority in a coordinated fashion to the OCC and FDIC. The FTC
has this authority for nonbanks, but there have been severe
constraints in using it. Congress should work to give the FTC
the capability and funding to apply it to nonbanks much more
aggressively.
Improve disclosure, using consumer testing: Disclosures can
and should be improved, although it will not be easy. Current
disclosures are by-and-large driven by lawyers and the need to
cover the many legal complexities involved to protect against
the real threat of litigation. Congress, the regulators, the
industry, and consumer advocates need to overcome this bias.
Progress has been made through the insights gained from
consumer testing. Simple disclosures, perhaps in combination
with larger, separate ones required for legal purposes, should
be made in ways that most benefit consumers. Concepts gleaned
from behavioral science relating to how consumers really react
should be included in disclosure design.
Enable basic products without stifling competition,
innovation and consumer choice: In some cases financial
products have become overly complex and difficult, if not
impossible, for consumers to understand. This is not unusual in
our economy as many product offerings--from consumer
electronics, to telephone plans, to insurance--have become very
complex. Often this complexity results from efforts to add
options that consumers may want. Sometimes, as we all know, the
complexity induces consumers to buy products or enhancements
that are not right for them or for which they pay too much.
However, as discussed previously, ABA believes the answer is
not to have the Government design products, mandate that they
be offered, and give them an advantage over private sector
products. Nevertheless, there is a need to have product options
that are basic and easily compared, and to have, at the same
time, a flexible, private-sector driven system that does not
stifle competition and innovation. For example, the private
sector, perhaps through the ABA as the industry's trade
association, could consult with the regulators, Congress, and
consumer advocates to develop basic product forms that could be
easily compared.
Develop centralized call centers for consumer complaints:
It is difficult, perhaps impossible, for many consumers to
understand whom they should call in the Government to register
concerns or complaints. ABA supports a centralized call center
for consumers that could forward complaints to the right agency
and serve as a coordinated information source.
Require regular reports to Congress: The structure of
consumer regulation within agencies can be reviewed and
strengthened. Regular reports to Congress could be required.
Empower the systemic risk oversight regulator to look
specifically at consumer issues that pose systemic concerns:
One clear lesson from the mortgage crisis is that consumer
issues can raise systemic issues. If a systemic regulator had
been in place, we would hope that it would have identified the
rapid growth of subprime lending as a problem that had to be
addressed well before it grew to such a hurricane force. The
systemic regulator could be given the power to require
regulatory agencies to address in a timely manner systemic
consumer issues.
Conclusion
The ABA has very serious concerns about the proposed CFPA and the
authorities it is to be given under the President's proposal. We
believe it will result in a huge regulatory burden, particularly for
community banks, while nonbanks, which are primarily responsible for
the crisis, will have ineffective enforcement.
Healthy, well-regulated banks have already been hurt deeply by
unscrupulous players and regulatory failures. They watched mortgage
brokers and others make loans to consumers that a good banker just
would not make. They watched local economies suffer when the housing
bubble burst. Now they face the prospect of another burdensome layer of
regulation. It is simply unfair to inflict another burden on these
banks that had nothing to do with the problems that were created. The
separate consumer regulator will only add costs to these banks,
particularly community banks, which already suffer under the enormous
regulatory burden placed on them. As you contemplate major changes in
regulation--and change is needed--I urge you to ask this simple
question: How will this change impact those thousands of banks that did
not create the problem and are making the loans needed to get our
economy moving again? Another question that should be asked is: How
will this proposal really assure strong enforcement and examination of
the nonbanks?
Furthermore, the proposal will dramatically undermine incentives to
innovate and to offer new products from which consumers will benefit.
Competition will be lessened, as the Government designed products
limits avenues for competition. Finally, the availability of credit
will be reduced, particularly in the short run, because of great
uncertainty about the new, evolving rules and the increased legal
liability.
As outlined above, we believe that separating safety and soundness
regulation from consumer regulation would be a mistake. Nevertheless,
there are important improvements that can and should be made in the
consumer arena, and we will work with Members of this Committee to make
such improvement in this arena, as well as on the many other important
issues in regulatory reform.
______
PREPARED STATEMENT OF TRAVIS B. PLUNKETT
Legislative Director,
Consumer Federation of America
July 14, 2009
Summary
Thank you, Chairman Dodd, Ranking Member Shelby, and Members of the
Committee. My name is Travis Plunkett and I am the Legislative Director
of the Consumer Federation of America (CFA). \1\ I am pleased to be
able to offer the views of leading consumer, community, and civil
rights groups \2\ in support of the establishment of a Consumer
Financial Protection Agency, as proposed first by Senators Durbin,
Schumer, and Kennedy and most recently by President Obama. In addition
to CFA, I am testifying on behalf of, Americans for Fairness in
Lending, \3\ Americans for Financial Reform, \4\ A New Way Forward, \5\
the Association of Community Organizations for Reform Now (ACORN), \6\
Center for Responsible Lending, \7\ Community Reinvestment Association
of North Carolina, \8\ Consumer Action, \9\ Consumers Union, \10\
Demos, \12\ Florida PIRG, \13\ The International Brotherhood of
Teamsters, \14\ National Association of Consumer Advocates, \15\
National Community Reinvestment Coalition, \16\ National Consumer Law
Center (on behalf of its low-income clients), \17\ National Consumers
League, \18\ National Fair Housing Alliance, \19\ Neighborhood Economic
Development Advocacy Project, \21\ Public Citizen, \22\ Sargent Shriver
National Center on Poverty Law, \23\ Service Employees International
Union, \24\ USAction, \25\ and U.S. PIRG. \26\
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\1\ The Consumer Federation of America is a nonprofit association
of over 280 proconsumer groups, with a combined membership of 50
million people. CFA was founded in 1968 to advance consumers' interests
through advocacy and education.
\2\ The testimony was drafted by Travis Plunkett and Jean Ann Fox
of the Consumer Federation of America, Gail Hillebrand of Consumers
Union, Lauren Saunders of the National Consumer Law Center, and Ed
Mierzwinski of U.S. PIRG.
\3\ Americans for Fairness in Lending works to reform the lending
industry to protect Americans' financial assets. AFFIL works with its
national Partner organizations, local ally organizations, and
individual members to advocate for reform of the lending industry.
\4\ Americans for Financial Reform is a coalition of close to 200
national State and local organizations representing people from every
walk of life, including homeowners, shareowners, workers, and low and
moderate income community residents dedicated to making sure that the
``main street'' voice is heard in the debate on financial regulatory
reform.
\5\ A New Way Forward is a movement of citizens, started in March
2009. It harnesses the voice of citizens to stop the excessive and
dangerous partnership between Government and the largest institutions
of the financial sector in order to reinvigorate the public sphere.
ANWF organizers are letting the world know that the way Congress is
handling the financial crisis rewards the wrong people, is likely to
fail, and doesn't get at the core structural problems in our economy.
ANWF helped organize 60 protests ad 25 educational forums in the past 4
months.
\6\ ACORN, the Association of Community Organizations for Reform
Now, is the Nation's largest community organization of low- and
moderate-income families, working together for social justice and
stronger communities.
\7\ The Center for Responsible Lending (CRL) is a not-for-profit,
nonpartisan research and policy organization dedicated to protecting
homeownership and family wealth by working to eliminate abusive
financial practices. CRL is an affiliate of Self-Help, which consists
of a credit union and a nonprofit loan fund focused on creating
ownership opportunities for low-wealth families, primarily through
financing home loans to low-income and minority families who otherwise
might not have been able to purchase homes. Self-Help has provided over
$5 billion in financing to more than 60,000 low-wealth families, small
businesses and nonprofit organizations in North Carolina and across the
United States. Another affiliate, Self-Help Credit Union, offers a full
range of retail products, and services over 3,500 checking accounts and
approximately 20,000 other deposit accounts, and recently inaugurated a
credit card program.
\8\ The Community Reinvestment Association of North Carolina's
mission is to promote and protect community wealth through advocacy,
research, financial literacy and community development.
\9\ Consumer Action is a national nonprofit education and advocacy
organization serving more than 9,000 community based organizations with
training, educational modules, and multilingual consumer publications
since 1971. Consumer Action's advocacy work centers on credit, banking,
and housing issues.
\10\ Consumers Union is a nonprofit membership organization
chartered in 1936 under the laws of the State of New York to provide
consumers with information, education and counsel about good, services,
health and personal finance, and to initiate and cooperate with
individual and group efforts to maintain and enhance the quality of
life for consumers. Consumers Union's income is solely derived from the
sale of Consumer Reports, its other publications and from noncommercial
contributions, grants and fees. In addition to reports on Consumers
Union's own product testing, Consumer Reports with more than 5 million
paid circulation, regularly, carries articles on health, product
safety, marketplace economics and legislative, judicial, and regulatory
actions which affect consumer welfare. Consumers Union's publications
carry no advertising and receive no commercial support.
\12\ Demos is a New York City-based nonpartisan public policy
research and advocacy organization founded in 2000. A multi-issue
national organization, Demos combines research, policy development, and
advocacy to influence public debates and catalyze change.
\13\ Florida PIRG takes on powerful interests on behalf of
Florida's citizens, working to win concrete results for our health and
our well-being. With a strong network of researchers, advocates,
organizers and students across the State, we stand up to powerful
special interests on issues to stop identity theft, fight political
corruption, provide safe and affordable prescription drugs, and
strengthen voting rights.
\14\ The Teamsters union represents more than 1.4 million workers
in North America. Teamsters work from ports to airlines, from road to
rail, from food processing to waste and recycling, from manufacturing
to public services. The Union fights to improve the lives of workers,
their families and their communities across the global supply chain.
\15\ The National Association of Consumer Advocates, Inc., is a
nonprofit 501(c)(3) organization founded in 1994. NACA's mission is to
provide legal assistance and education to victims of consumer abuse.
NACA, through educational programs and outreach initiatives protects
consumers, particularly low income consumers, from fraudulent, abusive
and predatory business practices. NACA also trains and mentors a
national network of over 1400 attorneys in representing consumers'
rights.
\16\ National Community Reinvestment Coalition is an association
of more than 600 community-based organizations that promotes access to
basic banking services, including credit and savings, to create and
sustain affordable housing, job development, and vibrant communities
for America's working families.
\17\ The National Consumer Law Center, Inc. is a nonprofit
corporation, founded in 1969, specializing in low-income consumer
issues, with an emphasis on consumer credit. On a daily basis, NCLC
provides legal and technical consulting and assistance on consumer law
issues to legal services, Government, and private attorneys
representing low-income consumers across the country. NCLC publishes
and regularly updates a series of 16 practice treatises and annual
supplements on consumer credit laws, including Truth In Lending, Cost
of Credit, Consumer Banking and Payments Law, Foreclosures, and
Consumer Bankruptcy Law and Practice, as well as bimonthly newsletters
on a range of topics related to consumer credit issues and low-income
consumers. NCLC attorneys have written and advocated extensively on all
aspects of consumer law affecting low income people, conducted training
for tens of thousands of legal services and private attorneys on the
law and litigation strategies to deal predatory lending and other
consumer law problems, and provided extensive oral and written
testimony to numerous Congressional committees on these topics. NCLC's
attorneys have been closely involved with the enactment of the all
Federal laws affecting consumer credit since the 1970s, and regularly
provide comprehensive comments to the Federal agencies on the
regulations under these laws.
\18\ The National Consumers League has been fighting for the
rights of consumers and workers since its founding in 1899. The League
was instrumental in seeking a safety net for Americans during the Great
Depression and in the New Deal years, writing legislation to gain
passage of minimum wage laws, unemployment insurance, workers
compensation, social security and health care programs like medicare
and medicaid. The League continues to champion the fair treatment and
protections for all consumers in today's marketplace.
\19\ Founded in 1988, the National Fair Housing Alliance is a
consortium of more than 220 private, nonprofit fair housing
organizations, State and local civil rights agencies, and individuals
from throughout the United States. Headquartered in Washington, DC, the
National Fair Housing Alliance, through comprehensive education,
advocacy and enforcement programs, provides equal access to apartments,
houses, mortgage loans and insurance policies for all residents of the
Nation.
\21\ Neighborhood Economic Development Advocacy Project (NEDAP) is
a resource and advocacy center for community groups in New York City.
Their mission is to promote community economic justice and to eliminate
discriminatory economic practices that harm communities and perpetuate
inequality and poverty.
\22\ Public Citizen is a national nonprofit membership
organization that has advanced consumer rights in administrative
agencies, the courts, and the Congress, for 38 years.
\23\ Founded by Sargent Shriver in 1967, the mission of the
Sargent Shriver National Center on Poverty Law is to provide national
leadership in identifying, developing, and supporting creative and
collaborative approaches to achieve social and economic justice for
low-income people. The Community Investment Unit of the Shriver Center
advances the mission of the organization through innovative and
collaborative public policy advocacy to enable low-income people and
communities to move from poverty to prosperity.
\24\ The Service Employees International Union is North America's
largest union with more than 2 million members. SEIU has taken a lead
in holding financial institutions, including private equity and big
banks, accountable for their impact on working families.
\25\ USAction builds power by uniting people locally and
nationally, on the ground and online, to win a more just and
progressive America. We create and participate the Nation's leading
progressive coalitions making democracy work by organizing issue
campaigns to improve people's lives. Our 28 State affiliates and
partners, and our True Majority online members, bring the voices and
concerns of the grassroots inside the Beltway.
\26\ The U.S. Public Interest Research Group serves as the
federation of and Federal advocacy office for the State PIROs, which
are nonprofit, nonpartisan public interest advocacy groups that take on
powerful interests on behalf of their members.
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In this testimony, we outline the case for establishment of a
robust, independent Federal Consumer Financial Protection Agency to
protect consumers from unfair credit, payment and debt management
products, no matter what company or bank sells them and no matter what
agency may serve as the prudential regulator for that company or bank.
We describe the many failures of the current Federal financial
regulators. We discuss the need for a return to a system where Federal
financial protection law serves as a floor not as a ceiling, and
consumers are again protected by the three-legged stool of Federal
protection, State enforcement and private enforcement. We rebut
anticipated opposition to the proposal, which we expect will come from
the companies and regulators that are part of the system that has
failed to protect us. We offer detailed suggestions to shape the
development of the agency in the legislative process. We believe that,
properly implemented, a Consumer Financial Protection Agency will
encourage innovation by financial actors, increase competition in the
marketplace, and lead to better choices for consumers.
We look forward to working with you and Committee Members to enact
a strong Consumer Financial Protection Agency bill through the Senate
and into law. We also look forward to working with you on other
necessary aspects of financial regulatory reform to restore the faith
and confidence of American families that the financial system will
protect their homes and their economic security.
SECTION 1. LEARNING FROM EXPERIENCE TO CREATE A FEDERAL CONSUMER
FINANCIAL PROTECTION AGENCY
It has become clear that a major cause of the most calamitous
worldwide recession since the Great Depression was the simple failure
of Federal regulators to stop abusive lending, particularly
unsustainable home mortgage lending. Such action would not only have
protected many families from serious financial harm but would likely
have stopped or slowed the chain of events that has led to the current
economic crisis.
The idea of a Federal consumer protection agency focused on credit
and payment products has gained broad and high-profile support because
it targets the most significant underlying causes of the massive
regulatory failures that occurred. First, Federal agencies did not make
protecting consumers their top priority and, in fact, seemed to compete
against each other to keep standards low, ignoring many festering
problems that grew worse over time. If agencies did act to protect
consumers (and they often did not), the process was cumbersome and
time-consuming. As a result, agencies did not act to stop some abusive
lending practices until it was too late. Finally, regulators were not
truly independent of the influence of the financial institutions they
regulated.
Meanwhile, despite an unprecedented Government intervention in the
financial sector, the passage of mortgage reform legislation in the
House of Representatives and the enactment of a landmark law to prevent
abusive credit card lending, problems with the sustainability of home
mortgage and consumer loans keep getting worse. With an estimated 2
million households having already lost their homes to foreclosure
because of the inability to repay unsound loans, Credit Suisse now
predicts that foreclosures will exceed 8 million through 2012. \27\ The
amount of revolving debt, most of which is credit card debt, is
approaching $1 trillion. \28\ Based on the losses that credit card
issuers are now reporting, delinquencies and defaults are expected to
peak at their highest levels ever within the next year. \29\ One in two
consumers who get payday loans default within the first year, and
consumers who receive these loans are twice as likely to enter
bankruptcy within 2 years as those who seek and are denied them. \30\
Overall, personal bankruptcies have increased sharply, up by one-third
in the last year. \31\
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\27\ ``Foreclosures Could Top 8 million: Credit Suisse,'' 9
December 2008, MarketWatch, available at http://www.marketwatch.com/
story/more-than-8-million-homes-face-foreclosure-in-next-4-years (last
visited 21 June 2009).
\28\ See the Federal Reserve statistical release G19, Consumer
Credit, available at http://www.federalreserve.gov/releases/g19/
\29\ ``Fitch Inc. said it continues to see signs that the credit
crunch will escalate into next year, and it said card chargeoffs may
approach 10 percent by this time next year.'' ``Fitch Sees Chargeoffs
Nearing 10 percent,'' Dow Jones, May 5, 2009.
\30\ Paige Marta Skiba and Jeremy Tobacman, ``Payday Loans,
Uncertainty, and Discounting: Explaining Patterns of Borrowing,
Repayment, and Default,'' August 21, 2008. http://
www.law.vanderbilt.edu/faculty/faculty-personal-sites/paige-skiba/
publication/download.aspx?id=1636 and Paige Marta Skiba and Jeremy
Tobacman, ``Do Payday Loans Cause Bankruptcy?'' October 10, 2008 http:/
/www.law.vanderbilt.edu/faculty/faculty-personal-sites/paige-skiba/
publication/download.aspx?id=2221 (last visited 21 June 2009).
\31\ ``Bankruptcy Filings Continue to Rise'' Administrative Office
of the U.S. Courts, news release, 8 June 2009, available at http://
www.uscourts.gov/Press_Releases/2009/BankruptcyFilingsMar2009.cfm (last
visited 21 June 2009).
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The failure of Federal banking agencies to stem subprime mortgage
lending abuses is fairly well known. They did not use the regulatory
authority granted to them to stop unfair and deceptive lending
practices before the mortgage foreclosure crisis spun out of control.
In fact, it wasn't until July of 2008 that these rules were finalized,
close to a decade after analysts and experts started warning that
predatory subprime mortgage lending would lead to a foreclosure
epidemic.
Less well known are Federal regulatory failures that have
contributed to the extension of unsustainable consumer loans, such as
credit card, overdraft and payday loans, which are now imposing a
crushing financial burden on many families. As with problems in the
mortgage lending market, failures to rein in abusive types of consumer
loans were in areas where Federal regulators had existing authority to
act, and either chose not to do so or acted too late to stem serious
problems in the credit markets.
Combining safety and soundness supervision--with its focus on bank
profitability--in the same institution as consumer protection magnified
an ideological predisposition or antiregulatory bias by Federal
officials that led to unwillingness to rein in abusive lending before
it triggered the housing and economic crises. Though we now know that
consumer protection leads to effective safety and soundness, structural
flaws in the Federal regulatory system compromised the independence of
banking regulators, encouraged them to overlook, ignore, and minimize
their mission to protect consumers. This created a dynamic in which
regulatory agencies competed against each other to weaken standards and
ultimately led to an oversight process that was cumbersome and
ineffectual. These structural weaknesses threatened to undermine even
the most diligent policies and intentions. They complicated enforcement
and vitiated regulatory responsibility to the ultimate detriment of
consumers.
These structural flaws include: a narrow focus on ``safety and
soundness'' regulation to the exclusion of consumer protection; the
huge conflict-of-interest that some agencies have because they rely
heavily on financial assessments on regulated institutions that can
choose to pay another agency to regulate them; the balkanization of
regulatory authority between agencies that often results in either very
weak or extraordinarily sluggish regulation (or both); and a regulatory
process that lacks transparency and accountability. Taken together,
these flaws severely compromised the regulatory process and made it far
less likely that agency leaders would either act to protect consumers
or succeed in doing so.
SECTION 2. CORRECTING REGULATORY SHORTCOMINGS BY CREATING A CONSUMER
FINANCIAL PROTECTION AGENCY
Although a Consumer Financial Protection Agency (CFPA) would not be
a panacea for all current regulatory ills, it would correct many of the
most significant structural flaws that exist, realigning the regulatory
architecture to reflect the unfortunate lessons that have been learned
in the current financial crisis and sharply increasing the chances that
regulators will succeed in protecting consumers in the future. A CFPA
would be designed to achieve the regulatory goals of elevating the
importance of consumer protection, prompting action to prevent harm,
ending regulatory arbitrage, and guaranteeing regulatory independence.
A. Put consumer protection at the center of financial regulation.
Right now, four Federal regulatory agencies are required both to
ensure the solvency of the financial institutions they regulate and to
protect consumers from lending abuses. \32\ Jurisdiction over consumer
protection statutes is scattered over several more agencies, with rules
like RESPA and TILA, which both regulate mortgage disclosures, in
different agencies.
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\32\ The Office of the Comptroller of the Currency (OCC) and
Office of Thrift Supervision (OTC) charter and supervise national
banks, and thrifts, respectively. State chartered banks can choose
whether to join and be examined and supervised by either the Federal
Reserve System or the Federal Deposit Insurance Corporation (FDIC). The
FTC is charged with regulating some financial practices (but not safely
and soundness) in the nonbank sector, such as credit cards offered by
department stores and other retailer.
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Within agencies in which these functions are combined, regulators
have often treated consumer protection as less important than their
safety and soundness mission or even in conflict with that mission.
\33\ For example, after more than 6 years of effort by consumer
organizations, Federal regulators are just now contemplating incomplete
rules to protect consumers from high-cost ``overdraft'' loans that
financial institutions often extend without the knowledge of or
permission from consumers. Given the longstanding inaction on this
issue, it is reasonable to assume that regulators were either
uninterested in consumer protection or viewed restrictions on overdraft
loans as an unnecessary financial burden on banks that extend this form
of credit, even if it is deceptively offered and financially harmful to
consumers. In other words, because regulators apparently decided that
their overriding mission was to ensure that the short-term balance
sheets of the institutions they regulated were strong, they were less
likely to perceive that questionable products or practices (like
overdraft loans or mortgage prepayment penalties) were harmful to
consumers.
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\33\ Occasionally, safety and soundness concerns have led
regulators to propose consumer protections, as in the eventually
successful efforts by Federal banking agencies to prohibit ``rent-a-
charter'' payday lending, in which payday loan companies partnered with
national or out-of-State banks in an effort to skirt restrictive State
laws. However, from a consumer protection point-of-view, this multiyear
process took far too long. Moreover, the outcome would have been
different if the agencies had concluded that payday lending would be
profitable for banks and thus contribute to their soundness.
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As mentioned above, recent history has demonstrated that this
shortsighted view of consumer protection and bank solvency as competing
objectives is fatally flawed. If regulatory agencies had acted to
prevent loan terms or practices that harmed consumers, they would also
have vastly improved the financial solidity of the institutions they
regulated. Nonetheless, the disparity in agencies' focus on consumer
protection versus ``safety and soundness'' has been obvious, both in
the relative resources that agencies devoted to the two goals and in
the priorities they articulated. These priorities frequently minimized
consumer protection and included reducing regulatory restrictions on
the institutions they oversaw. \34\
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\34\ For example, in 2007 the OTS cited consumer protection as
part of its ``mission statement'' and ``strategic goals and vision.''
However, in identifying its eight ``strategic priorities'' for how it
would spend its budget in Fiscal Year 2007, only part of one of these
priorities appears to be directly related to consumer protection
(``data breaches''). On the other hand, OTS identified both
``Regulatory Burden Reduction'' and ``Promotion of the Thrift Charter''
as major strategic budget priorities. Office of Thrift Supervision,
``OMB FY2007 Budget and Performance Plan,'' January 2007.
