WORD ON THE STREET: Many factors contributed to the crisis, but none more so than an orgy of unsound leverage in the home mortgage market. Federal financial regulators had sufficient ability to limit the excesses in the mortgage lending market.
The Federal Reserve Board had the power to restrict some of the most predatory products under the Home Owners Equity Protection Act, and the Office of the Comptroller of the Currency (OCC) and Office of Thrift Supervision (OTS) had broad ability to rein in the most egregious bank and bank service company activities both in direct lending and in the warehouse lending and securitization that financed non-bank mortgage lenders. None of them acted.
Astonishingly, the financial crisis has not chastened these regulators. This past year, in the midst of the nation's worst foreclosure crisis ever, the Federal Reserve Board proposed a rulemaking that would have gutted the Truth in Lending Act right of rescission – the strongest defense homeowners have against foreclosures.
The Federal Reserve Board again proved itself deaf to consumer protection concerns in its recent rulemaking under the Durbin Interchange Amendment, in which it ignored basic economics to question whether there would be any consumer savings as the result of lowered interchange fees. And the OCC, which used preemption to shield subprime mortgage lenders from state regulation without substituting its own consumer protections, has proposed revised preemption standards that flagrantly disregard Congress's express directions on preemption in the Dodd-Frank Act.
Had the Consumer Financial Protection Bureau (CFPB) existed in 2004-2008, it might well have saved this country from the housing bubble and subsequent collapse. It could have regulated the mortgage market to curtail predatory lending practices, such as the widespread use of payment-option adjustable-rate mortgages and other unsustainable financial products. The CFPB could also have insisted on the very standards that Congress demanded in title XIV of the Dodd-Frank Act, including that mortgage lending be conditioned on the ability to repay – not the ability to refinance.
Congress rightly recognized the severe shortcomings of the current system of consumer financial protection when it enacted Title X of the Dodd- Act and created the CFPB. In so doing, it consolidated consumer financial protection into a single agency with a single director who can be held accountable for the agency's performance. Congress also gave the new agency sufficient funding and budgetary independence to ensure that consumer financial protection, like other parts of bank regulation, will not be held hostage to politics because it is too important to financial stability.
The new agency has substantial powers to regulate consumer financial products, but it is also subject to even more substantial safeguards that make it more accountable than any other comparable federal agency.
The CFPB's mission is to ensure a fair, equitable and transparent consumer financial products marketplace and protecting consumers from unfair, deceptive or abusive products.
Unfortunately, the dynamics of the consumer finance marketplace discourage transparency and easy-to-price products. It is precisely this dynamic that calls for regulatory involvement to foster transparency and, thus, encourage optimal competition.
Transparently priced products have smaller profit margins, because consumers can comparison-shop more easily on an apples-to-apples basis.
This creates a strong incentive for financial service providers to market complex, opaquely priced products that cannot be readily compared with other products. This is done by having multiple price points on products, by bundling products together or by having behaviorally contingent pricing, such as late fees. As a result, it is very difficult to know in advance the total cost of using most consumer financial products.
Consider the purchase of a new car. One can easily shop around on the Web for price quotes, but those are quotes for the car itself (and frequently not for exactly the model the dealer has in stock). The car, however, is sold as part of a bundle of goods and services. The total price paid is a combination of the sale price on the car, warranties, financing costs, trade-in value, rust-proofing, gap insurance, etc. It is extremely difficult to do comparison-shopping on the all-in price of the car purchase.
A similar story exists for credit cards. Credit cards have multiple price points – typically a purchase APR, a cash-advance APR and a default APR, an overlimit fee, an annual fee, a late fee, a foreign transaction fee, and numerous other possible fees. They also have rewards programs, which are a type of negative pricing. Unless a consumer knows exactly how he or she will use a card, it is impossible to know just how much the card will cost to use and, therefore, how it compares with other cards. The Credit CARD Act of 2009 rectified some of these problems, such as the possibility that interest rates would change on cardholders retroactively, but the complexity of credit card pricing still bedevils consumer attempts to compare total costs of use in advance.
In the world of mortgages, it is only slightly better. It is relatively easy to compare the cost of simple, largely standardized products like 30-year fixed-rate mortgages, especially as the Real Estate Settlement Procedures Act requires disclosure of the closing costs in advance. But adjustable-rate products and prepaid interest (points) complicate comparison-shopping.
Moreover, there is no place a consumer can go to get mortgage quotes from every lender in the market. The mortgage market is a market where financial institutions from across the U.S. should be competing on every loan. Yet mortgage brokers typically offer quotes from only three or four lenders, and online sites like LendingTree have similarly limited stables of lenders. Comparison is easier, but the menu is restricted.
All of this produces an inefficient consumer finance marketplace in which consumers often overpay for products they neither need (e.g., credit life or gap insurance), nor want (e.g., American Express provides cardholders with insurance for repatriation of remains if you die abroad – an irrelevant benefit to those who do not travel abroad).
Consumer financial products should be commodities with very thin commodity profit margins; they involve the ultimate fungible – money. Consumer financial