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Though the link between consumer protection and safety and
soundness is now obvious, the two functions are not the same, and do
conflict at times. In some circumstances, such as with overdraft loans,
a financial product might well be profitable, even though it is
deceptively offered and has a financially devastating effect on a
significant number of consumers. \35\
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\35\ Testimony of Travis Plunkett, Legislative Director, Consumer
Federation of America and Edmund Mierzwinski, Consumer Program
Director, U.S. PIRG, Before the Subcommittee on Financial Institutions
and Consumer Credit of the U.S. House of Representatives, Committee of
Financial Services, March 19, 2009.
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Until recently, regulatory agencies have also focused almost
exclusively on bank examination and supervision to protect consumers,
which lacks transparency. This process gives bank regulators a high
degree of discretion to decide what types of lending are harmful to
consumers, a process that involves negotiating behind-the-scenes with
bank officials. \36\ Given that multiple regulators oversee similar
institutions, the process has also resulted in different standards for
products like credit cards offered by different types of financial
institutions. In fact, widespread abusive lending in the credit markets
has discredited claims by bank regulators like the Comptroller of the
Currency that a regulatory process consisting primarily of supervision
and examination results in a superior level of consumer protection
compared to taking public enforcement action against institutions that
violate laws or rules. \37\ Financial regulatory enforcement actions
are a matter of public record which has a positive impact on other
providers who might be engaged in the same practices and provides
information to consumers on financial practices sanctioned by
regulators.
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\36\ ``Findings made during compliance examinations are strictly
confidential and are not made available to the public except at the
OCC's discretion. Similarly, the OCC is not required to publish the
results of its safety-and-soundness orders . . . . Thus, the OCC's
procedures for compliance examinations and safety-and-soundness orders
do not appear to provide any public notice or other recourse to
consumers who have been injured by violations identified by the OCC.''
Testimony of Arthur E. Wilmarth, Jr., Professor of Law, George
Washington University Law School, before the Subcommittee on Financial
Institutions and Consumer Credit of the House Financial Services
Committee, April 26, 2007.
\37\ `` . . . ours is not an `enforcement-only' compliance
regime--far better to describe our approach as `supervision first,
enforcement if necessary,' with supervision addressing so many early
problems that enforcement is not necessary,'' Testimony of John C.
Dugan, Comptroller of the Currency, before the Committee on Financial
Services of the U.S. House of Representatives, June 13, 2007.
---------------------------------------------------------------------------
Additionally, the debate about the financial and foreclosure crisis
often overlooks the fact that predatory lending practices and the
ensuing crisis have had a particularly harsh impact on communities of
color. African Americans and Latinos suffered the brunt of the
predatory and abusive practices found in the subprime market. While
predatory and abusive lending practices were not exclusive to the
subprime market, because of lax regulation in that sector, most abuses
were concentrated there. Several studies have documented pervasive
racial discrimination in the distribution of subprime loans. One such
study found that borrowers of color were more than 30 percent more
likely to receive a higher-rate loan than White borrowers even after
accounting for differences in creditworthiness. \38\ Another study
found that high-income African Americans in predominantly Black
neighborhoods were three times more likely to receive a subprime
purchase loan than low-income White borrowers. \39\
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\38\ See Bocian, D.G., K.S. Ernst, and W. Li, ``Unfair Lending:
The Effect of Race and Ethnicity on the Price of Subprime Mortgages,''
Center for Responsible Lending, May 2006.
\39\ ``Unequal Burden: Income and Racial Disparities in Subprime
Lending in America'' (Washington, DC: HUD, 2000).
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African Americans and Latinos receive a disproportionate level of
high cost loans, even when they quality for a lower rate and/or prime
mortgage. Fannie Mae and Freddie Mac estimated that up to 50 percent of
those who ended up with a sub prime loan would have qualified for a
mainstream, ``prime-rate'' conventional loan in the first place. \40\
According to a study conducted by the Wall Street Journal, as much as
61 percent of those receiving subprime loans would ``qualify for
conventional loans with far better terms.'' \41\ Moreover, racial
segregation is linked with the proportion of subprime loans originated
at the metropolitan level, even after controlling for percent minority,
low credit scores, poverty, and median home value. \42\ The resulting
flood of high cost and abusive loans in communities of color has
artificially elevated the costs of homeownership, caused unprecedented
high rates of foreclosures, and contributed to the blight and
deterioration of these neighborhoods. It is estimated that communities
of color will realize the greatest loss of wealth as a result of this
crisis, since Reconstruction.
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\40\ See the Center for Responsible Lending's ``Fact Sheet on
Predatory Mortgage Lending'', at http://www.responsiblelending.org/
pdfs/2b003-mortgage2005.pdf, and ``The Impending Rate Shock: A Study of
Home Mortgages in 130 American Cities'', ACORN, August 15, 2006,
available at www.acorn.org.
\41\ See ``Subprime Debacle Traps Even Very Creditworthy'', Wall
Street Journal, December 3, 2007.
\42\ Squires, Gregory D., Derek S. Hyra, and Robert N. Renner,
``Segregation and the Subprime Lending Crisis'', Paper presented at the
2009 Federal Reserve System Community Affairs Research Conference,
Washington, DC (April 16, 2009).
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A CFPA, by contrast, would have as its sole mission the development
and effective implementation of standards that ensure that all credit
products offered to borrowers are safe and not discriminatory. The
agency would then enforce these standards for the same types of
products in a transparent, uniform manner. Ensuring the safety and
fairness of credit products would mean that the CFPA would not allow
loans with terms that are discriminatory, deceptive or fraudulent. The
agency should also be designed to ensure that credit products are
offered in a fair and sustainable manner. In fact, a core mission of
the CFPA would be to ensure the suitability of classes of borrowers for
various credit products, based on borrowers' ability to repay the loans
they are offered--especially if the cost of loans suddenly or sharply
increase, and that the terms of loans do not impose financial penalties
on borrowers who try to pay them off. As we've learned in the current
crisis, focusing exclusively on consumer and civil rights protection
would often be positive for lenders' stability and soundness over the
long term. However, the agency would be compelled to act in the best
interest of consumers even if measures to restrict certain types of
loans would have a negative short-term financial impact on financial
institutions.
B. Prevent regulatory arbitrage. Act quickly to prevent unsafe forms of
credit.
The present regulatory system is institution centered, rather than
consumer centered. It is structured according to increasingly
irrelevant distinctions between the type of financial services company
that is lending money, rather than the type of product being offered to
consumers. Right now, financial institutions are allowed (and have
frequently exercised their right) to choose the regulatory body that
oversees them and to switch freely between regulatory charters at the
Federal level and between State and Federal charters. Many financial
institutions have switched charters in recent years seeking regulation
that is less stringent. Two of the most notorious examples are
Washington Mutual and Countrywide, \43\ which became infamous for
promoting dangerous sub-prime mortgage loans on a massive scale. \44\
Both switched their charters to become thrifts regulated by the Office
of Thrift Supervision (OTS). At the Federal level, where major agencies
are funded by the institutions they oversee, this ability to ``charter
shop,'' has undeniably led regulators like the OTS to compete to
attract financial institutions by keeping regulatory standards weak. It
has also encouraged the OTS and OCC to expand their preemptive
authority and stymie efforts by the States to curb predatory and high-
cost lending. The OCC in particular appears to have used its broad
preemptive authority over State consumer protections and its aggressive
legal defense of that authority as a marketing tool to attract
depository institutions to its charter. \45\
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\43\ Of course, following their stunning collapses, Countrywide
was acquired by Bank of America and Washington Mutual by Chase, both in
regulator-ordered winding-downs.
\44\ In fact, several other large national banks have chosen in
recent years to convert their State charter to a national charter.
Charter switches by JPMorgan Chase, HSBC, and Bank of Montreal (Harris
Trust) alone in 2004-05 moved over $1 trillion of banking assets from
the State to the national banking system, increasing the share of
assets held by national banks to 67 percent from 56 percent, and
decreasing the State share to 33 percent from 44 percent. Arthur E.
Wilmarth, Jr., ``The OCC's Preemption Rules Threaten to Undermine the
Dual Banking System, Consumer Protection and the Federal Reserve
Board's role in Bank Supervision'', Proceedings of the 42nd Annual
Conference on Bank Structure and Competition (Fed. Res. Bank of
Chicago, 2006) at 102, 105-106.
\45\ For a detailed analysis, see brief amicus curiae of Center
for Responsible Lending et al. in the case currently before the Supreme
Court, Cuomo v. Clearinghouse and OCC (08-453) available at http://
www.abanet.org/publiced/preview/briefs/pdfs/07-08/08-
453_PetitionerAmCu10ConsumerProtectionOrgs.pdf (last visited 21 June
2009) at pp. 20-39.
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When agencies do collaborate to apply consumer protections
consistently to the institutions they regulate, the process has been
staggeringly slow. As cited in several places in this testimony,
Federal regulators dithered for years in implementing regulations to
stop unfair and deceptive mortgage and credit card lending practices.
One of the reasons for these delays has often been that regulators
disagree among themselves regarding what regulatory measures must be
taken. The course of least resistance in such cases is to do nothing,
or to drag out the process. Although the credit card rule adopted late
last year by Federal regulators was finalized over protests from the
OCC, these objections were likely one of the reasons that Federal
regulators delayed even beginning the process of curbing abusive credit
card lending practices until mid-2008.
The ``charter shopping'' problem would be directly addressed
through the creation of a single CFPA with regulatory authority over
all forms of credit. Federal agencies would no longer compete to
attract institutions based on weak consumer protection standards or
anemic enforcement of consumer rules. The CFPA would be required to
focus on the safety of credit products, features and practices, no
matter what kind of lender offered them. As for regulatory competition
with States, it would only exist to improve the quality of consumer
protection. Therefore, the CFPA should be allowed to set minimum
national credit standards, which States could then enforce (as well as
victimized consumers). States would be allowed to exceed these
standards if local conditions require them to do so. If the CFPA sets
``minimum'' standards that are sufficiently strong, a high degree of
regulatory uniformity is likely to result. With strong national minimum
standards in place, States are most likely to act only when new
problems develop first in one region or submarket. States would then
serve as an early warning system, identifying problems as they develop
and testing policy solutions, which could then be adopted nationwide by
the CFPA if merited. Moreover, the agency would have a clear incentive
to stay abreast of market developments and to act in a timely fashion
to rein in abusive lending because it will be held responsible for
developments in the credit market that harm consumers.
C. Create an independent regulatory process.
The ability of regulated institutions to ``charter shop'' combined
with aggressive efforts by Federal regulators to preempt State
oversight of these institutions has clearly undermined the independence
of the OTS and OCC. This situation is made worse by the fact that large
financial institutions like Countrywide were able to increase their
leverage over regulators by taking a significant chunk of the agency's
budget away when it changed charters and regulators. The OTS and OCC
are almost entirely funded through assessments on the institutions they
regulate (see Appendix 4). The ability to charter shop combined with
industry funding has created a significant conflict-of-interest that
has contributed to the agencies' disinclination to consider upfront
regulation of the mortgage and consumer credit markets.
Given that it supervises the largest financial institutions in the
country, the OCC's funding situation is the most troublesome.
More than 95 percent of the OCC's budget is financed by
assessments paid by national banks, and the twenty biggest
national banks account for nearly three-fifths of those
assessments. Large, multistate banks were among the most
outspoken supporters of the OCC's preemption regulations and
were widely viewed as the primary beneficiaries of those rules.
In addition to its preemption regulations, the OCC has
frequently filed amicus briefs in Federal court cases to
support the efforts of national banks to obtain court decisions
preempting State laws. The OCC's effort to attract large,
multistate banks to the national system have already paid
handsome dividends to the agency . . . . Thus, the OCC has a
powerful financial interest in pleasing its largest regulated
constituents, and the OCC therefore faces a clear conflict of
interest whenever it considers the possibility of taking an
enforcement action against a major national bank. \46\
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\46\ Testimony of Arthur E. Wilmarth. Jr., Professor of Law,
George Washington University Law School, before the Subcommittee on
Financial Institutions and Consumer Credit of the House Financial
Services Committee, April 26, 2007.
The leadership sofa CFPA would be held to account based on its
ability to inform consumers and help protect them from unsafe products.
In order to function effectively, the leadership would need to show
expertise in and commitment to consumer protection. Crucial to the
success of the agency would be to ensure that its funding is adequate,
consistent and does not compromise this mission. Congress could also
ensure that the method of agency funding that is used does not
compromise the CFPA's mission by building accountability mechanisms
into the authorizing statute and exercising effective oversight of the
agency's operations. (See Section 4 below.)
Recent history has demonstrated that even an agency with an
undiluted mission to protect consumers can be undermined by hostile or
negligent leadership or by Congressional meddling on behalf of special
interests. However, unless the structure of financial services
regulation is realigned to change not just the focus of regulation but
its underlying philosophy, it is very unlikely that consumers will be
adequately protected from unwise or unfair credit products in the
future. The creation of a CFPA is necessary because it ensures that the
paramount priority of Federal regulation is to protect consumers, that
the agency decision making is truly independent, and that agencies do
not have financial or regulatory incentives to keep standards weaker
than necessary.
SECTION 3: ERRORS OF OMISSION AND COMMISSION BY THE FEDERAL BANK
REGULATORS
Current regulators may already have some of the powers that the new
agency would be given, but they haven't used them. Conflicts of
interest and a lack of will work against consumer enforcement. In this
section, we detail numerous actions and inactions by the Federal
banking regulators that have led to or encouraged unfair practices,
higher prices for consumers, and less competition.
A. The Federal Reserve Board ignored the growing mortgage crisis for
years after receiving Congressional authority to enact
antipredatory mortgage lending rules in 1994.
The Federal Reserve Board was granted sweeping antipredatory
mortgage regulatory authority by the 1994 Home Ownership and Equity
Protection Act (HOEPA). Final regulations were issued on 30 July 2008
only after the world economy had collapsed due to the collapse of the
U.S. housing market triggered by predatory lending. \47\
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\47\ 73 FR 147, p. 44522, Final HOEPA Rule, 30 July 2008.
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B. At the same time, the Office of the Comptroller of the Currency
engaged in an escalating pattern of preemption of State laws
designed to protect consumers from a variety of unfair bank
practices and to quell the growing predatory mortgage crisis,
culminating in its 2004 rules preempting both State laws and
State enforcement of laws over national banks and their
subsidiaries.
In interpretation letters, amicus briefs and other filings, the OCC
preempted State laws and local ordinances requiring lifeline banking
(NJ 1992, NY, 1994), prohibiting fees to cash ``on-us'' checks (par
value requirements) (TX, 1995), banning ATM surcharges (San Francisco,
Santa Monica and Ohio and Connecticut, 1998-2000), requiring credit
card disclosures (CA, 2003) and opposing predatory lending and
ordinances (numerous States and cities). \48\ Throughout, OCC ignored
Congressional requirements accompanying the 1994 Riegle-Neal Act not to
preempt without going through a detailed preemption notice and comment
procedure, as the Congress had found many OCC actions ``inappropriately
aggressive.'' \49\
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\48\ ``Role of the Office of Thrift Supervision and Office of the
Comptroller of the Currency in the Preemption of State Law'', USGAO,
prepared for Financial Services Committee Chairman James Leach, 7
February 2000, available at http://www.gao.gov/corresp/ggd-00-51r.pdf
(last visited 21 June 2009).
\49\ Statement of managers filed with the conference report on
H.R. 3841, the Riegle-Neal Interstate Banking and Branching Efficiency
Act of 1994, Congressional Record Page S10532, 3 August 1994.
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In 2000-2004, the OCC worked with increasing aggressiveness to
prevent the States from enforcing State laws and stronger State
consumer protection standards against national banks and their
operating subsidiaries, from investigating or monitoring national banks
and their operating subsidiaries, and from seeking relief for consumers
from national banks and subsidiaries.
These efforts began with interpretative letters stopping State
enforcement and State standards in the period up to 2004, followed by
OCC's wide-ranging preemption regulations in 2004 purporting to
interpret the National Bank Act, plus briefs in court cases supporting
national banks' efforts to block State consumer protections.
We discuss these matters in greater detail below, in Section 5,
rebutting industry arguments against the CFPA.
C. The agencies took little action except to propose greater
disclosures, as unfair credit card practices increased over the
years, until Congress stepped in.
Further, between 1995 and 2007, the Office of the Comptroller of
Currency issued only one public enforcement action against a Top Ten
credit card bank (and then only after the San Francisco District
Attorney had brought an enforcement action). In that period, ``the OCC
has not issued a public enforcement order against any of the eight
largest national banks for violating consumer lending laws.'' \50\ The
OCC's failure to act on rising credit card complaints at the largest
national banks triggered Congress to investigate, resulting in passage
of the 2009 Credit Card Accountability, Responsibility and Disclosure
Act (CARD Act). \51\ While this Committee was considering that law,
other Federal regulators finally used their authority under the Federal
Trade Commission Act to propose and finalize a similar rule. \52\ By
contrast, the OCC requested the addition of two significant loopholes
to a key protection of the proposed rule.
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\50\ Testimony of Professor Arthur Wilmarth, 26 April 2007, before
the Subcommittee on Financial Institutions and Consumer Credit, hearing
on Credit Card Practices: Current Consumer and Regulatory Issues at
http://www.house.gov/financialservices/hearing110/htwilmarth042607.pdf.
\51\ H.R. 627 was signed into law by President Obama as Pub. L.
No. 111-24 on 22 May 2009.
\52\ The final rule was published in the Federal Register a month
later. 74 FR 18, page 5498 Thursday, January 29, 2009.
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Meanwhile, this Committee and its Subcommittee on Financial
Institutions and Consumer Credit had conducted numerous hearings on the
impact of current credit card issuer practices on consumers. The
Committee heard testimony from academics and consumer representatives
regarding abusive lending practices that are widespread in the credit
card industry, including:
The unfair application of penalty and ``default'' interest
rates that can rise above 30 percent;
Applying these interest rate hikes retroactively on
existing credit card debt, which can lead to sharp increases in
monthly payments and force consumers on tight budgets into
credit counseling and bankruptcy;
High and increasing ``penalty'' fees for paying late or
exceeding the credit limit. Sometimes issuers use tricks or
traps to illegitimately bring in fee income, such as requiring
that payments be received in the late morning of the due date
or approving purchases above the credit limit;
Aggressive credit card marketing directed at college
students and other young people;
Requiring consumers to waive their right to pursue legal
violations in the court system and forcing them to participate
in arbitration proceedings if there is a dispute, often before
an arbitrator with a conflict of interest; and
Sharply raising consumers' interest rates because of a
supposed problem a consumer is having paying another creditor.
Even though few credit card issuers now admit to the
discredited practice of ``universal default,'' eight of the ten
largest credit card issuers continue to permit this practice
under sections in cardholder agreements that allow issuers to
change contract terms at ``any time for any reason.'' \53\
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\53\ Testimony of Linda Sherry of Consumer Action, House
Subcommittee on Financial Institutions and Consumer Credit, April 26,
2007.
In contrast to this absence of public enforcement action by the OCC
against major national banks, State officials and other Federal
agencies have issued numerous enforcement orders against leading
national banks or their affiliates, including Bank of America, Bank
One, Citigroup, Fleet, JPMorgan Chase, and USBancorp--for a wide
variety of abusive practices over the past decade. \54\
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\54\ Testimony of Arthur E. Wilmarth, Jr., Professor of Law,
George Washington University Law School, April 26, 2007.
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The OCC and PRB were largely silent while credit card issuers
expanded efforts to market and extend credit at a much faster speed
than the rate at which Americans have taken on credit card debt. This
credit expansion had a disproportionately negative effect on the least
sophisticated, highest risk and lowest income households. It has also
resulted in both relatively high losses for the industry and record
profits. That is because, as mentioned above, the industry has been
very aggressive in implementing a number of new--and extremely costly--
fees and interest rates. \55\ Although the agencies did issue
significant guidance in 2003 to require issuers to increase the size of
minimum monthly payments that issuers require consumers to pay, \56\
neither agency has proposed any actions (or asked for the legal
authority to do so) to rein in aggressive lending or unjustifiable fees
and interest rates.
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\55\ Testimony of Travis B. Plunkett of the Consumer Federation of
America, Senate Banking Committee, January 25, 2007.
\56\ Joint press release of Board of Governors of the Federal
Reserve System, Federal Deposit Insurance Corporation, Office of the
Comptroller of the Currency and Office of Thrift Supervision, ``FFIEC
Agencies Issue Guidance on Credit Card Account Management and Loss
Allowance Practices,'' January 8, 2003, see attached ``Account
Management and Loss Allowance Guidance'' at 3.
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In addition, in 1995 the OCC amended a rule, with its action later
upheld by the Supreme Court, \57\ that allowed credit card banks to
export fees nationwide, as if they were interest, resulting in massive
increases in the size of penalty late and overdraft fees.
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\57\ The rule is at 12 C.F.R. 7.4001(a). The case is Smiley v.
Citibank, 517 U.S. 735.
---------------------------------------------------------------------------
D. The Federal Reserve has allowed debit card cash advances (overdraft
loans) without consent, contract, cost disclosure, or fair
repayment terms.
The FRB has refused to require banks to comply with the Truth in
Lending Act (TILA) when they loan money to customers who are permitted
to overdraw their accounts. While the FRB issued a staff commentary
clarifying that TILA applied to payday loans, the Board has refused in
several proceedings to apply the same rules to banks that make nearly
identical loans. \58\ As a result, American consumers spend at least
$17.5 billion per year on cash advances from their banks without
signing up for the credit and without getting cost-of-credit
disclosures or a contract stating that the bank would in fact pay
overdrafts. Consumers are induced to withdraw more cash at ATMs than
they have in their account and spend more than they have with debit
card purchases at point of sale. In both cases, the bank could simply
deny the transaction, saving consumers average fees of $35 each time.
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\58\ National Consumer Law Center and Consumer Federation of
America, Comments to the Federal Reserve Board, Docket No. R-1136,
January 27, 2003. Appendix ``Bounce Protection: How Banks Turn Rubber
Into Gold by Enticing Consumers To Write Bad Checks.'' Also, CFA,
Consumers Union, and U.S. Public Interest Research Group, Supplemental
Comments relating to Docket R-1136, May 2, 2003. CFA, et al. Comments
to the Federal Reserve System, 12 CFR Part 230, Docket No. R-1197,
Proposed Amendments to Regulation DD, August 6, 2004. Letter from CFA
and national groups to the Chairman of the Federal Reserve Board and
Federal Bank Regulators, urging Truth in Lending for overdraft loans,
June 8, 2005. CFA, et al., Comments, Federal Reserve System, OTS, and
NCUA, FRB Docket No. R-1314, OTS-2008-0004, NCUA RIN 3133-AD47, August
4, 2008. CFA Comments, Federal Reserve System, FRB Docket No. R-1343,
March 30, 2009.
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The FRB has permitted banks to avoid TILA requirements because
bankers claim that systematically charging unsuspecting consumers very
high fees for overdraft loans they did not request is the equivalent to
occasionally covering a paper check that would otherwise bounce.
Instead of treating short term bank loans in the same manner as all
other loans covered under TILA, as consumer organizations recommended,
the FRB issued and updated regulations under the Truth in Savings Act,
pretending that finance charges for these loans were bank ``service
fees.'' In several dockets, national consumer organizations provided
well-researched comments, urging the Federal Reserve to place consumer
protection ahead of bank profits, to no avail.
As a result, consumers unknowingly borrow billions of dollars at
astronomical interest rates. A $100 overdraft loan with a $35 fee that
is repaid in 2 weeks costs 910 percent APR. The use of debit cards for
small purchases often results in consumers paying more in overdraft
fees than the amount of credit extended. The FDIC found last year that
the average debit card point of purchase overdraft is just $20, while
the sample of State banks surveyed by the FDIC charged a $27 fee. If
that $20 overdraft loan were repaid in two weeks, the FDIC noted that
the APR came to 3,520 percent. \59\
---------------------------------------------------------------------------
\59\ FDIC Study of Bank Overdraft Programs, Federal Deposit
Insurance Corporation, November 2008 at v.
---------------------------------------------------------------------------
As the Federal Reserve has failed to protect bank account customers
from unauthorized overdraft loans, banks are raising fees and adding
new ones. In the CFA survey of the 16 largest banks updated in July
2009, we found that 14 of the 16 largest banks charge $35 or more for
initial or repeat overdrafts and nine of the largest banks use a tiered
fee structure to escalate fees over the year. For example, USBank
charges $19 for the first overdraft in a year, $35 for the second to
fourth overdraft, and $37.50 thereafter. Ten of the largest banks
charge a sustained overdraft fee, imposing additional fees if the
overdraft and fees are not repaid within days. Bank of America began in
June to impose a second $35 fee if an overdraft is not repaid within 5
days. As a result, a Bank of America customer who is permitted by her
bank to overdraw by $20 with a debit card purchase can easily be
charged $70 for a 5 day extension of credit. \60\ (For more detail,
please see CFA Survey: Sixteen Largest Bank Overdraft Fees and Terms,
Appendix 5.)
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\60\ Bank of America, ``Important Information Regarding Changes to
Your Account'' p. 2. Accessed online June 15, 2009. ``Extended
Overdrawn Balance Charge, June 5, 2009: For each time we determine your
account is overdrawn by any amount and continues to be overdrawn for 5
or more consecutive business days, we will charge one fee of $35. This
fee is in addition to applicable Overdraft Item Fees and NSF Returned
Item Fees.''
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Cash advances on debit cards are not protected by the Truth in
Lending Act prohibition on banks using set off rights to collect
payment out of deposits into their customers' accounts. If the purchase
involved a credit card, on the other hand, it would violate Federal law
for a bank to pay the balance owed from a checking account at the same
bank. Banks routinely pay back debit card cash advances to themselves
by taking payment directly out of consumers' checking accounts, even if
those accounts contain entirely exempt funds such as Social Security.
The Federal Reserve is considering comments filed in yet another
overdraft loan docket, this time considering whether to require banks
to permit consumers to opt-out of fee-based overdraft programs, or,
alternatively, to require banks to get consumers to opt in for
overdrafts. This proposal would change Reg E which implements the
Electronic Fund Transfer Act and would only apply to overdrafts created
by point of sale debit card transactions and to ATM withdrawals,
leaving all other types of transactions that are permitted to overdraw
for a fee unaddressed. Consumer organizations urged the Federal Reserve
to require banks to get their customers' affirmative consent, the same
policy included in the recently enacted credit card bill which requires
affirmative selection for creditors to permit over-the-limit
transactions for a fee. \61\
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\61\ Federal Reserve Board, Docket No. R-1343, comments were due
March 30, 2009.
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E. The Fed is allowing a shadow banking system (prepaid cards) outside
of consumer protection laws to develop and target the unbanked
and immigrants; The OTS is allowing bank payday loans (which
preempt State laws) on prepaid cards.
The Electronic Funds Transfer Act requires key disclosures of fees
and other practices, protects consumer bank accounts from unauthorized
transfers, requires resolution of billing errors, gives consumers the
right to stop electronic payments, and requires Statements showing
transaction information, among other protections. The EFTA is also the
statute that will hold the new protections against overdraft fee
practices that the Fed is writing.
Yet the Fed has failed to include most prepaid cards in the EFTA's
protections, even while the prepaid industry is growing and is
developing into a shadow banking system. In 2006, the Fed issued rules
including payroll cards--prepaid cards that are used to pay wages
instead of a paper check for those who do not have direct deposit to a
bank account--within the definition of the ``accounts'' subject to the
EFTA. But the Fed permitted payroll card accounts to avoid the
Statement requirements for bank accounts, relying instead on the
availability of account information on the Internet. Forcing consumers
to monitor their accounts online to check for unauthorized transfers
and fees and charges is particularly inappropriate for the population
targeted for these cards: consumers without bank accounts, who likely
do not have or use regular Internet access.
Even worse, the Fed refused to adopt the recommendations of
consumer groups that self-selected payroll cards--prepaid cards that
consumers shop for and choose on their own as the destination for
direct deposit of their wages--should receive the same EFTA protections
that employer designated payroll cards receive. The Fed continues to
take the position that general prepaid cards are not protected by the
EFTA.
This development has become all the more glaring as Federal and
State government agencies have moved to prepaid cards to pay many
Government benefits, from Social Security and Indian Trust Funds to
unemployment insurance and State-collected child support. Some
agencies, such as the Treasury Department when it created the Social
Security Direct Express Card, have included in their contract
requirements that the issuer must comply with the EFTA. But not all
have, and compliance is uneven, despite the fact that the EFTA itself
clearly references and anticipates coverage of electronic systems for
paying unemployment insurance and other non-needs-tested Government
benefits.
The Fed's failure to protect this shadow banking system is also
disturbing as prepaid cards are becoming a popular product offered by
many predatory lenders, like payday lenders.
Indeed, the Fed is not the only one that has recently dropped the
ball on consumer protection on prepaid cards. One positive effort by
the banking agencies in the past decade was the successful effort to
end rent-a-bank partnerships that allowed payday lenders to partner
with depositories to use their preemptive powers to preempt State
payday loan laws. \62\ But more recently, one prepaid card issuer, Meta
Bank, has developed a predatory, payday loan feature--iAdvance--on its
prepaid cards that receive direct deposit of wages and Government
benefits. At a recent conference, an iAdvance official boasted that
Meta Bank's regulator--the OTS--has been very ``flexible'' with them
and ``understands'' this product.
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\62\ Payday lending is so egregious that even the Office of the
Comptroller of the Currency refused to let storefront lenders hide
behind their partner banks' charters to export usury.
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F. Despite advances in technology, the Federal Reserve has refused to
speed up availability of deposits to consumers.
Despite rapid technological changes in the movement of money
electronically, the adoption of the Check 21 law to speed check
processing, and electronic check conversion at the cash register, the
Federal Reserve has failed to shorten the amount of time that banks are
allowed to hold deposits before they are cleared. Money flies out of
bank accounts at warp speed. Deposits crawl in. Even cash that is
deposited over the counter to a bank teller can be held for 24 hours
before becoming available to cover a transaction. The second business
day rule for local checks means that a low-income worker who deposits a
pay check on Friday afternoon will not get access to funds until the
following Tuesday. If the paycheck is not local, it can be held for
five business days. This long time period applies even when the check
is written on the same bank where it is deposited. Consumers who
deposit more than $5,000 in one day face an added wait of about 5 to 6
more business days. Banks refuse to cash checks for consumers who do
not have equivalent funds already on deposit. The combination of
unjustifiably long deposit holds and banks' refusal to cash account
holders' checks pushes low income consumers towards check cashing
outlets, where they must pay 2 to 4 percent of the value of the check
to get immediate access to cash.
Consumer groups have called on the Federal Reserve to speed up
deposit availability and to prohibit banks from imposing overdraft or
insufficient fund (NSF) fees on transactions that would not have
overdrawn if deposits had been available. The Federal Reserve
vigorously supported Check 21, which has speeded up withdrawals but has
refused to reduce the time period for local and nonlocal check hold
periods for consumers.
G. The Federal Reserve has supported the position of payday lenders and
telemarketing fraud artists by permitting remotely created
checks (demand drafts) to subvert consumer rights under the
electronic funds transfer act.
In 2005, the National Association of Attorneys General, the
National Consumer Law Center, Consumer Federation of America, Consumers
Union, the National Association of Consumer Advocates, and U.S. Public
Interest Research Group filed comments with the Federal Reserve in
Docket No. R-1226, regarding proposed changes to Regulation CC with
respect to demand drafts. Demand drafts are unsigned checks created by
a third party to withdraw money from consumer bank accounts. State
officials told the FRB that demand drafts are frequently used to
perpetrate fraud on consumers and that the drafts should be eliminated
in favor of electronic funds transfers that serve the same purpose and
are covered by protections in the Electronic Funds Transfer Act. Since
automated clearinghouse transactions are easily traced, fraud artists
prefer to use demand drafts. Fraudulent telemarketers increasingly rely
on bank debits to get money from their victims. The Federal Trade
Commission earlier this year settled a series of cases against
telemarketers who used demand drafts to fraudulently deplete consumers'
bank accounts. Fourteen defendants agreed to pay a total of more than
$16 million to settle FTC charges while Wachovia Bank paid $33 million
in a settlement with the Comptroller of the Currency. \63\
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\63\ Press Release, ``Massive Telemarketing Scheme Affected Nearly
One Million Consumers Nationwide; Wachovia Bank To Provide an
Additional $33 Million to Suntasia Victims,'' Federal Trade Commission,
January 13, 2009, viewed at http://www.ftc.gov/opa/2009/01/
suntasia.shtm.
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Remotely created checks are also used by high cost lenders to
remove funds from checking accounts even when consumers exercise their
right to revoke authorization to collect payment through electronic
funds transfer. CFA first issued a report on Internet payday lending in
2004 and documented that some high-cost lenders converted debts to
demand drafts when consumers exercised their EFTA right to revoke
authorization to electronically withdraw money from their bank
accounts. CFA brought this to the attention of the Federal Reserve in
2005, 2006, and 2007. No action has been taken to safeguard consumers'
bank accounts from unauthorized unsigned checks used by telemarketers
or conversion of a loan payment from an electronic funds transfer to a
demand draft to thwart EFTA protections or exploit a loophole in EFTA
coverage.
The structure of online payday loans facilitates the use of demand
drafts. Every application for a payday loan requires consumers to
provide their bank account routing number and other information
necessary to create a demand draft as well as boiler plate contract
language to authorize the device. The account information is initially
used by online lenders to deliver the proceeds of the loan into the
borrower's bank account using the ACH system. Once the lender has the
checking account information, however, it can use it to collect loan
payments via remotely created checks per boilerplate contract language
even after the consumer revokes authorization for the lender to
electronically withdraw payments.
The use of remotely created checks is common in online payday loan
contracts. ZipCash LLC ``Promise to Pay'' section of a contract
included the disclosure that the borrower may revoke authorization to
electronically access the bank account as provided by the Electronic
Fund Transfer Act. However, revoking that authorization will not stop
the lender from unilaterally withdrawing funds from the borrower's bank
account. The contract authorizes creation of a demand draft which
cannot be terminated. ``While you may revoke the authorization to
effect ACH debit entries at any time up to 3 business days prior to the
due date, you may not revoke the authorization to prepare and submit
checks on your behalf until such time as the loan is paid in full.''
(Emphasis added.) \64\
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\64\ Loan Supplement (ZipCash LLC) Form #2B, on file with CFA.
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H. The Federal Reserve has taken no action to safeguard bank accounts
from Internet payday lenders.
In 2006, consumer groups met with Federal Reserve staff to urge
them to take regulatory action to protect consumers whose accounts were
being electronically accessed by Internet payday lenders. We joined
with other groups in a follow up letter in 2007, urging the Federal
Reserve to make the following changes to Regulation E:
Clarify that remotely created checks are covered by the
Electronic Funds Transfer Act.
Ensure that the debiting of consumers' accounts by Internet
payday lenders is subject to all the restrictions applicable to
preauthorized electronic funds transfers.
Prohibit multiple attempts to ``present'' an electronic
debit.
Prohibit the practice of charging consumers a fee to revoke
authorization for preauthorized electronic funds transfers.
Amend the Official Staff Interpretations to clarify that
consumers need not be required to inform the payee in order to
stop payment on preauthorized electronic transfers.
While FRB staff was willing to discuss these issues, the FRB took
no action to safeguard consumers when Internet payday lenders and other
questionable creditors evade consumer protections or exploit gaps in
the Electronic Fund Transfer Act to mount electronic assaults on
consumers' bank accounts.
As a result of inaction by the Federal Reserve, payday loans
secured by repeat debit transactions undermine the protections of the
Electronic Fund Transfer Act, which prohibits basing the extension of
credit with periodic payments on a requirement to repay the loan
electronically. \65\ Payday loans secured by debit access to the
borrower's bank account which cannot be cancelled also functions as the
modern banking equivalent of a wage assignment--a practice which is
prohibited when done directly. The payday lender has first claim on the
direct deposit of the borrower's next paycheck or exempt Federal funds,
such as Social Security, SSI, or Veterans Benefit payments. Consumers
need control of their accounts to decide which bills get paid first and
to manage scarce family resources. Instead of using its authority to
safeguard electronic access to consumers' bank accounts, the Federal
Reserve has stood idly by as the online payday loan industry has
expanded.
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\65\ Reg E, 12 C.F.R. 205.10(e). 15 U.S.C. 1693k states that
``no person'' may condition extension of credit to a consumer on the
consumer's repayment by means of a preauthorized electronic fund
transfer.
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I. The banking agencies have failed to stop banks from imposing
unlawful freezes on accounts containing social security and
other funds exempt from garnishment.
Federal benefits including Social Security and Veteran's benefits
(as well as State equivalents) are taxpayer dollars targeted to relieve
poverty and ensure minimum subsistence income to the Nation's workers.
Despite the purposes of these benefits, banks routinely freeze bank
accounts containing these benefits pursuant to garnishment or
attachment orders, and assess expensive fees--especially insufficient
fund (NSF) fees--against these accounts.
The number of people who are being harmed by these practices has
escalated in recent years, largely due to the increase in the number of
recipients whose benefits are electronically deposited into bank
accounts. This is the result of the strong Federal policy to encourage
this in the Electronic Funds Transfer Act. And yet, the banking
agencies have failed to issue appropriate guidance to ensure that the
millions of Federal benefit recipients receive the protections they are
entitled to under Federal law.
J. The Comptroller of the Currency permits banks to manipulate payment
order to extract maximum bounced check and overdraft fees, even
when overdrafts are permitted.
The Comptroller of the Currency permits national banks to rig the
order in which debits are processed. This practice increases the number
of transactions that trigger an overdrawn account, resulting in higher
fee income for banks. When banks began to face challenges in court to
the practice of clearing debits according to the size of the debit--
from the largest to the smallest--rather than when the debit occurred
or from smallest to largest check, the OCC issued guidelines that allow
banks to use this dubious practice.
The OCC issued an Interpretive Letter allowing high-to-low check
clearing when banks follow the OCC's considerations in adopting this
policy. Those considerations include: the cost incurred by the bank in
providing the service; the deterrence of misuse by customers of banking
services; the enhancement of the competitive position of the bank in
accordance with the bank's business plan and marketing strategy; and
the maintenance of the safety and soundness of the institution. \66\
None of the OCC's considerations relate to consumer protection.
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\66\ 12 C.F.R. 7.4002(b).
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The Office of Thrift Supervision (OTS) addressed manipulation of
transaction-clearing rules in the Final Guidance on Thrift Overdraft
Programs issued in 2005. The OTS, by contrast, advised thrifts that
transaction-clearing rules (including check-clearing and batch debit
processing) should not be administered unfairly or manipulated to
inflate fees. \67\ The Guidelines issued by the other Federal
regulatory agencies merely urged banks and credit unions to explain the
impact of their transaction clearing policies. The Interagency ``Best
Practices'' State: ``Clearly explain to consumers that transactions may
not be processed in the order in which they occurred, and that the
order in which transactions are received by the institution and
processed can affect the total amount of overdraft fees incurred by the
consumers.'' \68\
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\67\ Office of Thrift Supervision, Guidance on Overdraft
Protection Programs, February 14, 2005, p. 15.
\68\ Department of Treasury, Joint Guidance on Overdraft
Protection Programs, February 15, 2005, p. 13.
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CFA and other national consumer groups wrote to the Comptroller and
other Federal bank regulators in 2005 regarding the unfair trade
practice of banks ordering withdrawals from high-to-low, while at the
same time unilaterally permitting overdrafts for a fee. One of the
OCC's ``considerations'' is that the overdraft policy should ``deter
misuse of bank services.'' Since banks deliberately program their
computers to process withdrawals high-to-low and to permit customers to
overdraw at the ATM and Point of Sale, there is no ``misuse'' to be
deterred.
No Federal bank regulator took steps to direct banks to change
withdrawal order to benefit low-balance consumers or to stop the unfair
practice of deliberately causing more transactions to bounce in order
to charge high fees. CFA's survey of the 16 largest banks earlier this
year found that all of them either clear transactions largest first or
reserve the right to do so. \69\ Since ordering withdrawals largest
first is likely to deplete scarce resources and trigger more overdraft
and insufficient funds fees for many Americans, banks have no incentive
to change this practice absent strong oversight by bank regulators.
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\69\ Consumer Federation of America, Comments to Federal Reserve
Board, Docket No. R-1343, Reg. E, submitted March 30, 2009.
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K. The regulators have failed to enforce the Truth In Savings Act
requirement that banks provide account disclosures to
prospective customers.
According to a 2008 GAO report \70\ to Rep. Carolyn Maloney, then-
chair of the Financial Institutions and Consumer Credit Subcommittee,
based on a secret shopper investigation, banks don't give consumers
access to the detailed schedule of account fee disclosures as required
by the 1991 Truth In Savings Act. From GAO:
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\70\ ``Federal Banking Regulators Could Better Ensure That
Consumers Have Required Disclosure Documents Prior to Opening Checking
or Savings Accounts'', GAO-08-28I, January 2008, available at http://
www.gao.gov/new.items/d08281.pdf (last visited 21 June 2009).
Regulation DD, which implements the Truth in Savings Act
(TISA), requires depository institutions to disclose (among
other things) the amount of any fee that may be imposed in
connection with an account and the conditions under which such
fees are imposed. [ . . . ] GAO employees posed as consumers
shopping for checking and savings accounts [ . . . ] Our visits
to 185 branches of depository institutions nationwide suggest
that consumers shopping for accounts may find it difficult to
obtain account terms and conditions and disclosures of fees
upon request prior to opening an account. Similarly, our review
of the Web sites of the banks, thrifts, and credit unions we
visited suggests that this information may also not be readily
available on the Internet We were unable to obtain, upon
request, a comprehensive list of all checking and savings
account foes at 40 of the branches (22 percent) that we
visited. [ . . . ] The results are consistent with those
reported by a consumer group [U.S. PIRG] that conducted a
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similar exercise in 2001.
This, of course, keeps consumers from being able to shop around and
compare prices. As cited by GAO, U.S. PIRG then complained of these
concerns in a 2001 letter to then Federal Reserve Board Chairman Alan
Greenspan. \71\ No action was taken. The problem is exacerbated by a
2001 Congressional decision to eliminate consumers' private rights
olfaction for Truth In Savings violations.
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\71\ The 1 November 2001 letter from Edmund Mierzwinski, U.S.
PIRG, to Greenspan is available at http://static.uspirg.org/reports/
bigbanks2001/greenspanltr.pdf (last visited 21 June 2009). In that
letter, we also urged the regulators to extend Truth In Savings
disclosure requirements to the Internet. No action was taken.
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L. The Federal Reserve actively campaigned to eliminate a Congressional
requirement that it publish an annual survey of bank account
fees.
One of the consumer protections included in the 1989 savings and
loan bailout law known as the Financial Institutions Reform, Recovery
and Enforcement Act was Section 1002, which required the Federal
Reserve to publish an annual report to Congress on fees and services of
depository institutions. The Fed actively campaigned in opposition to
the requirement and succeeded in convincing Congress to sunset the
survey in 2003. \72\ Most likely, the Fed was unhappy with the report's
continued findings that each year bank fees increased, and that each
year, bigger banks imposed the biggest fees.
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\72\ The final 2003 report to Congress is available here http://
www.federalreserve.gov/boarddocs/rptcongress/2003fees.pdf (last visited
21 June 2009). The 1997-2003 reports can all be accessed from this
page, http://www.federalreserve.gov/pubs/reports_other.htm (last
visited 21 June 2009).
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SECTION 4. STRUCTURE AND JURISDICTION OF A CONSUMER FINANCIAL
PROTECTION AGENCY
If the CFPA is to be effective in its mission, it must be
structured so that it is strong and independent with full authority to
protect consumers. Our organizations have strongly endorsed President
Obama's proposal regarding what should be the agency's jurisdiction,
responsibilities, rule-writing authority, enforcement powers and
methods of funding. \73\ His proposal would create a Consumer Financial
Protection Agency (CFPA) with a broad jurisdiction over credit, savings
and payment products, as well as fair lending and community
reinvestment laws. \74\ (Recommendations for improvement to the
Administration bill are flagged below.) The legislation has been
introduced (without providing the agency jurisdiction over the
Community Reinvestment Act) by House Financial Services Chairman Barney
Frank as H.R. 3126.
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\73\ Senators Durbin, Schumer, Kennedy and Dodd offered the first
legislative proposal to create a consumer financial agency (S. 566),
known as the Financial Product Safety Commission. The bill was
originally introduced in the last Congress.
\74\ ``Financial Regulatory Reform, A New Foundation: Rebuilding
Financial Supervision and Regulation,'' Department of the Treasury,
June 17, 2009, pp. 55-70. The White House has since proposed
legislation to effectuate the proposal in this ``White Paper.''
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In its work to protect consumers and the marketplace from abuses,
the CFPA as envisioned by the Administration would have a full set of
enforcement and analytical tools. The first tool would be that the CFPA
could gather information about the marketplace so that the agency
itself could understand the impact of emerging practices in the
marketplace. The agency could use this information to improve the
information that financial services companies must offer to customers
about products, features or practices or to offer advice to consumers
directly about the risk of a variety of products on the market. For
some of these products, features or practices, the agency might
determine that no regulatory intervention is warranted. For others,
this information about the market will inform what tools are used. A
second tool would be to address and rein in deceptive marketing
practices or require improved disclosure of terms. The third tool would
be the identification and regulatory facilitation of ``plain-vanilla,''
low risk products that should be widely offered. The fourth tool would
be to restrict or ban specific product features or terms that are
harmful or not suitable in some circumstances, or that don't meet
ordinary consumer expectations. Finally, the CFPA would also have the
ability to prohibit dangerous financial products. We can only wonder
how much less pain would have been caused for our economy if a
regulatory agency had been actively exercising the latter two powers
during the run up to the mortgage crisis.
A. Agency structure and jurisdiction.
Under the Administration's proposal, the agency would be governed
by a five-member board. Four of these members would be appointed by the
President and confirmed by the Senate. The final member would be the
director of the consolidated bank supervisory agency proposed by the
President. We strongly recommend that the stipulated qualifications for
board membership be improved to require that board members have actual
experience and expertise with consumer protection in the financial
services arena. An agency focused solely on protecting consumers must
be governed by leaders who have expertise not just in the financial
services marketplace, but with protecting consumers in that
marketplace.
The Administration proposes to have the agency oversee the sale and
marketing of credit, deposit and payment products and services and
related products and services, and will ensure that they are being
offered in a fair, sustainable and transparent manner. This should
include debit, prepaid debit, and stored value cards; loan servicing,
collection, credit reporting and debt-related services (such as credit
counseling, mortgage rescue plans and debt settlement) offered to
consumers and small businesses. Our organizations support this
jurisdiction because credit products can have different names and be
offered by different types of entities, yet still compete for the same
customers in the same marketplace. Putting the oversight of competing
products under one set of minimum Federal rules regardless of who is
offering that product will protect consumers, promote innovation,
provide consumers with valuable options, and spur vigorous competition.
As with the Administration, we recommend against granting this
agency jurisdiction over investment products that are marketed to
retail investors, such as mutual funds. While there is a surface logic
to this idea, we believe it is impractical and could inadvertently
undermine investor protections. Giving the agency responsibility for
investment products that is comparable to the proposed authority it
would have over credit products would require the agency to add
extensive additional staff with expertise that differs greatly from
that required for oversight of credit products. Apparently simple
matters, such as determining whether a mutual fund risk disclosure is
appropriate or a fee is fair, are actually potentially quite complex
and would require the new agency to duplicate expertise that already
exists within the SEC. Moreover, it would not be possible simply to
transfer the staff with that expertise to the new agency, since the SEC
would continue to need that expertise on its own staff in order to
fulfill its responsibilities for oversight of investment advisers and
mutual fund operations. In addition, unless the new agency was given
responsibility for all investment products and services a broker might
recommend, brokers would be able to work around the new protections
with potentially adverse consequences for investors. A broker who
wanted to avoid the enhanced disclosures and restrictions required when
selling a mutual fund, for example, could get around them by
recommending a separately managed account. The investor would likely
pay higher fees and receive fewer protections as a result. For these
reasons, we believe the costs and risks of this proposal outweigh the
potential benefits.
The Administration's plan wisely provides the agency with
jurisdiction over a number of insurance products that are central or
ancillary to credit transactions, including credit, title, and mortgage
insurance. \75\ This principal behind this approach is to provide the
agency with holistic jurisdiction over the entire credit transaction,
including ancillary services often sold with or in connection with the
credit. Additionally, there is ample evidence of significant consumer
abuses in many of these lines of insurance, including low loss ratios,
high mark ups, and ``reverse competition'' where the insurer competes
for the business of the lender, rather than of the insurance consumer.
\76\ This Federal jurisdiction could apply without interfering with the
licensing and rate oversight role of the States.
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\75\ The agency should also be given explicit authority over
``forced-place'' homeowner's insurance, which banks can require
borrowers to purchase if they cannot procure their own coverage.
\76\ Testimony of J. Robert Hunter, Director of Insurance,
Consumer Federation of America, before the Subcommittee on Capital
Markets, Insurance and Government Sponsored Enterprises of the U.S.
House Financial Services Committee, October 30, 2007, pp. 8-9.
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The United States has never sufficiently addressed the problems and
challenges of lending discrimination and red lining practices, the
vestiges of which include the present day unequal, two-tiered financial
system that forces minority and low-income borrowers to pay more for
financial services, get less value for their money, and exposes them to
greater risk. It is therefore, imperative that the Consumer Financial
Protection Agency also focus in a concentrated way on fair lending
issues. To that end, the Agency must have a comprehensive Office of
Civil Rights, which would ensure that no Federal agency perpetuated
unfair practices and that no member of the financial industry practices
business in a way that perpetuates discrimination. Compliance with
civil rights statutes and regulations must be a priority at each
Federal agency that has financial oversight or that enforces a civil
rights statute. There must be effective civil rights enforcement of all
segments of the financial industry. Moreover, each regulatory and
enforcement agency must undertake sufficient reporting and monitoring
activities to ensure transparency and hold the agencies accountable. A
more detailed description of the civil rights functions that must be
undertaken at the CFPA and at other regulatory and enforcement agencies
can be found in the Civil Rights Policy Paper available at
www.ourfinancialsecurity.org. \77\
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\77\ See http://ourfinancialsecurity.org/issues/leveling-the-
playing-field/
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B. Rule writing.
Under the Administration proposal, the agency will have broad rule-
making authority to effectuate its purposes, including the flexibility
to set standards that are adequate to address rapid evolution and
changes in the marketplace. Such authority is not a threat to
innovation, but rather levels the playing field and protects honest
competition, as well as consumers and the economy.
The Administration's plan also provides that the rule-making
authority for the existing consumer protection laws related to the
provision of credit would be transferred to this agency, including the
Truth in Lending Act (TILA), Truth in Savings Act (TISA), Home
Ownership and Equity Protection Act (HOEPA), Real Estate Protection Act
(RESPA), Fair Credit Reporting Act (FCRA), Electronic Fund Transfer Act
(EFTA), and Fair Debt Collection Practices Act (FDCPA). Current rule-
writing authority for nearly 20 existing laws is spread out among at
least seven agencies. Some authority is exclusive, some joint, and some
is concurrent. However, this hodgepodge of statutory authority has led
to fractured and often ineffectual enforcement of these laws. It has
also led to a situation where Federal rule-writing agencies may be
looking at just part of a credit transaction when writing a rule,
without considering how the various rules for different parts of the
transaction affect the marketplace and the whole transaction. The CFPA
with expertise, jurisdiction, and oversight that cuts across all
segments of the financial products marketplace, will be better able to
see inconsistencies, unnecessary redundancies, and ineffective
regulations. As a marketwide regulator, it would also ensure that
critical rules and regulations are not evaded or weakened as agencies
compete for advantage for the entities they regulate.
Additionally the agency would have exclusive ``organic'' Federal
rule-writing authority within its general jurisdiction to deem
products, features, or practices unfair, deceptive, abusive or
unsustainable, and otherwise to fulfill its mission and mandate. The
rules may range from placing prohibitions, restrictions, or conditions
on practices, products, or features to creating standards, and
requiring special monitoring, reporting, and impact review of certain
products, features, or practices.
C. Enforcement.
A critical element of a new consumer protection framework is
ensuring that consumer protection laws are consistently and effectively
enforced. As mentioned above, the current crisis occurred not only
because of gaps and weaknesses in the law, but primarily because the
consumer protection laws that we do have were not always enforced. For
regulatory reform to be successful, it must encourage compliance by
ensuring that wrongdoers are held accountable.
A new CFPA will achieve accountability by relying on a three-legged
stool: enforcement by the agency, by States, and by consumers
themselves.
First, the CFPA itself will have the tools, the mission and the
focus necessary to enforce its mandate. The CFPA will have a range of
enforcement tools under the Administration proposal. The
Administration, for example, would give the agency examination and
primary compliance authority over consumer protection matters. This
will allow the CFPA to look out for problems and address them in its
supervisory capacity. But unlike the banking agencies, whose mission of
looking out for safety and soundness led to an exclusive reliance on
supervision, the CFPA will have no conflict of interest that prevents
it from using its enforcement authority when appropriate. Under the
Administration proposal, the agency will have the full range of
enforcement powers, including subpoena authority; independent authority
to enforce violations of the statues it administers; and civil penalty
authority.
Second, both proposals allow States to enforce Federal consumer
protection laws and the CFPA's rules. As Stated in detail in Section 5,
States are often closer to emerging threats to consumers and the
marketplace. They routinely receive consumer complaints and monitor
local practices, which will permit State financial regulators to see
violations first, spot local trends, and augment the CFPA's resources.
The CFPA will have the authority to intervene in actions brought by
States, but it can conserve its resources when appropriate. As we have
seen in this crisis, States were often the first to act.
Finally, consumers themselves are an essential, in some ways the
most essential, element of an enforcement regime. Recourse for
individual consumers must, of course, be a key goal of a new consumer
protection system. The Administration's plan appropriately States that
the private enforcement provisions of existing statutes will not be
disturbed.
A significant oversight of the Administration's plan is that it
does not allow private enforcement of new CFPA rules. It is critical
that the consumers who are harmed by violations of these rules be able
to take action to protect themselves.
Consumers must have the ability to hold those who harm them
accountable for numerous reasons:
No matter how vigorous and how fully funded a new CFPA is,
it will not be able to directly redress the vast majority of
violations against individuals. The CFPA will likely have
thousands of institutions within its jurisdiction. It cannot
possibly examine, supervise or enforce compliance by all of
them.
Individuals have much more complete information about the
affect of products and practices, and are in the best position
to identify violations of laws, take action, and redress the
harm they suffer. An agency on the outside looking in often
will not have sufficient details to detect abusive behavior or
to bring an enforcement action.
Individuals are an early warning system that can alert
States and the CFPA of problems when they first arise, before
they become a national problem requiring the attention of a
Federal agency. The CFPA can monitor individual actions and
determine when it is necessary to step in.
Bolstering public enforcement with private enforcement
conserves public resources. A Federal agency cannot and should
not go after every individual violation.
Consumer enforcement is a safety net that ensures
compliance and accountability after this crisis has passed,
when good times return, and when it becomes more tempting for
regulators to think that all is well and to take a lighter
approach.
The Administration's plan rightly identifies mandatory
arbitration clauses as a barrier to fair adjudication and
effective redress. We strongly agree--but it is also critically
important regarding access to justice that consumers have the
right to enforce a rule.
Private enforcement is the norm and has worked well as a complement
to public enforcement in the vast majority of the consumer protection
statutes that will be consolidated under the CFPA, including TILA,
HOEPA, FDCPA, FCRA, EFTA and others.
Conversely, the statutes that lack private enforcement mechanisms
are notable for the lack of compliance. The most obvious example is the
prohibition against unfair and deceptive practices in Section 5 of the
FTC Act. Though the banking agencies eventually identified unfair and
deceptive mortgage and credit card practices that should be prohibited
(after vigorous congressional prodding), individuals were subject to
those practices for years with no redress because they could not
enforce the FTC Act. Not only consumers, but the entire economy and
even financial institutions would have been much better off if
consumers had been able to take action earlier on, when the abusive
practices were just beginning.
D. Product evaluation, oversight, and monitoring.
Under the Administration's proposal, the agency would have
significant enforcement and data collection authority to evaluate and
to remove, restrict, or prevent unfair, deceptive, abusive,
discriminatory, or unsustainable products, features or practices. The
agency could also evaluate and promote practices, products, and
features that facilitate responsible and affordable credit, payment
devices, asset-building, and savings. Finally, the agency could assess
the risks of both specific products and practices and overall market
developments for the purpose of identifying, reducing and preventing
excessive risk (e.g., monitoring longitudinal performance of mortgages
with certain features for excessive failure rates; and monitoring the
market share of products and practices that present greater risks, such
as weakening underwriting).
Specifically, we would recommend that the agency take the following
approach to product evaluation, approval and monitoring under the
proposal:
Providers of covered products and services in some cases
could be required to file adequate data and information to
allow the agency to make a determination regarding the
fairness, sustainability, and transparency of products,
features, and practices. This could include data on product
testing, risk modeling, credit performance over time, customer
knowledge and behavior, target demographic populations, etc.
Providers of products and services that are determined in
advance to represent low risk would have to provide de minimus
or no information to the agency.
``Plain-vanilla'' products, features or practices that are
determined to be fair, transparent and sustainable would be
determined to be presumptively in compliance and face less
regulatory scrutiny and fewer restrictions.
Products, features or practices that are determined to be
potentially unfair, unsustainable, discriminatory, deceptive or
too complex for its target population might be required to meet
increased regulatory requirements and face increased
enforcement and remedies.
In limited cases, products, features or practices that are
deemed to be particularly risky could face increased filing and
data disclosure requirements, limited roll-out mandates, post-
market evaluation requirements and, possibly, a stipulation of
preapproval before they are allowed to enter or be used in the
marketplace.
The long-term performance of various types of products and
features would be evaluated, and results made transparent and
available broadly to the public, as well as to providers,
Congress, and the media to facilitate informed choice.
The Agency should hold periodic public hearings to examine
products, practices and market developments to facilitate the
above duties, including the adequacy of existing regulation and
legislation, and the identification of both promising and risky
market developments. These hearings would be especially
important in examination of new market developments, such as,
for example, where credit applications will soon be submitted
via a mobile phone, for example, and consumer dependence on the
Internet for conducting financial transactions is expected to
grow dramatically. In such hearings, in rule-makings, and in
other appropriate circumstances, the Agency should ensure that
there is both opportunity and means for meaningful public
input, including consideration of existing models such as
funded public interveners.
E. Funding.
The Administration's proposal would authorize Congressional
appropriations as needed for the agency. It also allows the agency to
recover the amount of funds it spends through annual fees or
assessments on financial services providers it oversees.
Our view is that the agency should have a stable (not volatile)
funding base that is sufficient to support robust enforcement and is
not subject to political manipulation by regulated entities. Funding
from a variety of sources, as well as a mix of these sources, should be
considered, including Congressional appropriations, user fees or
industry assessments, filing fees, priced services (such as for
compliance examinations) and transaction-based fees. See Appendix 4 for
a comparison of current agency funding and fee structures.
None of these funding sources is without serious weaknesses.
Industry assessments or user fees can provide the regulated entity with
considerable leverage over the budget of the agency and facilitate
regulatory capture of the agency, especially if the regulated party is
granted any discretion over the amount of the assessment (or is allowed
to decide who regulates them and shift its assessment to another
agency.) Transaction-based fees can be volatile and unpredictable,
especially during economic downturns. Filing fees can also decline
significantly if economic activity falls. Congressional appropriations,
as we have seen with other Federal consumer protection agencies over
the last half-century, can be fairly easily targeted for reduction or
restriction by well' funded special interests if these interests
perceive that the agency has been too effective or aggressive in
pursing its mission.
If an industry-based funding method is used, it should ensure that
all providers of covered products and services are contributing equally
based on their size and the nature of the products they offer. A
primary consideration in designing any industry-based funding structure
is that certain elements of these sectors should not be able to evade
the full funding requirement, through charter shopping or other means.
If such requirements can be met, we would recommend a blended funding
structure from multiple sources that requires regulated entities to
fund the baseline budget of the agency and Congressional appropriations
to supplement this budget if the agency demonstrates an unexpected or
unusual demand for its services.
F. Consumer complaints.
The Administration proposal would require the agency to collect and
track federally directed complaints rewarding credit or payment
products, features, or practices under the agency's jurisdiction. \78\
This is a very important function but it should be improved in two
significant respects. First, the agency should also be charged with
resolving consumer complaints. Existing agencies, particularly the OCC,
have generally not performed this function well. \79\ Secondly, the
agency should be designated as the sole repository of consumer
complaints on products, features, or practices within its jurisdiction,
and should ensure that this is a role that is readily visible to
consumers, simple to access and responsive. The agency should also be
required to conduct real-time analysis of consumer complaints regarding
patterns and practices in the credit and payment systems industries and
to apply these analyses when writing rules and enforcing rules and
laws.
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\78\ The CFPA should have responsibility for collecting and
tracking complaints about consumer financial services and facilitating
complaint resolution with respect to federally supervised institutions.
Other Federal supervisory agencies should refer any complaints they
receive on consumer issues to the CFPA; complaint data should be shared
across agencies . . . , ``A New Foundation'', pp. 59-60, The Obama
Administration, June 2009.
\79\ Travis Plunkett testimony, July 2007 ``Improving Federal
Consumer Protections in Financial Services'', p. 10.
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G. Federal preemption of State laws.
As the Administration proposal States, the agency should establish
minimum standards within its jurisdictions. CFPA rules would preempt
weaker State laws, but States that choose to exceed the standards
established by the CFPA could do so. The agency's rules would preempt
statutory State law only when it is impossible to comply with both
State and Federal law.
We also strongly agree with the Administration's recommendation
that federally chartered institutions be subject to nondiscriminatory
State consumer protection and civil rights laws to the same extent as
other financial institutions. A clear lesson of the financial crisis,
which pervades the Administration's plan, is that protections should
apply consistently across the board, based on the product or service
that is being offered, not who is offering it.
Restoring the viability of our background State consumer protection
laws is also essential to the flexibility and accountability of the
system in the long run. The specific rules issued by the CFPA and the
specific statutes enacted by Congress will never be able to anticipate
every innovative abuse designed to avoid those rules and statutes. The
fundamental State consumer protection laws, both statutory and common
law, against unfair and deceptive practices, fraud, good faith and fair
dealing, and other basic, longstanding legal rules are the ones that
spring up to protect consumers when a new abuse surfaces that falls
within the cracks of more specific laws. We discuss preemption in
greater detail in the next section.
H. Other aspects of the Administration proposal.
As discussed briefly above, the CFPA should also have the authority
to grant intervener funding to consumer organizations to fund expert
participation in its stakeholder activities. The model has been used
successfully to fund consumer group participation in State utility rate
making. Second, a Government chartered consumer organization should be
created by Congress to represent consumers' financial services
interests before regulatory, legislative, and judicial bodies,
including before the CFPA. This organization could be financed through
voluntary user fees such as a consumer check-off included in the
monthly Statements financial firms send to their customers. It would be
charged with giving consumers, depositors, small investors and
taxpayers their own financial reform organization to counter the power
of the financial sector, and to participate fully in rulemakings,
adjudications, and lobbying and other activities now dominated by the
financial lobby. \80\
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\80\ As his last legislative activity, in October 2002, Senator
Paul Wellstone proposed establishment of such an organization, the
Consumer and Shareholder Protection Association, S 3143.
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Moreover, we recommend that the Administration's proposal deal more
explicitly with incentives that are paid to and whistleblower
protections that are provided to employees working in the credit
sector. An incentive system similar to one at the top is at work at the
street level of the biggest banks. In the tens of thousands of bank
branches and call centers of our biggest banks, employees-including
bank tellers earning an average of $11.32 an hour-are forced to meet
sales goals to keep their jobs and earn bonuses. Many goals for
employees selling high-fee and high-interest products like credit cards
and checking accounts have actually gone up as the economy has gone
down.
Risk-taking in the industry will quickly outpace regulatory
coverage unless financial sector employees can challenge bad practices
as they develop and direct regulators to problems. Whistleblowers are
critical to combating fraud and other institutional misconduct. The
Federal Government needs to hear from and protect finance sector
employees who object to bad practices that they believe violate the
law, are unfair or deceptive, or threaten the public welfare. If we
previously had more protections for whistleblowers, we would have had
more warning of the eventual collapse of Wall Street.
Since 2000, Congress has enacted or strengthened whistleblower
protections in six laws. They include consumer product manufacturing
and retail commerce, railroads, the trucking industry, metropolitan
transit systems, defense contractors, and all entities receiving
stimulus funds. All of these laws provide more incentives and
protections for disclosure of wrongdoing than does the current proposal
from the Administration. For example, it does not protect disclosures
made to an employer, which is often the first action taken by loyal,
concerned employees, and the impetus for retaliation. Also
conspicuously absent are administrative procedures and remedies that
include best practices for fair and adequate consideration of claims by
employees.
We recommend the following improvements in any reform legislation
before the Committee.
Whistleblower protections. Innovation in the industry will quickly
outpace regulatory coverage unless bank branch, call-center, and other
financial sector employees can challenge bad practices as they develop
and direct regulators to problems. The Federal Government needs to hear
from and provide best practice whistleblower rights consistent with
those in the stimulus and five laws passed or strengthened last
Congress to protect finance sector employees who object to bad
practices that they believe violate the law, are unfair or deceptive,
or threaten the public welfare.
Fair compensation. New rules need to restructure pay and incentives
for front-line finance sector employees away from the current ``sell-
anything'' culture. The hundreds of thousands of front-line workers who
work under pressure of sales goals need to be able to negotiate
sensible compensation policies that reward service and sound banking
over short-term sales.
SECTION 5. REBUTTAL TO ARGUMENTS AGAINST THE CFPA
Proactive, affirmative consumer protection is essential to
modernizing financial system oversight and to reducing risk. The
current crisis illustrates the high costs of a failure to provide
effective consumer protection. The complex financial instruments that
sparked the financial crisis were based on home loans that were poorly
underwritten; unsuitable to the borrower; arranged by persons not bound
to act in the best interest of the borrower; or contained terms so
complex that many individual homeowners had little opportunity to fully
understand the nature or magnitude of the risks of these loans. The
crisis was magnified by highly leveraged, largely unregulated financial
instruments and inadequate risk management.
Opponents of reform of the financial system have made several
arguments against the establishment of a strong independent Consumer
Financial Protection Agency. Indeed, the new CFPA appears to be among
their main targets for criticism, compared with other elements of the
reform plan. They have basically made six arguments. They have argued
that regulators already have the powers it would be given, that it
would be a redundant layer of bureaucracy, that consumer protection
cannot be separated from supervision, that it will stifle innovation,
that it would be unfair to small institutions and that its anti-
preemption provision would lead to balkanization. Each of these
arguments is fatally flawed:
A. Opponents argue that regulators already have the powers that the
CFPA would be given.
This argument is effectively a defense of the status quo, which has
led to disastrous results. Current regulators already have between them
some of the powers that the new agency would be given, but they haven't
used them. Conflicts of interest and missions and a lack of will have
worked against consumer enforcement. While our section above goes into
greater detail on the failures of the regulators, two examples will
illustrate:
No HOEPA Rules Until 2008: The Federal Reserve Board was
granted sweeping antipredatory mortgage regulatory authority by
the 1994 Home Ownership and Equity Protection Act (HOEPA).
Final regulations were issued on 30 July 2008 only after the
world economy had collapsed due to the collapse of the U.S.
housing market triggered by predatory lending. \81\
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\81\ 73 FR 147, Page 44522, Final HOEPA Rule, 30 July 2008.
No Action on Abusive Credit Card Practices Until Late 2008:
Further, between 1995 and 2007, the Office of the Comptroller
of Currency issued only one public enforcement action against a
Top Ten credit card bank (and then only after the San Francisco
District Attorney had brought an enforcement action) and only
one other public enforcement order against a mortgage
subsidiary of a large national bank (only after HUD initiated
action). In that period, ``the OCC has not issued a public
enforcement order against any of the eight largest national
banks for violating consumer lending laws.'' \82\ The OCC's
failure to act on rising credit card complaints at the largest
national banks triggered Congress to investigate, resulting in
passage of the 2009 Credit Card Accountability, Responsibility
and Disclosure Act (CARD Act). \83\ While that law was under
consideration, other Federal regulators used their authority
under the Federal Trade Commission Act to propose and finalize
a similar rule. \84\ By contrast, the OCC requested the
addition of two significant loopholes to a key protection of
the proposed rule.
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\82\ Testimony of Professor Arthur Wilmarth, 26 April 2007, before
the Subcommittee on Financial Institutions and Consumer Credit, hearing
on Credit Card Practices: Current Consumer and Regulatory Issues http:/
/www.house.gov/financialservices/hearing110/htwilmarth042607.pdf.
\83\ H.R. 627 was signed into law by President Obama as Pub. L.
No. 111-24 on 22 May 2009.
\84\ The final rule was published in the Federal Register a month
later. 74 FR 18, p. 5498 Thursday, January 29, 2009.
Federal bank regulators currently face at least two conflicts.
First, their primary mission is prudential supervision, with
enforcement of consumer laws taking a back seat. Second, charter
shopping in combination with agency funding by regulated entities
encourages a regulatory race to the bottom as banks choose the
regulator of least resistance. In particular, the Office of the
Comptroller of the Currency and the Office of Thrift Supervision have
failed utterly to protect consumers, let alone the safety and soundness
of regulated entities. Instead, they competed with each other to
minimize consumer protection standards as a way of attracting
institutions to their charters, which meant that they tied their own
hands and failed to fulfill their missions. (Note: they weren't trying
to fail, but that was a critical side effect of the charter
competition.)
Establishing a new consumer agency that has consumer protection as
its only mission and that regulated firms cannot hide from by charter-
shopping is the best way to guarantee that consumer laws will receive
sustained, thoughtful, proactive attention from a Federal regulator.
B. Opponents argue that the CFPA would be a redundant layer of
bureaucracy.
We do not propose a new regulatory agency because we seek more
regulation, but because we seek better regulation. The very
existence of an agency devoted to consumer protection in
financial services will be a strong incentive for institutions
to develop strong cultures of consumer protection. (The Obama
Administration, Financial Regulatory Reform: A New Foundation,
p. 57)
The new CFPA would not be a redundant layer of bureaucracy. To the
contrary, the new agency would consolidate and streamline Federal
consumer protection for credit, savings and payment products that is
now required in almost 20 different statutes and divided between seven
different agencies. As the New Foundation document continues:
The core of such an agency can be assembled reasonably quickly
from discrete operations of other agencies. Most rule-writing
authority is concentrated in a single division of the Federal
Reserve, and three of the four Federal banking agencies have
mostly or entirely separated consumer compliance supervision
from prudential supervision. Combining staff from different
agencies is not simple, to be sure, but it will bring
significant benefits for responsible consumers and
institutions, as well as for the market for consumer financial
services and products. \85\
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\85\ The Obama Administration, ``Financial Regulatory Reform: A
New Foundation'', p. 57.
And today, a single transaction such as a mortgage loan is subject
to regulations promulgated by several agencies and may be made or
arranged by an entity supervised by any of several other agencies.
Under the CFPA, one Federal agency will write the rules and see that
they are followed.
C. Opponents argue that consumer protection cannot be separated from
supervision.
The current regulatory consolidation of both of these functions has
led to the subjugation of consumer protection in most cases, to the
great harm of Americans and the economy. Nevertheless, trade
associations for many of the financial institutions that have inflicted
this harm claim that a new approach that puts consumer protection at
the center of financial regulatory efforts will not work. The American
Bankers Association, for example, States that while the length of time
banks hold checks under Regulation CC may be a consumer issue, ``fraud
and payments systems operational issues'' are not. \86\
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\86\ Letter of 28 May 2009 from the American Bankers Association
to Treasury Secretary Tim Geithner, available at http://www.aba.com/NR/
rdonlyres/4640E4F1-4BC9-4187-B9A6-E3705DD9B307/60161/
GeithnerMay282009.pdf (last viewed 21 June 2009).
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Again, as the Administration points out in its carefully thought-
out blueprint for the new agency:
The CFPA would be required to consult with other Federal
regulators to promote consistency with prudential, market, and
systemic objectives. Our proposal to allocate one of the CFPA's
five board seats to a prudential regulator would facilitate
appropriate coordination. \87\
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\87\ The Obama Administration, Financial Regulatory Reform: A New
Foundation, p. 59.
We concur that the new agency should have full rulemaking authority
over all consumer statutes. The checks and balances proposed by the
Administration, including the consultative requirement and the
placement of a prudential regulator on its board and its requirement to
share confidential examination reports with the prudential regulators
will address these concerns. In addition, the Administration's plan
provides the CFPA with full compliance authority to examine and
evaluate the impact of any proposed consumer protection measure on the
bottom line of affected financial institutions. While collaboration
between regulators will be very important, it should not be used as an
excuse by either the CFPA or other regulators to unnecessarily delay
needed action. The GAO, for example, has identified time delays in
interagency processes as a contributor to the mortgage crisis. \88\
This is why it is important that the CFPA retain final rulemaking
authority, as proposed under the Administration's plan. Such authority,
along with the above mentioned mandates, will ensure that both the CFPA
and the Federal prudential regulator collaborate on a timely basis.
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\88\ ``As we note in our report, efforts by regulators to respond
to the increased risks associated with the new mortgage products were
sometimes slowed in part because of the need for five Federal
regulators to coordinate their response.'' ``Financial Regulation: A
Framework for Crafting and Assessing Proposals to Modernize the
Outdated U.S. Financial Regulatory System'', Testimony before the U.S.
Senate Committee on Banking, Housing, and Urban Affairs, February 4,
2009, pp. 15-16.
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For most of the last 20 years, bank regulators have shown little
understanding of consumer protection and have not used powers they have
long held. OCC's traditional focus and experience has been on safety
and soundness, rather than consumer protection. \89\ Its record on
consumer protection enforcement is one of little experience and little
evidence of expertise. In contrast, as already noted, the States have
long experience in enforcement of non-preempted State consumer
protection laws. OCC admits that it was not until 2000 that it invoked
long-dormant consumer protection authority provided by the 1975
amendments to the Federal Trade Commission Act. \90\
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\89\ See Christopher L. Peterson, ``Federalism and Predatory
Lending: Unmasking the Deregulatory Agenda'', 78 Temp. L. Rev. 1, 73
(2005).
\90\ See Julie L. Williams and Michael L. Bylsma, ``On the Same
Page: Federal Banking Agency Enforcement of the FTC Act To Address
Unfair and Deceptive Practices by Banks'', 58 Bus. Law. 1243, 1244,
1246 and n. 25, 1253 (2003) (citing authority from the early 1970s
indicating that OCC had the authority to bring such an action under
Section 8 of the Federal Deposit Insurance Act, noting that OCC brought
its first such case in 2000, and conceding that ``[a]n obvious question
is why it took the Federal banking agencies more than 25 years to reach
consensus on their authority to enforce the FTC Act'').
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D. Opponents argue that a single agency focused on consumer protection
will ``stifle innovation'' in the financial services
marketplace.
To the contrary, protecting consumers from traps and tricks when
they purchase credit, savings or payment products should encourage
confidence in the financial services marketplace and spur innovation.
As Nobel Laureate Joseph Stiglitz has said:
There will be those who argue that this regulatory regime will
stifle innovation. However, a disproportionate part of the
innovations in our financial system have been aimed at tax,
regulatory, and accounting arbitrage. They did not produce
innovations which would have helped our economy manage some
critical risks better-like the risk of home ownership. In fact,
their innovations made things worse. I believe that a well-
designed regulatory system, along the lines I've mentioned,
will be more competitive and more innovative-with more of the
innovative effort directed at innovations which will enhance
the productivity of our firms and the well-being, including the
economic security, of our citizens. \91\
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\91\ ``Too Big to Fail or Too Big to Save? Examining the Systemic
Threats of Large Financial Institutions'', Joseph E. Stiglitz, April
21, 2009, p. 10.
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E. Opponents argue that the CFPA would place an unfair regulatory
burden on small banks and thrifts.
Small banks and thrifts that offer responsible credit and payment
products should face a lower regulatory burden under regulation by a
CFPA. Members of Congress, the media and consumer organizations have
properly focused on the role of large, national banks and thrifts in
using unsustainable, unfair and deceptive mortgage and credit card
lending practices. In contrast, many smaller banks and thrifts have
justifiably been praised for their more responsible lending practices
in theses areas. In such situations, the CFPA would promote fewer
restrictions and less oversight for ``plain-vanilla'' products that are
simple, straightforward and fair.
However, it is also important to note that some smaller hanks and
thrifts have, unfortunately, been on the cutting edge of a number of
other abusive lending practices that are harmful to consumers and that
must be addressed by a CFPA. More than 75 percent of State chartered
banks surveyed by the FDIC, for example, automatically enrolled
customers in high-cost overdraft loan programs without consumers'
consent. Some of these banks deny consumers the ability to even opt out
of being charged high fees for overdraft transactions that the banks
chose to permit. Smaller banks have also been leaders in facilitating
high-cost refund anticipation loans, in helping payday lenders to evade
State loan restrictions and in offering deceptive and extraordinarily
expensive ``fee harvester'' credit cards. (See Appendix 1 for more
information.)
F. Opponents argue that the agency's authority to establish only a
Federal floor of consumer protection would lead to regulatory
inefficiency and balkanization.
The loudest opposition to the new agency will likely be aimed at
the Administration's sensible proposal that CFPA's rules be a Federal
floor and that the States be allowed to enact stronger consumer laws
that are not inconsistent, as well as to enforce both Federal and State
laws. This proposed return to common sense protections is strongly
endorsed by consumer advocates and State attorneys general.
We expect the banks and other opponents to claim that the result
will be 51 balkanized laws that place undue costs on financial
institutions that are then passed onto consumers in the form of higher
priced or less available loans. In fact, this approach is likely to
lead to a high degree of regulatory uniformity (if the CFPA sets high
minimum standards,) greater protections for consumers without a
significant impact on cost or availability, increased public confidence
in the credit markets and financial institutions, and less economic
volatility. For example, comprehensive research by the Center for
Responsible Lending found that subprime mortgage loans in States that
acted vigorously to rein in predatory mortgage lending before they were
preempted by the OCC had fewer abusive terms. In States with stronger
protections, interest rates on subprime mortgages did not increase, and
instead, sometimes decreased, without reducing the availability of
these loans. \92\ Additionally, as Nobel Laureate Joseph Stiglitz has
pointed out, the cost of regulatory duplication is miniscule to the
cost of the regulatory failure that has occurred. \93\
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\92\ Wei Li and Keith S. Ernst, Center for Responsible Lending,
``The Best Value in the Subprime Market: State Predatory Lending
Reforms'', February, 23, 2006, p. 6.
\93\ ``Some worry about the cost of duplication. But when we
compare the cost of duplication to the cost of damage from inadequate
regulation--not just the cost to the taxpayer of the bail-outs but also
the costs to the economy from the fact that we will be performing well
below our potential--it is clear that there is not comparison,''
Testimony of Dr. Joseph E. Stiglitz, Professor, Columbia University,
before the House Financial Services Committee, October 21, 2008, p. 16.
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It is also clear that the long campaign of preemption by the OTS
and OCC, culminating in the 2004 OCC rules, contributed greatly to the
current predatory lending crisis. After a discussion of the OCC's
action eliminating State authority, we will discuss more generally why
Federal consumer law should always be a floor.
F.1. The OCC's Preemption of State Laws Exacerbated The Crisis. In
2000-2004, the OCC worked with increasing aggressiveness to prevent the
States from enforcing State laws and stronger State consumer protection
standards against national banks and their operating subsidiaries, from
investigating or monitoring national banks and their operating
subsidiaries, and from seeking relief for consumers from national banks
and subsidiaries.
These efforts began with interpretative letters stopping State
enforcement and State standards in the period up to 2004, followed by
OCC's wide-ranging preemption regulations in 2004 purporting to
interpret the National Bank Act, plus briefs in court cases supporting
national banks' efforts to block State consumer protections.
In a letter to banks on November 25, 2002, the OCC openly
instructed banks that they ``should contact the OCC in situations where
a State official seeks to assert supervisory authority or enforcement
jurisdiction over the bank . . . . \94\ The banks apparently accepted
this invitation, notifying the OCC of State efforts to investigate or
enforce State laws. The OCC responded with letters to banks and to
State banking agencies asserting that the States had no authority to
enforce State laws against national banks and subsidiaries, and that
the banks need not comply with the State laws. \95\
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\94\ Office of the Comptroller of the Currency, Interpretive
Letter No. 957 n.2 (Jan. 27, 2003) (citing OCC Advisory Letter 2002-9
(Nov. 25, 2002)) (viewed Jun. 19, 2009, at http://www.occ.treas.gov/
interp/mar03/int957.doc, and available at 2003 OCC Ltr. LEXIS 11).
\95\ E.g., Office of the Comptroller of the Currency, Interpretive
Letter No. 971 (Jan. 16, 2003) (letter to Pennsylvania Department of
Banking, that it does not have the authority to supervise an unnamed
national bank's unnamed operating subsidiary which engages in subprime
mortgage lending (unnamed because the interpretive letter is
unpublished) (viewed Jun. 19, 2009, at http://
comptrollerofthecurrency.gov/interp/sep03/int971.doc, and available at
2003 OCC QJ LEXIS 107).
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For example, the OCC responded to National City Bank of Indiana,
and its operating subsidiaries, National City Mortgage Company, First
Franklin Financial Corporation, and Altegra Credit Company, regarding
Ohio's authority to monitor their mortgage banking and servicing
businesses. That opinion concluded that ``the OCC's exclusive
visitorial powers preclude States from asserting supervisory authority
or enforcement jurisdiction over the Subsidiaries.'' \96\
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\96\ Office of the Comptroller of the Currency, Interpretive
Letter No. 958 (Jan. 27, 2003) (viewed Jun. 19, 2009, at http://
www.occ.treas.gov/interp/mar03/int958.pdf, and available at 2003 OCC
Ltr. LEXIS 10).
---------------------------------------------------------------------------
The OCC responded to Bank of America, N.A., and its operating
subsidiary, BA Mortgage LLC, regarding California's authority to
examine the operating subsidiary's mortgage banking and servicing
businesses and whether the operating subsidiary was required to
maintain a license under the California Residential Mortgage Lending
Act. That opinion concluded that ``the Operating Subsidiary also is not
subject to State or local licensing requirements and is not required to
obtain a license from the State of California in order to conduct
business in that State.'' \97\
---------------------------------------------------------------------------
\97\ The OCC's exclusive visitorial powers preclude States from
asserting supervisory authority or enforcement jurisdiction over the
Subsidiaries (Jan. 27, 2003) (viewed Jun. 19, 2009, at http://
www.occ.treas.gov/interp/mar03/int957.doc), and available at 2003 OCC
Ltr. LEXIS 11).
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The OCC wrote the Pennsylvania Department of Banking, stating that
Pennsylvania does not have the authority to supervise an unnamed
national bank's unnamed operating subsidiary which engages in subprime
mortgage lending. \98\ (The national bank and operating subsidiary were
not named because this interpretive letter was unpublished.)
---------------------------------------------------------------------------
\98\ Office of the Comptroller of the Currency, Interpretive
Letter No. 971 (unpublished) (Jan. 16, 2003) (viewed Jun. 19, 2009, at
http://comptrollerofthecurrency.gov/interp/sep03/int971.doc, and
available at 2003 OCC QJ LEXIS 107).
---------------------------------------------------------------------------
The OCC even issued a formal preemption determination and order,
stating that ``the provisions of the GFLA [Georgia Fair Lending Act]
affecting national banks' real estate lending are preempted by Federal
law'' and ``issuing an order providing that the GFLA does not apply to
National City or to any other national bank or national bank operating
subsidiary that engages in real estate lending activities in Georgia.''
\99\
---------------------------------------------------------------------------
\99\ Office of the Comptroller of the Currency, Preemption
Determination and Order, 68 Fed. Reg. 46,264, 46,264 (Aug. 5, 2003).
---------------------------------------------------------------------------
As Business Week pointed out in 2003, not only did States attempt
to pass laws to stop predatory lending, they also attempted to warn
Federal regulators that the problem was getting worse. \100\
---------------------------------------------------------------------------
\100\ Robert Berner and Brian Grow, ``They Warned Us About the
Mortgage Crisis'', Business Week, 9 October 2008, available at http://
www.businessweek.com/magazine/content/08_42/b4104036827981.htm, (last
visited 21 June 2009).
---------------------------------------------------------------------------
A number of factors contributed to the mortgage disaster and credit
crunch. Interest rate cuts and unprecedented foreign capital infusion
fueled thoughtless lending on Main Street and arrogant gambling on Wall
Street. The trading of esoteric derivatives amplified risks it was
supposed to mute. One cause, though, has been largely overlooked: the
stifling of prescient State enforcers and legislators who tried to
contain the greed and foolishness. They were thwarted in many cases by
Washington officials hostile to regulation and a financial industry
adept at exploiting this ideology.
Under the proposal, critical authority will be returned to those
attorneys general, who have demonstrated both the capacity and the will
to enforce consumer laws. In addition to losing the States' experience
in enforcing such matters, depriving the States of the right to enforce
their non-preempted consumer protection laws raises serious concerns of
capacity. According to a recent congressional report, State banking
agencies and State attorneys general offices employ nearly 700 full
time staff to monitor compliance with consumer laws, more than 17 times
the number of OCC personnel then allocated to investigate consumer
complaints. \101\
---------------------------------------------------------------------------
\101\ See H. Comm. on Financial Services, 108th Cong., Views and
Estimates on Matters To Be Set Forth in the Concurrent Resolution on
the Budget for Fiscal Year 2005, at 16 (Comm. Print 2004). ``In the
area of abusive mortgage lending practices alone, State bank
supervisory agencies initiated 20,332 investigations in 2003 in
response to consumer complaints, which resulted in 4,035 enforcement
actions.''
---------------------------------------------------------------------------
Earlier this year, Illinois Attorney General Lisa Madigan testified
before this Committee and outlined the numerous major, multistate cases
against predatory lending that have been brought by her office and
other State offices of attorneys general. However, she included this
caveat:
State enforcement actions have been hamstrung by the dual
forces of preemption of State authority and lack of Federal
oversight. The authority of State attorneys general to enforce
consumer protection laws of general applicability was
challenged at precisely the time it was most needed--when the
amount of sub prime lending exploded and riskier and riskier
mortgage products came into the marketplace. \102\
---------------------------------------------------------------------------
\102\ Testimony of Illinois Attorney General Lisa Madigan Before
the Committee on Financial Services, Hearing on Federal and State
Enforcement of Financial Consumer and Investor Protection Laws, 20
March 2009, available at http://www.house.gov/apps/list/hearing/
financialsvcs_dem/il_-_madigan.pdf (last visited 22 June 2009).
This month, General Madigan and seven colleagues sent President
Obama a letter supporting a Consumer Financial Protection Agency
---------------------------------------------------------------------------
preserving State enforcement authority:
[W]e believe that any reform must (1) preserve State
enforcement authority, (2) place Federal consumer protection
powers with an agency that is focused primarily on consumer
protection, and (3) place primary oversight with Government
agencies and not depend on industry selfregulation. \103\
---------------------------------------------------------------------------
\103\ Letter of 15 June 2009, from the chief legal enforcement
officers of eight States (California, Connecticut, Illinois, Iowa,
Maryland, Massachusetts, North Carolina, and Ohio) to President Obama,
on file with the authors.
F.2. Why Federal Law Should Always Be a Floor. Consumers need State
laws to prevent and solve consumer problems. State legislators
generally have smaller districts than members of Congress do. State
legislators are closer to the needs of their constituents than members
of Congress. States often act sooner than Congress on new consumer
problems. Unlike Congress, a State legislature may act before a harmful
practice becomes entrenched nationwide. In a September 22, 2003, speech
to the American Bankers Association in Hawaii, Comptroller John D.
Hawke admitted that consumer protection activities ``are virtually
always responsive to real abuses.'' He continued by pointing out that
Congress moves slowly. Comptroller Hawke said, ``It is generally quite
unusual for Congress to move quickly on regulatory legislation--the
Gramm-Leach-Bliley privacy provisions being a major exception. Most
often they respond only when there is evidence of some persistent abuse
in the marketplace over a long period of time.'' U.S. consumers should
not have to wait for a persistent, nationwide abuse by banks before a
remedy or a preventative law can be passed and enforced by a State to
protect them.
States can and do act more quickly than Congress, and States can
and do respond to emerging practices that can harm consumers while
those practices are still regional, before they spread nationwide.
These examples extend far beyond the financial services marketplace.
States and even local jurisdictions have long been the laboratories
for innovative public policy, particularly in the realm of
environmental and consumer protection. The Federal Clean Air Act grew
out of a growing State and municipal movement to enact air pollution
control measures. The national organic labeling law, enacted in October
2002, was passed only after several States, including Oregon,
Washington, Texas, Idaho, California, and Colorado, passed their own
laws. In 1982, Arizona enacted the first ``Motor Voter'' law to allow
citizens to register to vote when applying for or renewing drivers'
licenses; Colorado placed the issue on the ballot, passing its Motor
Voter law in 1984. National legislation followed suit in 1993. Cities
and counties have long led the smoke-free indoor air movement,
prompting States to begin acting, while Congress, until this month,
proved itself virtually incapable of adequately regulating the tobacco
industry. A recent and highly successful FTC program--the National Do
Not Call Registry to which 58 million consumers have added their names
in 1 year--had already been enacted in 40 States.
But in the area of financial services, where State preemption has
arguably been the harshest and most sweeping, examples of innovative
State activity are still numerous. In the past 5 years, since the OCC's
preemption regulations have blocked most State consumer protections
from application to national banks, one area illustrating the power of
State innovation has been in identity theft, where the States have
developed important new consumer protections that are not directed
primarily at banking. In the area of identity theft, States are taking
actions based on a non-preemptive section of the Fair Credit Reporting
Act, where they still have the authority to act against other actors
than national banks or their subsidiaries.
There are 7 to 10 million victims of identity theft in the U.S.
every year, yet Congress did not enact modest protections such as a
security alert and a consumer block on credit report information
generated by a thief until passage of the Fair and Accurate Credit
Transactions Act (FACT Act or FACTA) in 2003. That law adopted just
some of the identity theft protections that had already been enacted in
States such as California, Connecticut, Louisiana, Texas, and Virginia.
\104\
---------------------------------------------------------------------------
\104\ See California Civil Code 1785.11.1, 1785.11.2, 1785,16.1;
Conn. SB 688 9(d), (e), Conn. Gen. Stats. 36a-699; IL Re. Stat. Ch.
505 2MM; LA Rev. Stat. 9:3568B.1, 9:3568C, 9:3568D, 9:3571.1 (H)-
(L); Tex. Bus. & Comm. Code 20.01(7), 20.031, 20.034-039, 20.04; VA
Code 18.2-186.31 :E.
---------------------------------------------------------------------------
Additionally FACTA's centerpiece protection against both
inaccuracies and identity theft, access to a free credit report
annually on request, had already been adopted by seven States:
Colorado, Georgia, Maine, Maryland, Massachusetts, New Jersey, and
Vermont. Further, California in 2000, following a joint campaign by
consumer groups and realtors, became the first State to prohibit
contractual restrictions on realtors showing consumers their credit
scores, ending a decade of stalling by Congress and the FTC. \105\ The
FACT act extended this provision nationwide.
---------------------------------------------------------------------------
\105\ See 2000 Cal. Legis. Serv. 978 (West). This session law was
authored by State Senator Liz Figueroa. ``An act to amend Sections
1785.10, 1785.15, and 1785.16 of, and to add Sections 1785.15.1,
1785.15.2, and 1785.20.2 to the Civil Code, relating to consumer
credit.''
---------------------------------------------------------------------------
Yet, despite these provisions, advocates knew that the 2003 Federal
FACTA law would not solve all identity theft problems. Following
strenuous opposition by consumer advocates to the blanket preemption
routinely sought by industry as a condition of all remedial Federal
financial legislation, the final 2003 FACT Act continued to allow
States to take additional actions to prevent identity theft. The
results have been significant.
Since its passage, fully 47 States and the District of Columbia
have granted consumers the right to prevent access to their credit
reports by identity thieves through a security freeze. Indeed, even the
credit bureaus, longtime opponents of the freeze, then adopted the
freeze nationwide. \106\
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\106\ Consumers Union, U.S. PIRG and AARP cooperated on a model
State security freeze proposal that helped ensure that the State laws
were not balkanized, but converged toward a common standard. More
information on the State security freeze laws is available at http://
www.consumersunion.org/campaigns/learn_more/003484indiv.html (last
visited 21 June 2009).
---------------------------------------------------------------------------
A key principle of federalism is the role of the States as
laboratories for the development of law. \107\ State and Federal
consumer protection laws can develop in tandem. After one or a few
States legislate in an area, the record and the solutions developed in
those States provide important information for Congress to use in
deciding whether to adopt a national law, how to craft such a law, and
whether or not any new national law should displace State law.
---------------------------------------------------------------------------
\107\ New State Ice Co. v. Leibman, 285 U.S. 262, 311 (1932)
(Brandeis, J., dissenting).
---------------------------------------------------------------------------
A few more examples from California illustrate the important role
of the States as a laboratory and a catalyst for Federal consumer
protections for bank customers. In 1986, California required that
specific information be included in credit card solicitations with
enactment of the then-titled Areias-Robbins Credit Card Full Disclosure
Act of 1986. That statute required every credit card solicitation to
contain a chart showing the interest rate, grace period, and annual
fee. \108\ Two years later, Congress chose to adopt the same concept in
the Federal Fair Credit and Charge Card Disclosure Act (FCCCDA),
setting standards for credit card solicitations, applications and
renewals. \109\ The 1989 Federal disclosure box \110\ (know as the
``Schumer Box'') is strikingly similar to the disclosure form required
under the 1986 California law.
---------------------------------------------------------------------------
\108\ 1986 Cal. Stats., Ch. 1397, codified at California Civil
Code 1748.11.
\109\ Pub. L. 100-583, 102 Stat. 2960 (Nov. 1, 1988), codified in
part at 15 U.S.C. 1637(c) and 1610(e).
\110\ 54 Fed. Reg. 13855 (April 6, 1989, Appendix G, form G-
10(B)).
---------------------------------------------------------------------------
States also led the way in protecting financial services consumers
from long holds on deposited checks. California enacted restrictions on
the length of time a bank could hold funds deposited by a consumer in
1983; Congress followed in 1986. California's 1983 funds availability
statute required the California Superintendent of Banks, Savings and
Loan Commissioner, and Commissioner of Corporations to issue
regulations to define a reasonable time after which a consumer must be
able to withdraw funds from an item deposited in the consumer's
account. \111\ Similar laws were passed in Massachusetts, New York, New
Jersey, and other States. Congress followed a few years later with the
Federal Expedited Funds Availability Act of 1986. \112\ California led
the way on security breach notice legislation. Its law and those of
other States have functioned as a de facto national security breach
law, while Congress has failed to act. \113\
---------------------------------------------------------------------------
\111\ 1983 Cal. Stat. Ch. 1011, 2, codified at Cal. Fin. Code
866.5.
\112\ Pub. L. 100-86, Aug. 10, 1987, 101 Stat. 552, 635, codified
at 12 U.S.C. 4001.
\113\ More information on State security breach notice laws is
available at http://www.consumersunion.org/campaigns/
financialprivacynow/002215indiv.html (last visited 21 June 2009).
---------------------------------------------------------------------------
It is certainly not the case that States always provide effective
consumer protection. The States have also been the scene of some
notable regulatory breakdowns in recent years, such as the failure of
some States to properly regulate mortgage brokers and nonbank lenders
operating in the subprime lending market, and the inability or
unwillingness of many States to rein in lenders that offer
extraordinarily high-cost, short term loans and trap consumers in an
unsustainable cycle of debt, such as payday lenders and auto title loan
companies. Conversely, Federal lawmakers have had some notable
successes in providing a high level of financial services consumer
protections in the last decade, such as the Credit Repair Organizations
Act and the recently enacted Military Lending Act. \114\ This is why it
is necessary for this new Federal agency to ensure that a minimum level
of consumer protection is established in all States.
---------------------------------------------------------------------------
\114\ Military Lending Act, 10 U.S.C. 987. Credit Repair
Organizations Act, 15 U.S.C. 1679h (giving State Attorneys General and
FTC concurrent enforcement authority).
---------------------------------------------------------------------------
Nonetheless, as these examples show, State law is an important
source of ideas for future Federal consumer protections. As Justice
Brandeis said in his dissent in New State Ice Co., ``Denial of the
right [of States] to experiment may be fraught with serious
consequences to the Nation'' (285 U.S. at 311). A State law will not
serve this purpose if States cannot apply their laws to national banks,
who are big players in the marketplace for credit and banking services.
State lawmakers simply won't pass new consumer protection laws that do
not apply to the largest players in the banking marketplace.
Efficient Federal public policy is one that is balanced at the
point where even though the States have the authority to act, they feel
no need to do so. Since we cannot guarantee that we are ever at that
optimum, setting Federal law as a floor of protection as the default--
without also preempting the States--allows us to retain the safety net
of State-Federal competition to guarantee the best public policy. \115\
---------------------------------------------------------------------------
\115\ For further discussion, see Edmund Mierzwinski, ``Preemption
of State Consumer Laws: Federal Interference Is a Market Failure,''
Government, Law, and Policy Journal of the New York State Bar
Association, Spring 2004 (Vol. 6, No. 1, pp. 6-12).
---------------------------------------------------------------------------
Conclusion
As detailed above, a strong Federal commitment to robust consumer
protection is central to restoring and maintaining a sound economy. The
Nation's financial crisis grew out of the proliferation of
inappropriate and unsustainable lending practices that could have and
should have been prevented. That failure harmed millions of American
families, undermined the safety and soundness of the lending
institutions themselves, and imperiled the economy as a whole. In
Congress, a climate of deregulation and undue deference to industry
blocked essential reforms. In the agencies, the regulators' failure to
act, despite abundant evidence of the need, highlights the inadequacies
of the current regulatory regime, in which none of the many financial
regulators regard consumer protection as a priority.
As outlined in the testimony above, establishment of a single
Consumer Financial Protection Agency is a critical part of financial
reform. As detailed above, its funding must be robust, independent and
stable. Its board and governance must be structured to ensure strong
and effective consumer input, and a Consumer Advocate should be
appointed to report semi-annually to Congress on agency effectiveness.
Our organizations, along with many other consumer, community, civil
rights, labor and progressive financial institutions, believe that
restoring consumer protection should be a cornerstone of financial
reform. It will reduce risk and make the system more accountable to
American families. We recognize, however, that other reforms are needed
to restore confidence to the financial system. Our coalition ideas on
these and other matters can be found at the Web site of Americans For
Financial Reform, available at ourfinancialsecurity.org.
Thank you for the opportunity to testify. Our organizations look
forward to working with you to move the strongest possible Consumer
Financial Protection Agency through the Senate and into law.
Appendices:
Appendix 1: Abusive Lending Practices by Smaller Banks and Thrifts
Appendix 2: Private Student Loan Regulatory Failures and Reform
Recommendations
Appendix 3: Rent-A-Bank Payday Lending
Appendix 4: Information on Income (Primarily User and Transaction Fees
Depending on Agency) of Major Financial Regulatory Agencies
Appendix 5: CFA Survey: Sixteen Largest Bank Overdraft Fees and Terms
______
PREPARED STATEMENT OF PETER WALLISON
Arthur F. Burns Fellow,
American Enterprise Institute
July 14, 2009
The Consumer Financial Protection Agency (CFPA), as proposed by the
Obama Administration, is intended to be an independent agency with sole
rule-making and enforcement authority for all Federal consumer
financial protection laws (with the exception of those covered by the
SEC and the CFTC). The draft legislation \1\ submitted by the
Administration gives the agency jurisdiction over all companies,
regardless of size, that are engaged generally in providing credit,
savings, collection, or payment services. This is accomplished by
transferring to the CFPA most or all of the authorities in 16 Federal
statutes--ranging from the CRA to the Truth in Savings Act--that cover
lending, mortgage financing, fair housing, credit repair, debt
collection practices, fair credit reporting, and a multitude of other
consumer financial products and services. The agency will be funded by
fees imposed on the thousands of companies--from banks and credit card
companies to local finance companies and department stores--that are
subject to the legislation. In many cases, the agency's jurisdiction
will be concurrent with the jurisdiction of State agencies, but the
CFPA will not preempt State law.
---------------------------------------------------------------------------
\1\ Consumer Financial Protection Agency Act of 2009, 1018, as
proposed by the U.S. Department of the Treasury, June 30, 2009,
available at www.financialstability.gov/docs/CFPA-Act.pdf (accessed
July 6, 2009).
---------------------------------------------------------------------------
Prior to submitting the legislation, the Administration circulated
a white paper \2\ that contains clear Statements of the policies and
intentions underlying the legislation. In this testimony, I will refer
to the white paper as well as the legislation itself.
---------------------------------------------------------------------------
\2\ U.S. Department of the Treasury, ``Financial Regulatory
Reform: A New Foundation'' (June 30, 2009), 55-56, available at
www.financialstability.gov/docs/regs/FinalReport_web.pdf (accessed July
6, 2009).
---------------------------------------------------------------------------
As might be expected, the new agency will have jurisdiction over
disclosure to consumers. This is the customary way that consumer
protection has proceeded at the Federal level. In the past, consumers
were generally expected to have the ability to make decisions for
themselves if they were given the necessary information. The securities
laws, for example, are largely consumer protection laws, developed
during the New Deal period. In selling a security, an issuing company
and any underwriter or dealer must supply investors with all material
facts, including any additional facts needed to ensure that the
information disclosed is not misleading. This approach has worked well
for 75 years.
The material facts standard of the SEC is of course subject to
interpretation, but it is possible to give it some content by imagining
what an investor would want to know about the risks a company faces and
its financial and business prospects. The white paper States that the
CFPA will use a ``reasonableness'' standard, which it defines as
``balance in the presentation of risks and benefits, as well as clarity
and conspicuousness in the description of significant product costs and
risks.'' The draft legislation follows this pattern, so that disclosure
to consumers must--perhaps like a drug label or a securities
prospectus--include both the benefits and the risks of a product or
service. These will be difficult guidelines for the regulated industry
to follow, especially because enforcement actions and lawsuits may
result from violations. Despite substantial disclosure on drug labels
and in securities prospectuses--in some cases ordered by the regulatory
agency--successful law-suits in both areas have claimed that the
disclosure was not sufficient.
The Suitability Problem
The real trouble begins, however, when the Administration's plan
gets beyond the relatively simple issue of disclosure and proposes that
the CFPA define standards for what the white paper calls ``plain-
vanilla'' products and services. The draft legislation describes them
as ``standard consumer financial products or services'' that will be
both ``transparent'' and ``lower risk.'' According to the white paper,
the CFPA will have authority ``to require all providers and
intermediaries to offer these products prominently, alongside whatever
other lawful products they choose to offer.'' \3\ This idea, seemingly
quite simple, raises a host of significant questions. If there is a
plain-vanilla product, who is going to be eligible for the product that
has strawberry sauce? In other words, once the baseline is established
for a product that can or must be offered to everyone, who is going to
be eligible for the product that, because of its additional but more
complex features, offers financial advantages? This is the suitability
problem--requiring providers to decide whether a particular product or
service is suitable for a particular customer--and the Administration's
plan is caught in its web.
---------------------------------------------------------------------------
\3\ Ibid., 15.
---------------------------------------------------------------------------
As an example, consider a mortgage with a prepayment penalty. The
white paper notes that the ``CFPA could determine that prepayment
penalties should be banned for certain types of products, because
penalties make loans too complex for the least sophisticated consumers
or those least able to shop effectively.'' \4\ This seems logical if
one assumes--as the Administration seems prepared to do--that some
consumers can be denied access to products they want. As the white
paper notes, ``[t]he CFPA should be authorized to use a variety of
measures to help ensure alternative mortgages were obtained only by
consumers who understood the risks and could manage them.'' \5\
---------------------------------------------------------------------------
\4\ Ibid., 68.
\5\ Ibid., 66.
---------------------------------------------------------------------------
So, what about the husband and wife who intend to keep their home
until their children are grown and are willing, for this reason, to
accept a prepayment penalty in order to get a lower rate on their
fixed-rate mortgage? The Administration is suggesting that this option
might not be available to them if the mortgage provider (and ultimately
the CFPA) does not consider them ``sophisticated'' consumers. This kind
of discrimination between and among Americans is something new and
troubling. The Administration's plan clearly intends for some consumers
to be denied access to certain products and services. ``As mortgages
and credit cards illustrate,'' the white paper declares, ``even
seemingly `simple' financial products remain complicated to large
numbers of Americans. As a result, in addition to meaningful
disclosure, there must also be standards of appropriate business
conduct and regulations that help ensure providers do not have undue
incentives to undermine those standards.'' \6\ In other words, by
requiring that all providers offer plain-vanilla products and services
in addition to other products, the Administration is creating a regime
in which providers must keep ``complicated'' products out of the hands
of Americans who may not be able to understand them.
---------------------------------------------------------------------------
\6\ Ibid., 67.
---------------------------------------------------------------------------
This approach bears a strong resemblance to a paper published in
October 2008 by the New America Foundation. \7\ One of the authors of
the piece, Michael Barr, is now an assistant secretary of the Treasury.
The underlying theory of the Barr paper is that consumers should be
offered a baseline, simple and low risk version of every product
offered by credit and other financial providers. This simple product is
called a ``plain-vanilla'' product in the New America Foundation paper,
just as it is in the Administration's white paper. Referring to
mortgages, the Barr paper describes this sequence of events:
``Borrowers . . . would get the standard mortgage offered, unless they
chose to opt out in favor of a nonstandard [i.e., more complex and
risky] option offered by the lender, after honest and comprehensible
disclosures from brokers and lenders about the terms and risks of the
alternative mortgages. An opt-out mortgage system would mean borrowers
would be more likely to get straightforward loans they could
understand.'' \8\
---------------------------------------------------------------------------
\7\ Michael Barr, et al., ``Behaviorally Informed Financial
Services Regulation'', New America Foundation, October 2008.
\8\ Ibid., 9.
---------------------------------------------------------------------------
What the Barr paper fails to understand is the risks that are faced
by the provider in offering to customers anything more complex than the
plain-vanilla product. Although providers will be free to do so, the
possibility of enforcement actions by the CFPA or the Federal Trade
Commission, suits by State attorneys general (specifically authorized
to enforce the CFPA's regulations), and the inevitable class action
lawsuits will make the offering of the more complex product very risky.
Although the Barr paper suggests that the provider can protect itself
by making a full and fair disclosure, even the white paper recognizes
that this is unlikely to be effective. The white paper notes: ``Even if
disclosures are fully tested and all communications are properly
balanced, product complexity itself can lead consumers to make costly
errors.'' \9\ When these costly errors are made, they will be prima
facie evidence that the product was too complex for the consumer, and
the provider will be faced with a fine, an expensive enforcement
action, or worse. Thus, we are not talking about a question of
disclosure--making the risks and costs plain. Instead, what the
Administration is setting up is a mechanism that will ultimately deny
some people access to some products because of their deficiencies in
experience, sophistication, and perhaps even intelligence.
---------------------------------------------------------------------------
\9\ White paper, 66.
---------------------------------------------------------------------------
This approach seems to be an unprecedented departure by the U.S.
Government from some of the fundamental ideas of individual equality
that have underpinned U.S. society since its inception. Conservatives
have long argued that liberalism reflects a paternalistic desire on the
part of elites to control and limit others' choices while leaving
themselves unaffected. The white paper seems to validate exactly that
critique. Providers will be at risk if they offer some products to
ordinary consumers but could feel safe in offering the same products to
those who are well educated and sophisticated. In important ways, the
Administration's approach raises the issues in the famous Louis
Brandeis Statement, quoted by Milton and Rose Friedman at the beginning
of their book, Free to Choose: ``Experience should teach us to be most
on our guard to protect liberty when the Government's purposes are
beneficial. Men born to freedom are naturally alert to repel invasion
of their liberty by evil-minded rulers. The greater dangers to liberty
lurk in insidious encroachment by men of zeal, well-meaning but without
understanding.'' \10\
---------------------------------------------------------------------------
\10\ Olmstead v. United States, 277 U.S. 479 (1928).
---------------------------------------------------------------------------
In addition, there are troubling questions about how determinations
of sophistication or even mental capacity are going to be made, who is
going to make them, and what standards will be followed. It appears
that the provider must make this decision, but what kinds of guidelines
will the CFPA provide to protect the provider against the inevitable
legal attacks? Vague language in the legislation suggests the consumer
can opt out of the plain-vanilla alternative, but as noted above this
simply changes the nature of the provider's risk from the qualities of
the product to the qualities of the disclosures that were made to the
consumer about what such an opt out would mean. Finally, the elements
of a plain-vanilla mortgage can be quite arbitrary, forcing people into
structures that are financially disadvantageous. How can anyone know,
for example, whether a 30-year fixed-rate mortgage is better than a 30-
year adjustable-rate loan with a reasonable cap on interest costs? If
interest rates rise in the future, the fixed-rate mortgage is best, but
if they fall, a variable rate should be preferred. Should a Government
agency have the power to determine whether a homebuyer is allowed to
make this choice?
In contrast, the disclosure system has always seemed appropriate in
our society because it does not require invidious or arbitrary
discrimination between one person and another. As long as the
disclosure is fair and honest, why should anyone be prohibited from
buying a product or service? While it is apparent that everyone is not
equal in understanding or sophistication, our national sensibility has
been that these differences should be ignored in favor of the higher
ideal of equality. Where consumers of limited understanding are
protected by this system is through consumer protection actions that
charge providers with fraud and deception while taking into account the
limited capacities of the consumer. Under this approach, fraud and
deception are punished, but the Government is not involved ex ante in
deciding whether one person or another is eligible to receive what our
economy has to offer. Yet the white paper says: ``The CFPA should be
authorized to use a variety of measures to help ensure that alternative
mortgages were obtained only by consumers who understood the risks and
could manage them. For example, the CFPA could . . . require providers
to have applicants fill out financial experience questionnaires.'' \11\
If this sounds a bit like a literacy or property test for voting--ideas
long ago discredited--it is not surprising. Both impulses spring from
the same source: a sense that some people are not as capable as others
to make important choices.
---------------------------------------------------------------------------
\11\ White paper, 66.
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To be sure, the securities laws contemplate that some distinctions
will be made among customers on the basis of suitability. A broker-
dealer may not sell a securities product to a customer if the customer
does not have the resources to bear the risk or the ability to
understand its nature. This is the closest analogy to what the
Administration is contemplating for all consumers, but as a precedent
it is inapposite. Owning a security is not a necessity for living in
our economically developed society, but obtaining credit certainly is.
Whether through a credit card, an account at a food or department
store, a car loan, or a lay-away savings plan at a local furniture
dealer, credit is a benefit that enables every person and every family
to live better in our economy. Denying a credit product suitable to
one's needs but deemed to be beyond one's capacity to understand has a
far greater immediate adverse effect on a family's standard of living
than telling an investor that a collateralized debt obligation is not a
suitable product for his 401(k).
Moreover, investors tend to be customers of broker-dealers over
extended periods, so their financial and other capacities are well
known to the brokers who handle their accounts. This is unlikely to be
true for various credit products, which are likely to be established in
single transactions and with little follow-up. Any attempt to determine
a customer's ability to handle the risks associated with, say, a credit
card could also involve investigation into matters that the customer
considers private. Neither the draft legislation nor the white paper
suggests how the provider of a financial service is to determine
suitability while still protecting the customer's privacy. As discussed
below, simply determining what other credit products and obligations
particular applicants might have--and thus whether they are able to
meet their obligations--will be difficult and costly. These problems do
not normally arise in the suitability inquiry that broker-dealers must
undertake.
Other Effects
Several other serious problems arise out of the structure that the
Administration seems to have in mind. The decision on a particular
consumer's eligibility for a product will not be made by the CFPA but
by the provider of the product or service. Apart from consumers
themselves, providers are the first victims of this legislation. They
will have to decide--at the risk of a CFPA enforcement action or a
likely lawsuit--whether a particular customer is suitable for a
particular product. This will place them in a difficult, if not
impossible, position. If they accede to a customer's demand, and the
customer later complains, the provider may face a costly enforcement
proceeding or worse, but if the provider denies the customer the
desired product, the provider will be blamed, not the Government
agency. In not a few cases, the provider may be sued for denial of
credit to someone later deemed suitable, rather than for granting
credit to a person later deemed unsuitable. The white paper points out
that the Administration does not intend to disturb private rights of
action and in some cases ``may seek legislation to increase statutory
damages.'' As noted above, State attorneys general are specifically
authorized to enforce the CFPA's regulations. Although the white paper
offers the possibility that a provider might get a ``no action letter''
or approval of its product and its disclosure, the personal financial
condition and other capacities of the customer are what will count, not
the simplicity of the product.
The second victim will be innovation. Why should anyone take the
risk to create a new product? Even if the CFPA will review it to
determine whether it is accurately and fairly described--a process that
may require the services of a lawyer and the usual expenses of
completing applications and answering questions from a Government
agency--the developer will still have to decide whether the people who
want it are suitable to have it. The suitability decision can be
expensive; a provider's better choice might be to stay with plain-
vanilla products and give up the idea of developing new products to
attract new customers.
The third victim will be low-cost credit. The tasks of getting
approval for a product and investigating the suitability of every
person who wants something more than a plain-vanilla product--whatever
that may be--will substantially increase the cost of credit and reduce
its availability. Leaving aside the effect on economic growth
generally, higher credit costs and the denial of credit facilities that
are deemed to be unsuitable for particular consumers will seriously
impair the quality of life for many people of modest means or limited
education. Credit provided by stores to regular customers may become
too costly to administer. As a result, small neighborhood
establishments may simply abandon the idea of providing credit and
small finance companies and other small enterprises engaged in consumer
financial services may well go out of business or merge with larger
competitors. Even large credit providers may find that the additional
business they attract with this service does not compensate for the
risk and expense. Withdrawal of these competitors from the market will
not only mean that many customers will be deprived of any credit
sources and other services, but also that the reduced competition will
allow credit fees to rise.
Litigation will also be a factor in the decision of credit sources
about whether to develop new products or offer the complex products and
services that might lead to disputes with customers or the CFPA.
Investor complaints about suitability in the securities field are
handled through an arbitration process, so that an investor who claims
that he was sold a product for which he was unsuitable must make his
case to an arbitrator rather than a court. The current costs of a
mistake in the suitability judgment are thus much smaller for the
broker-dealer. The legislation would give the CFPA the authority to ban
mandatory arbitration clauses in credit arrangements, and the white
paper recommends that the SEC consider ending the arbitration process
for securities. If the SEC decides to do this, litigation in the
securities field will substantially increase the costs of broker-
dealers and investment advisers.
Finally, inherent conflicts between consumer protection and
prudential regulation will arise when consumer protection
responsibility is moved from the bank supervisors to the CFPA. How
these might be resolved has not been described in the legislation and,
perhaps was not considered. For example, as noted above, the white
paper suggests that prepayment penalties should be banned for certain
types of products because they make loans too complex for the least
sophisticated consumers. A prudential supervisor, however, might want
prepayment penalties to be included in a prudently underwritten
mortgage, since the ability of the borrower to prepay at any time
without penalty raises the lender's interest rate risk. It is likely
that the bank supervisors and the CFPA will have different policies on
this and many other issues, and the banks will be caught in the middle.
Conclusion
The Consumer Financial Protection Agency Act of 2009 is one of the
most far-reaching and intrusive Federal laws ever proposed by an
Administration. Not only does it reach down to regulate the most local
levels of commercial activity, but the act would also set up procedures
and incentives that will inevitably deny some consumers an opportunity
to obtain products and services that are readily available to others.
This legislation should be rejected.
______
PREPARED STATEMENT OF SENDHIL MULLAINATHAN
Professor of Economics,
Harvard University
July 14, 2009
Chairman Dodd, Ranking Member Shelby, and Members of the Committee,
thank you for providing me with an opportunity to testify. By way of
background, I am a Professor of Economics at Harvard who specializes in
behavioral economics, a topic that combines two areas--economics and
psychology. Any discussion of financial regulation must incorporate
both areas--economists have a healthy respect for market forces while
psychologists have a healthy respect for both people's immense
capacities and limitations; they recognize that people are not
financial engines churning out optimal choices in all environments.
Understanding the current crisis--with its combination of competing
lenders and sometimes-confused borrowers--requires behavioral
economics.
In my comments I will make four points:
First, some decision environments allow consumers to choose
well while others result in poor choices.
Second, when customers choose well there is healthy
competition: firms clamor to provide better products at lower
prices. When customers choose badly, there can be a race to the
bottom. Even a few unprincipled firms offering products that
exploit human fallibility can put pressure on the entire
market.
Third, a two-part approach to financial regulation can
promote consumers capacity to choose well. Safe products would
be lightly regulated while less safe ones--where low road firms
could potentially exploit customers--would be more heavily
regulated. A fence around the safer products creates a more
level playing field between safe and less safe but
superficially attractive products. It provides an additional
tool that is less intrusive than bans, mandates or selective
bans for some customers. It allows all customers to access
products but simply ensures that those who access less safe
ones would be doing so with greater safeguards.
Though the scope of the proposed regulation is broad, I will use the
choice between mortgages--at the heart of the current financial
crisis--to illustrate my points.
Choosing Well and Badly
First, let me describe the psychology of choice. Over the decades
much research has helped us understand how people choose. I will
illustrate the insights from this research using two familiar examples.
Most of you have painted a room in your house. You probably
remember choosing from thousands of colors; Benjamin Moore alone
proudly offers 140 shades of white. How do you tackle this ocean of
choice? You pick a general color--blue, yellow, whatever. You pick a
few shades within that color. You try them out in small swatches on one
wall, see if you like them and repeat until you have a color you like.
The bottom line: despite the explosion of choice people are largely
happy with the end outcome. And certainly we don't think the Government
could step in and improve this market through regulation.
I am also sure most of you have bought a digital camera. Going into
the electronics store, you have some sense of what you want--do you
need a small camera or a big one, do you prefer one brand over another?
But once there the problem gets tougher. One camera has 8 megapixels
and is smaller and cheaper; another has 12 megapixels and is bigger and
more expensive. How do you choose? What is a megapixel? How many is
enough? Are 8 megapixels 50 percent better than 12? You can ask the
camera salesman but are his incentives to give you the best advice? If
the bigger camera is the cheaper per megapixel it may draw you to buy
that one even without knowing fully understanding what megapixels are.
Though there are far fewer cameras than paint colors the choice is far
more difficult. At the end of the process, you hope you have bought the
best camera but you're never really sure.
Part of choosing a mortgage is like choosing a paint color.
Choosing a 30-year fixed rate mortgage means deciding on what is an
affordable monthly payment. How much do you earn? What are your other
expenses? The consumer can intuit much of this--in fact they may know
it better than any outsider.
But sometimes when choosing a mortgage you encounter features all
too similar to megapixels. Suppose one mortgage costs $1,000 a month
for the first 2 years and then the payment is 3 points above 1 month
LIBOR, while another says it is $900 a month and then the payment is 4
points about the 1 year constant Treasury bills rate. How do you make
this choice? What is the difference between the LIBOR and the T-Bill
rate? How much do they vary? Are 3 and 4 points about the right number?
If the provider says you can refinance in 2 years, should you worry
about being able to get another loan? Notice that in this morass, the
$900 mortgage has some appeal; whatever else, it is cheaper now and
allows you afford a bigger house. Few know the answers to these
questions and those who do are the kind of people you avoid at a dinner
party. This is worse than megapixels.
Choices such as these are at the heart of why choosing mortgages
and other financial products pose so many difficulties for customers.
With paint, you can try different colors; you can't really try on many
mortgages. With paint, you get feedback; with mortgages feedback comes
rarely and far too late--when the payments explode. With paint, a
mistake is, well, easily painted over; with mortgages mistakes have
lifetime consequences. And most importantly, we understand the colors
we like whereas few of us understand the financial technicalities that
can have large consequences.
Under such conditions, errors abound. For example, as Bucks and
Pence show in their recent study ``40 percent of borrowers with income
less than $50,000--corresponding roughly to the bottom half of the
income distribution of ARM borrowers--do not know the per-period caps
on their interest rate changes.'' \1\ To cite another example, nearly
50 percent of ARM borrowers think their mortgages can be converted to
fixed rate ones whereas only 9 percent actually appear to be
convertible.
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\1\ Brian Bucks and Karen Pence (2006) ``Do Homeowners Know Their
House Values and Mortgage Terms?'' Federal Reserve Board of Governors.
FEDS Working Paper No. 2006-03. Available at SSRN: http://ssrn.com/
abstract=899152.
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Put simply, confusing choices do not represent real choices. Rather
than empowering consumers it can frustrate them. To promote effective
free choice one must ensure the choices can be made sense of.
Competition
This leads to my second point: how markets operate depends on how
people choose. It is useful to separate the world between high road and
low road lenders. High road lenders are in the game for the long run
and trying to do what is best for their customers. They recognize that
a bad mortgage is bad for business in the long run. Low road lenders
have shorter time horizons; their management is focusing on the bottom
line now. These firms would give out a bad mortgage--one that hurts
consumers--if it makes them money today, even if it costs them in the
long term.
The fortunes of high and low road firms depend on how people
choose. When people choose well, low road firms can do no better than
offer better products or lower prices. Here markets work well and
innovation helps consumers.
Things change when consumers are choosing badly. High road firms
now suffer from the actions of low road ones. Suppose a consumer is
offered a reasonable 30-year fixed rate mortgage by one firm and
offered a balloon ARM with an appealing teaser rate. Unless they
understand the arcane financial details of the adjustable rate jump and
amortization clauses, the balloon ARM will look deceptively attractive.
The better product can look like the worse product. One lender offers a
reasonable debt-to-income; another a much less safe debt-to-income. One
lender offers standard principal payments while another offers a
payment option ARM and advertises the minimum payments that do not even
cover interest and lead to negative amortization. In all these cases,
customers could easily be misled as to which is the good safe product
and which is the bad unsafe one. Good firms suffer again when they
start losing staff to bad firms who can pay more. And so on. This can
lead all firms to begrudgingly adopt low road strategies.
John Bogle, founder of Vanguard, has personal insight into this
process. Vanguard faced it directly in marketing a no-load minimum-fee
index fund. He points out that competition from (what I refer to as)
low-road funds has shifted the ``industry's focus from management to
marketing.'' He further notes, ``Small wonder that in all the rush to
salesmanship in the fund industry, stewardship seems to have been left
in the dust.'' \2\
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\2\ See http://johncbogle.com/wordpress/wp-content/uploads/2009/
03/iacompliance2.pdf.
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The experience of credit unions provides another interesting window
in to the race to the bottom. Because of their structure--they are not
for profit cooperatives--they may be better equipped to resist low road
approaches. According to a recent Experian-Oliver Wyman study, credit
unions are experiencing as little as one-fifth the delinquency rate on
mortgages and half the delinquency rate on credit cards as banks, even
within the same credit score band. \3\ This does not mean credit unions
are necessarily a panacea to the mortgage problem; it merely
illustrates the possibility of a high-road strategy.
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\3\ See http://www.marketintelligencereports.com.
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When consumers choose badly innovation--one of the greatest
benefits of markets--is also perverted. What did mortgage markets
innovate in the beginning of this decade? Teaser rates, negatively
amortizing loans, exploding subprime interest rates, prepayment
penalties and low- or no-doc lending are hardly shining examples of how
financial innovation helps consumers. Instead these products, while
surely useful for a few customers, have been abused because they have a
superficial appeal to confused customers. They likely contributed
heavily to the defaults we must now deal with. In short, when borrowers
choose badly innovation can be geared towards exploiting mistakes
rather than producing products that help customers.
The Challenge of Regulation
I believe the financial crisis we have faced illustrates the
importance of how market forces combine with how people choose. When
the worst of these collide--bad banks introducing mortgages that
exploit confused customers--the result is a toxic combination that
leaves not just consumers but the entire financial system at risk.
Successful financial regulation must pay attention to both of these.
The challenge of regulation is to ensure a system where customers
can choose well according to their needs. In such a system, high road
lenders will face a level playing field; competition and innovation
will benefit customers. This is much like the need for a referee in any
sport. If there are no referees, dirty players cheat and good players
lose or must follow suit. It's not a foul unless a referee calls it. A
good referee applying sensible rules can ensure that all players--
honest and dishonest--play by the same rules. At the same time, the
referee must let players play the game and not interfere too often. I
believe appropriately implemented the Consumer Financial Products
Agency (CFPA) can be like a good referee for the financial sector. It
can ensure that firms compete on a level playing field. It can allow
players to play the game as long as they are within the bounds of the
rules.
As Michael Barr, Eldar Shafir, and I have proposed, a two-part
approach to regulation is particularly important to accomplishing this
goal. \4\ Some financial products--call them first choice products--are
easily understood and easy to choose between. First choice products are
regulated minimally: ensure disclosure, prevent fraud; we know how to
do this, do much of it already and know how to do more of it. But
notice this is not enough.
---------------------------------------------------------------------------
\4\ Michael Barr, Sendhil Mullainathan, and Eldar Shafir,
``Behaviorally Informed Home Mortgage Regulation'', In Borrowing To
Live: Consumer and Mortgage Credit Revisited, eds. N. Retsinas and E.
Belsky, 170-202. Washington, DC: Brookings Institution Press, 2008.
Also see ``Behaviorally Informed Financial Services Regulation.'' New
America Foundation, 2008.
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This is because other products--option ARMs, subprime ARMs with
interest rates set to increase substantially--can pose significant
risks for the typical consumer. They allow bad choices and for low road
lenders to enter. These exotic products may make sense for some
sophisticated consumers of course. But unchecked they are dangerous
because their superficial appeal--with hidden risks--makes them unfair
competition for the first choice products. These products would need to
be regulated far more stringently. The Federal Reserve, for example,
has put forward fact sheets that might serve as disclosure for more
exotic mortgages. \5\ While a good start to what can be done this is
not enough. New products appear all the time, and marketing can be
endlessly inventive in sidestepping disclosure. As a result, an agency
like the CFPA would need to constantly update as the product mix
changes. Done correctly, it would assure that customers could access
exotic products. But they would do so with a greater understanding that
their superficial attractiveness comes laden with hidden risks.
---------------------------------------------------------------------------
\5\ See http://www.federalreserve.gov/newsevents/press/bcreg/
20070531b.htm.
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This is analogous to how we regulate drugs. Those with minimal
risks that consumers understand--ibuprofen, cold medicine--are
regulated only to prevent fraud and malfeasance. More complicated
drugs--powerful antibiotics--are more stringently regulated. Testing
mechanisms ensure efficacy. Independent advisors--a prescriber--ensure
those who receive them understand their purposes and risks. In short,
we create a fence around a set of products within which firms can
compete freely. Outside of this fence, for the more exotic products,
there is greater regulation. Individuals taking a door through the
fence would know they are moving to a less safe suite of products.
A few points are worth noting about this two-part approach.
The vast majority of the market is already inside the
fence. For example, Freddie Mac reports that fixed rate
mortgages made up 67-75 percent of applications in 2006. \6\
First choice products of course would include more than just
fixed rate mortgages and not all fixed rates (because we do not
know the LTV or DTI of these mortgages) would be first choice.
Still this number gives us the sense that most products offered
would likely fall into the first rate category. So such
regulation would in fact help most lenders; it would insulate
them from competition by low road products, which would now sit
outside the fence facing higher scrutiny.
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\6\ See http://www.freddiemac.com/news/finance/refi-
arm_archives.htm.
It is not necessary to mandate the offer of first choice or
vanilla products. Done correctly, the ring-fenced area will be
made attractive enough that firms will--as they do now--want to
offer products there. The challenge here is to ensure
sufficient safeguards for the nonfirst choice products.
Otherwise high road firms wanting to offer good products will
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once again face unfair competition from bad products.
There are several precedents for this type of two-part
approach. Individuals wishing to trade options or other
sophisticated products must initially complete more paperwork
and are given greater warnings of their dangers. In July 2008,
the Federal Reserve placed higher-priced mortgages (which
include all loans in the subprime market but excludes nearly
all prime market loans) under far greater scrutiny such as a
greater requirement for income verification, an explicit
affordability requirement, ad higher-than-normal penalties for
violation of these requirements. I understand that the
authority for this regulation would permit the Federal Reserve,
or the CFPA, to place other mortgages, such as option ARMs, in
this category of mortgages that receive greater scrutiny and
higher penalties. \7\
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\7\ See http://www.federalreserve.gov/newsevents/press/bcreg/
20080714a.htm.
For credit cards, Rep. Hensarling (R-Texas) has proposed a
close cousin in the form of an amendment to the bill that
eventually became the Credit Card Act in 2009. For potentially
harmful features, as long as all of a lender's customers are
offered a card without the feature, allow customers to opt-in
to one with the feature. By ensuring the opt-in includes
sufficient warnings, the CFPA could allow exactly this type of
door in the fence between first choice and more exotic
products. In this particular case, Congress' judgment was that
the ``first choice'' approach would not work to protect
consumers, and that a ban of these features was necessary. I
believe, however, that it is important for the CFPA to have the
first choice tool as an alternative to outright bans even if in
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some cases the ban is used.
Private firms already realize the value of clarifying and
simplifying choice. Charles Schwab for example has created a
category of ``Select Funds'' which are prescreened for loads,
fees and other qualitative criteria. \8\ Of course, no firm can
control the choice set offered by the entire market; however
well structured one firms' choice set is, it sits and competes
with other firms' offerings.
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\8\ ``Schwab's Income Select List was developed and is managed by
the Schwab Center for Financial Research (SCFR) experts and includes
mutual funds that have met their rigorous criteria, including both
quantitative and qualitative factors. All are no-load and no-
transaction fee and are selected based on their ability to generate
income in their respective asset classes. The list is designed to help
you achieve income and growth.'' http://www.schwab.wallst.com/retail/
public/research/mutualfunds/oneSource.asp.
For such an approach to be successful there must be a transparent,
predictable process by which products become first choice. First choice
is not a one-size fits all solution. Since it aims to facilitate choice
by customers, first choice products must include a suite of products.
Who decides what is in this suite? On what basis? This is especially
important as we look forward to the financial innovations that are
surely on the horizon. A transparent, predictable will give lenders who
create a good product comfort that they can reap rewards from it. I
believe such a process can be put in place. At the very least this
ought to be one of the injunctions to the CFPA to develop and codify
this process.
Conclusion
The financial crisis has lain bare the dangers of bad financial
products and generated a strong and understandable impetus for consumer
protection. I believe that the research on behavioral economics gives
guidance on how best to express this urge. The challenge is to provide
protection while promoting healthy market competition. The two-part
approach in the proposed legislation accomplishes this by providing an
attractive tool that is an alternative to bans and mandates.
On the one hand, the proposed CFPA would regulate strongly the most
exotic products. On the other hand, vanilla or first choice products--
the ones consumers really can choose well between--would be given far
greater freedom. This promotes competition and helps high-road firms
who operate in the part of the market that the typical consumer
operates in. The result I feel will be a financial sector that benefits
consumers by allowing them to choose better; that benefits firms by
allowing good firms to not be undercut by bad firms offering bad
products and that benefits sophisticated consumers by still letting
them access more exotic products on the other side of the fence.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD
FROM MICHAEL S. BARR
Q.1. Correcting Incentives--We have heard a number of reports
of how financial sector employees are incentivized to push
harmful financial products on to customers--sometimes to keep
their jobs. For example, one Bank of America call-center worker
claimed, ``the more money [she] sold [a customer] and the
higher the rate, the more money [she] made. That's what the
bank rewards--sales, not service.'' These products harmed not
just customers but the entire U.S. economy. The President's
plan recognizes that ``an important component of risk
management involves properly aligning incentives, and that
properly designed compensation practices for both executives
and employees are a necessary part of ensuring safety and
soundness in the financial sector.'' \1\ Secondly, it suggests
the creation of a whistleblower fund, saying that ``financial
firms and public companies should be accountable to their
clients and investors by expanding protections for
whistleblowers.'' \2\ This raises two questions:
---------------------------------------------------------------------------
\1\ See http://www.financialstability.gov/docs/regs/
FinalReport_web.pdf, p. 30.
\2\ See http://www.financialstability.gov/docs/regs/
FinalReport_web.pdf, pp. 15 and 72.
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How could a Consumer Financial Protection Agency ensure
that employees are not provided with these incentives to push
negative financial products onto customers?
A.1. The Consumer Financial Protection Agency (CFPA) will have
the authority and tools to address practices that harm
consumers in the marketplace for consumer financial products
and services. This authority would extend to business
practices, including compensation practices that push consumers
to purchase inappropriate products and services.
The authority the CFPA would have to address harmful
employee incentive practices includes, for example, the
following: Under Section 1031, the CFPA could issue rules to
restrict unfair, deceptive or abusive acts and practices. The
CFPA will also have the authority, under Section 1033, to
promulgate rules regarding sales practices, to ensure that
consumer financial products and services are provided in a
manner, setting and circumstances which ensure that the risks,
costs, and benefits of the products or services are fully and
accurately represented to consumers. In addition, under Section
1037, the CFPA will have the authority to prescribe rules
imposing duties on a covered person, or an employee of a
covered person, who deals directly with consumers in providing
financial products and services, as the CFPA deems appropriate
to ensure fair dealing with consumers. With this authority, the
CFPA will be able to impose duties on salespeople and mortgage
brokers to offer appropriate loans, take care with the
financial advice they offer, and meet the duty of best
execution. The CFPA also would be able to prevent lenders from
paying higher commissions to brokers or salespeople (yield
spread premiums) for selling loans to consumers with higher
rates than consumers qualify for.
Q.2. Would the Consumer Financial Protection Agency play any
role in protecting whistleblowers who call attention to abuses
against consumers, much like the whistleblower protections
given to employees of contractors and State and local
governments in this year's stimulus bill? \3\
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\3\ American Recovery & Reinvestment Act of 2009, Pub. L. No. 111-
5, 1553.
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A.2. Yes, the CFPA will play a role in protecting
whistleblowers who call attention to abuses against consumers.
Section 1057 provides protections for employees who, among
other things, provide information to the Agency or testify in
any proceeding resulting from the enforcement of the CFPA Act.
Employees who believe they have been terminated or otherwise
discriminated against because of the information they have
provided have a right to review by the Agency of such action,
including a right to a public hearing as part of the required
investigation by the Agency. After investigation, the Agency
has the authority to issue an order which provides for
reinstating or rehiring the employee.
Q.3. Senators Wyden and Whitehouse's Amendments From the Credit
Card Bill--Earlier this year when the Credit Card
Accountability, Responsibility and Disclosure Act was on the
Senate floor, Senator Wyden and Senator Whitehouse each had an
amendment that ultimately did not get incorporated into the
final legislation. Senator Wyden's amendment would have
established a five-star rating system for credit cards, and
Senator Whitehouse's amendment would have overturned the
Supreme Court's Marquette decision that allowed interest rates
to be exported across State lines.
How would your proposal deal with the issues that these two
amendments sought to address? Would the proposal allow the
Consumer Financial Protection Agency to set up some type of
rating system for credit cards to the extent it determines
necessary to protect cardholders?
And what effects would your proposal have on the Marquette
decision?
A.3. The CFPA would have the authority to achieve the same ends
as the proposed credit card rating system--fairness and
transparency. It is given the mandate to ensure that consumers
have the clear and accurate information they need to make
responsible financial decisions. Ensuring that consumers have,
reasonably can understand, and can use the information they
need to make responsible decisions is the first of the CFPA's
four objectives under Section 1021(b)(1).
We do not propose to alter existing law under Marquette,
which allows banks to charge the interest rate permitted by
their chartering State.
Q.4. In his testimony, Mr. Yingling cites the Treasury's plan
as saying ``that 94 percent of high cost mortgages were made
outside the traditional banking system,'' (p. 4). On the other
hand, you testify that ``about one-half of the subprime
originations in 2005 and 2006--the shoddy originations that set
off the wave of foreclosures--were by banks and thrifts and
their affiliates.'' Please explain the discrepancy.
A.4. Mr. Yingling's assertion is incorrect. Here is the
relevant paragraph from our white paper, Financial Regulatory
Reform: A New Foundation (pp. 68-69). http://10.75.16.79:8080/
docs/regs/FinalReport_web.pdf. See in particular the last
sentence.
Rigorous application of the Community Reinvestment Act (CRA)
should be a core function of the CFPA. Some have attempted to
blame the subprime meltdown and financial crisis on the CRA and
have argued that the CRA must be weakened in order to restore
financial stability. These claims and arguments are without any
logical or evidentiary basis. It is not tenable that the CRA
could suddenly have caused an explosion in bad subprime loans
more than 25 years after its enactment. In fact, enforcement of
CRA was weakened during the boom and the worst abuses were made
by firms not covered by CRA. Moreover, the Federal Reserve has
reported that only 6 percent of all the higher-priced loans
were extended by the CRA-covered lenders to lower income
borrowers or neighborhoods in the local areas that are the
focus of CRA evaluations.
The information from the last sentence is from an article
by Federal Reserve economists and refers just to subprime loans
made by a bank or thrift (a) to lower-income people or
neighborhoods and (b) in a bank or thrift's CRA assessment
area. See http://www.minneapolisfed.org/publications_papers/
pub_display.cfm?id=4136. This statistic does not refer to the
whole population of subprime loan originations. Of that
population, banks and thrifts held a significant share.
That fact is evident in Table 1 below (http://
www.minneapolisfed.org/pubs/cd/09-2/table1.pdf.) from the same
article. It shows that, in 2005, 36 percent of higher-priced
loans were by depositories or their subsidiaries; in 2006 the
figure rose to 41 percent. If you add in bank affiliates, in
2005, banks, their subsidiaries and affiliates made 48 percent
of all higher-cost loans, and 54 percent in 2006.
Q.5. Mr. Yingling claims that the creation of the CFPA will
result in a ``potentially massive new regulatory burden.'' He
then goes on to assert ``community banks will have greatly
increased fees to fund a system that falls disproportionately
on them.'' How do you respond?
A.5. We believe that the Federal regulatory structure for
consumer protection needs fundamental reform. We have proposed
to consolidate rule-writing, supervision, and enforcement
authority under one agency, with marketwide coverage over both
nonbanks and banks that provide consumer financial products and
services. With this consolidated authority and marketwide
coverage, the CFPA will be able to regulate in a manner that is
more streamlined and effective, not more burdensome.
The authorities for rulemaking, supervision, and
enforcement for consumer financial products and services are
presently scattered among seven different Federal agencies,
sometimes with overlapping authority. For example, the Federal
Reserve Board (FRB) has jurisdiction over required mortgage
disclosures under the Truth in Lending Act (TILA), while the
Department of Housing and Urban Development has authority to
require mortgage disclosure under the Real Estate and
Settlement Protection Act (RESPA). As another example, the
Federal Trade Commission (FTC) has authority to issue rules
relating to mortgage loans in the nonbank sector, while the
Federal Reserve has similar authority under the Home Ownership
and Equity Protection Act to issue rules regarding the entire
mortgage market. Such balkanization and overlap of regulatory
authority does not make sense. With consolidated authority, the
CFPA will, for example, be able to integrate the mortgage
disclosures required under TILA and RESPA into one, integrated
form. This simplification--and others like it--would decrease,
not increase, the compliance burden, while improving
protections for consumers.
Moreover, with respect to regulations, the CFPA will be
statutorily required to consider the potential costs and
benefits to consumers and institutions, including the potential
reduction in consumer access to financial products and
services. The CFPA will be required to consult with safety and
soundness regulators before issuing rules. As a result, the
CFPA's rules and supervisory approach will be balanced and
effective.
It is simply not true under our proposal that community
banks will pay higher fees to fund the CFPA. The Administration
proposes to provide by statute that community banks will pay no
more for Federal consumer protection supervision after the CFPA
is created than they do today. Moreover, we believe that
community banks will benefit from the CFPA in several ways.
First, today, community banks have to compete against
nonbank entities like mortgage brokers and mortgage companies,
which, unlike banks, are not subject to Federal oversight. In
recent years, nonbank firms won market share by lowering
lending standards and offering irresponsible--and often
deceptive--loans. Community banks were forced either to lower
their own standards or to become uncompetitive. The CFPA will
provide a level playing field, extending the reach of Federal
oversight to all providers of consumer financial products and
services, banks and nonbanks alike, for the first time. The
CFPA will put an end to community banks' competitive
disadvantage.
Second, CFPA's marketwide coverage and consolidated
authority for rule writing, supervision, and enforcement will
enable it to choose the least-cost, most-effective tools. For
example, it will be able to use ``supervisory guidance'' in
place of new regulations. Supervisory guidance is less
burdensome for financial institutions, but is not an effective
consumer protection tool today because it requires coordination
between numerous Federal and State agencies. With one Federal
agency in charge, supervisory guidance can more often be used
in place of new regulations.
Finally, the CFPA will have a mandate to allocate more
resources to those companies that pose more risks to consumers
when providing consumer financial products and services.
Community banks are close to their customers and have often
provided simpler, easier-to-understand products with greater
care and transparency than other segments of the market. Such
banks will receive proportionally less oversight from the CFPA.
Q.6. Mr. Yingling asserts that the CFPA is ``instructed to
create its own products and mandate that banks offer them. . .
. Community banks whether it fits their business model or not,
would be required to offer Government-designed products, which
would be given preference over their own products.'' This
raises two questions:
Would the Administration's proposal require the CFPA to
create its own products?
In the area of mortgages, for example, are the kinds of
``plain-vanilla'' mortgages that the plan would encourage
similar to products that community banks currently offer, or do
community banks tend to offer more exotic mortgages that might
attract the additional scrutiny contemplated by the proposal?
What about nonmortgage products such as credit cards, auto
loans, and the like?
A.6. The Administration's proposal would not require the CFPA
to design products. The proposal would permit the CFPA only to
identify a standard product that is commonly provided in the
marketplace already, and that is proven, simple, and poses less
risk to consumers. In the mortgage context, such standard
products would likely include both 30-year, fixed rate
mortgages and adjustable rate mortgage (ARM) products.
Most community banks that offer residential mortgages,
offer 30-year fixed rate and conventional ARM mortgage
products. These loans would generally meet the definition of
standard products. Some community banks certainly offered more
exotic mortgages such as payment option ARMs or subprime loans
with nontraditional features, but those institutions likely
offered conventional loans too.
The mortgage market has known standard products for years.
The Agency would have the authority to determine if the concept
would also apply in other contexts, such as credit cards and
auto loans. Recently at least one major card issuer has offered
a ``plain-vanilla'' credit card and it is possible that this
practice would spread.
Q.7. Had lenders been required to offer ``plain-vanilla''
mortgage products such as fixed-rate mortgages or traditional
ARMs during the significant growth in subprime lending starting
in 2003, what impact do you think it might have had on the
crisis?
A.7. Subprime mortgages grew extremely rapidly, reaching $600
billion in originations and 20 percent of the market by 2005.
It is clear today that the rapid development of this segment of
the market was disastrous; a Federal Reserve economist has
projected that approximately 45 percent of subprime loans
originated in 2006 and 2007 will end in foreclosure. A
substantial proportion of subprime borrowers qualified for much
safer conventional, standard mortgages, which had lower
interest rates, stable payments, escrows for taxes and
insurance, no barriers to exit such as prepayment penalties,
and substantially lower default rates. The financial incentives
for originators, however, were to steer borrowers into subprime
loans even if borrowers qualified for conventional loans.
A requirement to provide the consumer a comparison between
these more complex products and simpler products might have
made a difference. The banking agencies ultimately required
lenders to disclose these comparisons, but the agencies took so
long to agree on the disclosures that they made little
difference.
Q.8. Chairman Bernanke appeared before the Committee on July 23
to discuss monetary policy. At that hearing, he was asked about
the requirement that consumers be offered ``plain-vanilla''
choices. Bernanke said ``there is some economic analysis which
suggests that there might be benefits in some cases of having a
basic product available, so-called `vanilla product'.'' He goes
on to say, however, that the regulators would have to take care
not to ``roll back all of the innovation in financial markets
that has taken place over the past three decades or so.'' Do
you have any observations to make regarding these comments by
Chairman Bernanke?
A.8. Chairman Bernanke's comments are well taken. Our specific
proposal on ``plain vanilla'' is lighter touch regulation. A
vanilla product would serve to provide a standard of comparison
for borrowers, so they can make more informed choices about
what loan product would be best for them. It is another tool
besides disclosure, but less intrusive than outright banning
contract terms that harm consumers (as Congress just did on
credit cards). Our proposal would not dictate business plans or
decide for consumers what products are right for them. The goal
is to make it easier for consumers who want to choose simple
products to make that choice, and to make sure consumers who
choose more complicated products understand the risks they are
taking.
Here's an example. When the regulators put out a model
disclosure on subprime mortgages in 2008, it required mortgage
lenders to compare the payment schedule of a subprime
mortgage--with a big jump in interest rates in the third or
fourth year--to the payment schedule on a fixed-rate, 30-year
mortgage. That's the sort of action this agency would take.
Only, it would be able to act much faster--the regulators'
disclosure came out after the subprime mortgage market had
imploded.
I also agree with Chairman Bernanke on innovation. Our
proposals are designed to preserve the incentives and
opportunities for innovation. Many of the consumer lending
practices that led to this crisis gave innovation a bad name
and served simply to hide costs in a deceptive manner. We need
to create an agency that restores confidence of consumers in
innovation. We also need to restore confidence of the financial
investors who would fund innovation but have become wary of it.
This is why preserving innovation and promoting access are key
objectives of the agency. The agency will be required to
measure every proposal against these objectives.
Innovation has to be sustainable and respond to consumer
preferences. That requires transparency and fairness. We are
equipping the agency with the authority to ensure transparency
and fairness so that sustainable innovations can thrive.
Q.9. Mr. Wallison argued at the hearing that the
Administration's proposal would require lenders to determine
the ability of a potential customer to understand various
products, which, he goes on to assert will lead to limitations
on what they offer. How do you respond?
A.9. The intent of the standard products provision is to
provide a standard of comparison for borrowers, so they can
make more informed choices about what loan product would be
best for them. The Agency will also improve disclosures so that
it will be easier for consumers to understand the loan products
they are getting. It will remain the consumer's right and
responsibility to make the choice.
Q.10. Mr. Wallison said during the hearing that the liability
faced by lenders for offering more complex products would
effectively eliminate those options for consumers. How do you
respond?
A.10. A standard product would serve to provide a standard of
comparison for borrowers, so they can make more informed
choices about what loan product would be best for them. It's
another tool besides disclosure, but less intrusive than
outright banning complex contract terms (as Congress just did
on credit cards). Since borrowers would be entirely free to
select alternative, more complex products and many would do so,
lenders would have substantial incentives to offer them.
Q.11. Title X, section 1022(b)(2)(A) of the Administration's
proposal describes special rulemaking requirements applicable
to the Consumer Financial Products Agency (CFPA). These
requirements state that when engaged in a rulemaking, the CFPA
must ``consider the potential benefits and costs to consumers
and covered persons, including the potential reduction of
consumers' access to consumer financial products or services,
resulting from such rule.''
Please explain the rationale for requiring the CFPA to
conduct additional analysis beyond the typical notice and
comment procedures required of agencies engaged in a rulemaking
under the Administrative Procedures Act.
A.11. The goal of the CFPA is not more regulation, but smarter
regulation. There is no question that existing consumer
protection statutes and rules were not protective enough of
consumers, and we are all paying a price for that failure.
Better rules are needed. An essential part of the solution is
one agency, with marketwide reach, and consolidated authorities
of rule writing, supervision, and enforcement.
These rules must be balanced. Supervising and, when
necessary, enforcing against banks and nonbanks will provide
the new agency with essential information about which problems
to address, as well as market realities in banks and credit
unions that need to be respected. CFPA will consult with
prudential supervisors before writing rules, and the national
bank supervisor will be on the CFPA board.
The CFPA proposal requires that the Agency weigh costs in
addition to benefits, and consider impact on businesses as well
as access to credit, in order to ensure that it is a balanced
agency that acts in the most effective, prudent way possible.
This requirement is consistent with the Agency's mission of not
removing all risk from consumer financial products and
services, but rather providing consumers with clear and
unbiased information that permits them to make their own
decisions and weigh their own costs and benefits in a reasoned
manner. It is also the practice the Federal Reserve has
followed in implementing the consumer financial protection
statutes.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR JOHNSON
FROM MICHAEL S. BARR
Q.1. The Treasury's ``white paper'' on financial regulation
notes that one of the key goals of the consumer protection
agency is to establish consistent regulation of financial
products. In fact, the paper notes that ``[State insurance
regulation] has led to a lack of uniformity and reduced
competition across State and international boundaries,
resulting in inefficiency, reduced product innovation, and
higher costs for consumers.'' However, the bill forwarded to
Congress permits States to add additional and different
consumer protection standards for financial products. Does this
undercut the goal of consistent regulation? Should not all
consumers have the same protection regardless of where they
reside? Why not simply direct the new agency to write strong
rules in the first place? This ensures consumer protection, yet
avoids potential for conflict, confusion, and cost.
A.1. Since the adoption of the first major Federal financial
consumer protection law in 1969, the Truth in Lending Act,
Congress has with limited exceptions explicitly allowed the
States to adopt laws to protect financial consumers so long as
these laws do not conflict with Federal statutes or
regulations. Federal law thus establishes a floor, not a
ceiling. We propose to preserve that arrangement. It reflects a
decades-long judgment of Congress, which we share, that States
should retain authority to protect the welfare of their
citizens with respect to consumer financial services. Federal
law ensures all citizens a minimum standard of protection
wherever they reside. Citizens of a State, however, should be
able to provide themselves--through their legislators and
governors--more protection.
The continued ability of citizens to protect themselves
through their States is crucial to ensuring a strong Federal
standard. State initiatives can be an important signal to
Congress and Federal regulators of a need for action at the
Federal level. Even with the best of intentions and the best of
staff, it is impossible to simply mandate that Federal laws or
rules remain updated, since practices change so quickly. States
are much closer to abuses as they develop and they are able to
move more quickly when necessary. For example, a number of
States were far ahead of the Federal Government in regulating
subprime mortgages. If States were not permitted to take the
initiative to enact laws providing greater protection for
consumers, the Federal Government would lose a critical source
of information and incentive to adjust standards over time to
address emerging issues.
If the Consumer Financial Protection Agency (CFPA) is
created and endowed with the authorities we have proposed, we
expect the standards adopted by the Agency will promote
regulatory consistency, even while it respects the role of the
States.
We believe a strong and independent CFPA that is assigned a
clear mission to keep protections up-to-date with changes in
the marketplace will reduce the incentives for State action and
increase legal uniformity. If States retain the ability to
protect their citizens as new consumer protection problems
appear and the CFPA has the authority it needs to follow the
market and keep Federal protections up-to-date, then the CFPA
will be more likely to set a high standard that will satisfy a
substantial majority of States.
To be sure, federally chartered institutions have recently
enjoyed immunity from certain State consumer protection laws.
We propose to change that to ensure a level playing field.
National banks must already comply with a host of State laws,
such as those dealing with foreclosures, debt collection, and
discrimination. Under our proposal, federally chartered
depository institutions and their State-incorporated
subsidiaries would be subject to nondiscriminatory State
consumer protection to the same extent as other financial
institutions.
We would preserve preemption where it is critical to the
Federal charter. Our proposal explicitly does not permit the
States to discriminate against federally chartered
institutions. Discriminatory State laws would continue to be
preempted. Moreover, we do not seek to overturn preemption of
State laws limiting interest rates and fees (the Smiley and
Marquette decisions). Nor do we seek to disturb the exclusive
authority of the national bank prudential supervisor over
national banks with respect to prudential regulation and
supervision. Thus, we would preserve the value of the national
bank charter.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM MICHAEL S. BARR
Q.1. Mr. Barr, do you agree with Sheila Bair, Chair of the
Federal Deposit Insurance Corporation, that safety and
soundness cannot be separated from consumer protection?
A.1. I agree with Ms. Bair and other regulators who have
testified that safety and soundness and consumer protection
need not conflict. Following all applicable laws, including
consumer protection laws, is a requirement of a safe and sound
institution. And as we've seen in the mortgage and credit card
markets, poor treatment of consumers actually undermines the
safety and soundness of financial institutions. I think,
however, that these complementarities can be preserved with
separate agencies. Two banking agencies today, including the
FDIC, typically conduct their consumer compliance and safety
and soundness examinations with separate teams of examiners. It
is a further step to separate the examiners into different
agencies, but we would propose to require the CFPA and the
prudential agencies to communicate and coordinate closely, and
to share examination reports. Ultimately, we believe the
complementarities will be strengthened if the CFPA is given the
mandate and authority, as we propose, to identify questionable
practices and provide the market and institutions clear rules
of the road. The CFPA can help the prudential regulator
identify practices that exploit consumer confusion for short-
term profits but undermine bank earnings and reputations in the
long run.
Q.2. Appearing before the House Energy and Commerce Committee,
you said that this new agency would not set prices, dictate
what products could be offered, or regulate a firm's
advertising practices. Section 1039 of the President's
proposals states that, ``It shall be unlawful for any person to
advertise, market, offer, sell, enforce, or attempt to enforce,
any term, agreement, change in terms, fee or charge in
connection with a consumer financial product or service that is
not in conformity with this title or applicable rule or order
issued by the Agency.'' How do you explain this discrepancy?
A.2. In my testimony before the House Energy and Commerce
Committee on July 8, I did state that the CFPA would not set
prices. Section 1022(g) of the legislation specifically forbids
the CFPA from establishing usury limits. I also stated
correctly that the CFPA could not dictate what products firms
could offer. With respect, however, I did not testify that the
CFPA would not regulate the advertising practices of those
offering financial products and services to consumers.
Advertising regulations have long been a core element of
Federal consumer protection statutes such as the Truth in
Lending Act. Regrettably these regulations were not kept up-to-
date. Indeed, before the mortgage market collapsed, the
marketplace was awash with misleading advertising about low-
rate mortgage loans, credit cards, or financial products.
Accordingly, the CFPA would have authority, as you note, to
regulate advertising practices of persons that provide consumer
financial products and services to prevent incomplete or
misleading information from undermining competition.
Q.3. In the past, Mr. Barr, you've argued that derivation from
a standard, plain-vanilla product ``would require heightened
disclosures and additional legal exposure for lenders.'' Please
explain why this would, or would not, discourage lenders from
offering any products that are deemed unstandard or outside of
the agency's safe harbor?
A.3. A standard product would serve to provide a standard of
comparison for borrowers, so they can make more informed
choices about what loan product would be best for them. It's
another tool besides disclosure, but less intrusive than
outright banning complex contract terms (as Congress just did
on credit cards). Since borrowers would be entirely free to
select alternative, more complex products and many would do so,
lenders would have substantial incentives to offer them.
Q.4. How much latitude would this new agency have over
determining what is a ``consumer financial product or
service?'' The President's proposal says ``any financial
product or service to be used by a consumer primarily for
personal, family, or household purposes.'' Could agency have
authority over small business loans or commercial real estate?
A.4. As you note, the definition of ``consumer financial
product or service'' in the CFPA Act is limited to any
``financial product or service to be used by a consumer
primarily for personal, family or household purposes.'' In
applying that language, the CFPA would need to determine
whether the product or service is used ``primarily'' for
personal, family or household purposes as a factual matter.
Similar language appears in the definitions of several
other consumer protection statutes, including the Truth in
Lending Act (15 U.S.C. 1602(h)), the Electronic Funds Transfer
Act (15 U.S.C. 1693a(2)), the Fair Debt Collection Practices
Act (15 U.S.C. 1692a(5)), the Fair Credit Reporting Act (15
U.S.C. 1681a(d)(1)(A)), and the Equal Credit Opportunity Act
(12 CFR 202.2(h)), which implements 15 U.S.C. 1691, et seq.).
The use of such language is generally understood as meaning to
exclude business credit.
As a general matter, under the new authority granted to the
CFPA under the CFPA Act, the CFPA would not have authority over
small business loans or commercial real estate loans. However,
the Equal Credit Opportunity Act (ECOA) prohibits
discrimination against certain protected classes in lending for
business as well as personal and household purposes, and the
proposal would grant the CFPA rulemaking and enforcement
authority under the ECOA. To that extent, the CFPA would have
authority over business loans under the ECOA.
Q.5. How did the Treasury determine that the Securities and
Exchange Commission has done an adequate job protecting
consumers? For example, many of Allan Stanford's victims were
everyday people, not large, sophisticated institutional
investors.
A.5. In establishing a regulatory framework for the protection
of consumers and investors, the Administration's goal was for
there to be a Federal agency with the mission of consumer
protection. In the consumer financial products and services
area, this agency is lacking; in the nonbank sector, no Federal
agency has supervision and examination authority, regardless of
the mission, and in the banking sector, five different agencies
share this responsibility but each has safety and soundness as
its primary mission. The Securities and Exchange Commission
(SEC), on the other hand, does have as its mission the
protection of retail investors, so there was no need to
duplicate this responsibility within the CFPA. As the SEC has
acknowledged with respect to the Stanford and Madoff cases,
existing authority should have been sufficient to address these
frauds much earlier. The SEC needs additional authorities,
however, to provide the broader and more effective oversight
that is needed, and that is why the Administration proposes
strengthening the agency's authority in several important ways.
Q.6. Should one of the goals of the CFPA be to ``optimize
household behavior''? What do you think optimal savings means?
A.6. The CFPA will not optimize household behavior. It is for
every family to make its own financial decisions. In order to
help families make responsible decisions, the CFPA will work to
ensure that markets are transparent, people have the
information they need about their financial decisions, and bank
and nonbank firms alike follow clear rules of the road.
For many years, until the current recession, the personal
saving rate in the United States has been exceedingly low. In
addition, tens of millions of U.S. households have not placed
themselves on a path to become financially prepared for
retirement. In order to address this problem, the President has
proposed two innovative initiatives in his 2010 Budget: (1)
introducing an ``Automatic IRA'' (with opt-out) for employees
whose employers do not offer a plan; and (2) increasing tax
incentives for retirement savings for families that earn less
than $65,000 by modifying the ``saver's credit'' and making it
refundable. The proposals would offer a meaningful saving
incentive to tens of millions of additional households while
simplifying the current complex structure of the credit and
raising the eligibility income threshold to cover millions of
additional moderate-income taxpayers.
Q.7. Mr. Barr, do you believe that the Government should steer
people's choices in directions that will ``improve their
lives'' or should the Government allow consumers to make their
own choices free of interference or direction?
A.7. We believe that it is the responsibility of consumers to
make their own decisions on financial matters. There must be
clear rules of the road so that firms do not deceive consumers
by hiding the true costs of products. The CFPA will create a
level playing field with high standards for all firms, bank and
nonbank alike, which means that the marketplace will provide a
broader array of high quality products from which consumers can
freely choose.
Q.8. Do you believe that it is more profitable for a bank to
issue a mortgage or credit card loan to a customer who defaults
or to one who makes their payments?
A.8. If incentives are properly aligned, banks should make as
much or more money when a mortgage or credit card borrower pays
their loan as when they default. Problems arise, however, when
markets are structured so that the bank is indifferent to
future loan performance, as when the lender immediately sells
the loan into an investment conduit without retaining any of
the risk of default. This ``originate to distribute'' model
caused incentives to deviate. The lenders--the parties in the
best position to determine the creditworthiness of the
borrowers--had no incentive to carefully underwrite; they were
paid up front when the loan was made regardless of future
performance. That is why the Administration proposes that
originators of loans or the securitizer must retain 5 percent
of the credit risk associated with loans sold into a conduit.
Q.9. Will you please define what an ``objective reasonableness
standard'' means?
A.9. Disclosure mandates for consumer credit and other
financial products are typically very technical and detailed,
and it takes time for regulators to update them because of the
need for consumer testing and public input. The growth in the
types of risks stemming from new and complex credit card plans
and mortgages that preceded the credit crisis far outpaced the
ability of disclosure regulations to keep up. We propose a
regime strict enough to keep disclosures standard throughout
the marketplace, yet flexible enough to adapt to new products.
Our proposed legislation authorizes the CFPA to prescribe rules
that require disclosures and communications to be reasonable,
not merely technically compliant. The proposal is based in part
on the banking agencies' supervisory guidance on subprime and
nontraditional mortgages. This guidance requires originators to
make balanced disclosures.
Q.10. If a financial institution developed a new product today,
under the CFPA would that product be able to be brought to the
marketplace tomorrow? What will financial institutions be
required to do before introducing a new product?
A.10. If a financial institution developed a new product today,
under the CFPA Act that product could be offered in the market
tomorrow--the CFPA will not be approving financial products. Of
course, all products must comply with existing laws. For
example, credit cards may not contain terms, such as
retroactive rate increases, that would violate the Credit CARD
Act of 2009. It is the institution's responsibility to
determine that a new product complies with applicable laws
before the institution brings the product to the market. It is
CFPA's role to help ensure that products offered in the market
comply with applicable laws, and to take appropriate steps if a
product does not.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD
FROM EDWARD L. YINGLING
Q.1. In assessing the need for and scope of a new Consumer
Financial Protection Agency (CFPA), the Committee must conduct
an objective evaluation regarding the responsibility of various
types of financial services providers for the lending problems
that have occurred in recent years. In your written testimony,
you identify nonbank lenders as the source for the vast
majority of abusive mortgage lending in recent years.
Specifically you write that `` . . . the Treasury's plan noted
that 94 percent of high cost mortgages were made outside the
traditional banking system.'' Your testimony also says that ``
. . . it is likely that an even higher percent of the most
abusive loans were made outside our sector.''
On the other hand, the Committee heard testimony from
Professor McCoy of the University of Connecticut on March 3,
2009, that such an assertion, ``fails to mention that national
banks moved aggressively into Alt-A low-documentation and no-
documentation loans during the housing boom.'' Professor McCoy
cites data indicating that national banks and thrifts issued
mortgage loans from 2006-2008 with higher default rates than
State-chartered thrifts and banks. Moreover, Assistant
Secretary Barr testified on the panel prior to you that ``about
one-half of the subprime originations in 2005 and 2006--the
shoddy that set off the wave of foreclosures--were by banks and
thrifts and their affiliates.''
Is it your view that national banks and thrifts did not
play a significant role, either directly or through their
subsidiaries, in offering abusive or unsustainable mortgage
loans?
A.1. Thank you for your question, Mr. Chairman. Certainly, some
banks--both national and State chartered--were involved in
subprime lending, but the fundamental fact remains that the
vast majority of banks in the country never made a toxic
subprime loan. These regulated banks did not cause the problem;
rather, they are the solution to the economic problem we face.
The comment by Professor McCoy you cite in your question is
not directed at the Treasury's statistic we referenced, i.e.,
that a very high percentage of high cost loans were made
outside the banking industry. In fact, Professor McCoy refers
to a study by the OCC which finds that national banks only
accounted for 10 percent of subprime lending in 2006--thus
confirming the evidence that the heart of the problem is with
nonbanks.
Even though attempts have been made to increase Federal
regulation of the nonbank sector, the fact remains that in the
key areas of examination and enforcement, nonbanks still are
not regulated as strictly or robustly as banks. In fact, the
GAO recently released a study on Fair Lending (July 2009) which
found that the independent mortgage lenders represented
``higher fair lending risks than depository institutions'' yet
``Federal reviews of their activities are limited.''
Furthermore, GAO found that ``[d]epository institution
regulators also have established varying policies to help
ensure that many lenders not identified through HMDA screening
routinely undergo compliance examinations, which may include
fair lending components.'' This increased focus on insured
depository institutions occurs because the banking agencies
``have large examination staffs and other personnel to carry
out fair lending oversight.''
Traditional banks are the survivors of this financial
crisis, not the cause. The fly-by-night nonbank mortgage
lenders have disappeared as fast as they appeared. As I
mentioned in detail in my written statement, the focus of
policymaking should be on the core cause of the problem--the
unregulated nonbank financial sector--and not end up punishing
the very institutions that are most likely to restart our
economy.
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RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD
FROM TRAVIS B. PLUNKETT
Q.1. Both Mr. Yingling and Mr. Wallison testified repeatedly
that the Administration's plan would result in credit being
rationed to consumers, particularly consumers who need the
credit the most. They also argued that the requirement that
additional disclosures or warnings accompany products that are
not ``plain-vanilla'' products would result in only those
standard products being offered. Specifically, Mr. Wallison
testified that `` . . . when a provider is confronted with the
choice of whether to offer only the plain-vanilla product or
the more complex product, he has to decide whether this
particular consumer is going to be able to understand the
product.'' Because lenders will be reluctant to make such
judgments, they will, by default, offer the plain-vanilla
product only, thereby constraining consumer choices. How do you
respond to these arguments?
A.1. Poor regulation of abusive credit products by Federal
regulators over many years has led to exactly the result that
Mr. Yingling and Mr. Wallison are concerned about: credit
rationing. Deceptive and unsustainable lending practices by
credit card companies and mortgage lenders led to record
defaults and foreclosures by consumers, record losses by
lenders, a crisis in the housing markets and the recession.
These developments, in turn, have led to a ``credit crunch''
where credit card lenders, for example, have significantly
reduced credit lines and sharply increase interest rates, even
for borrowers with stellar credit scores. Had a Consumer
Financial Protection Agency existed to prevent the excesses
that occurred in the lending markets, there is a very good
chance that this country could have avoided the worst aspects
of the housing and economic crisis, and of the somewhat
indiscriminate reduction in credit availability that has
occurred. In other words, proper regulation will create the
kind of stability in the credit markets that encourages lenders
to offer credit to consumers, especially those who do not have
perfect credit ratings.
Similarly, the ``plain-vanilla'' requirement is designed to
create choices in the credit marketplace that don't exist now,
and certainly did not exist during the credit boom.
``Choices,'' such as prepayment penalties that lock consumers
into unaffordable loans and ``exploding ARM'' loans that
lenders knew many of their borrowers could not afford, crowded
out less abusive options from the marketplace and ultimately
harmed consumers and the economy. Lenders are quite capable of
designing simple, understandable financial products that are
profitable for them and useful for consumers, if they chose to
do so.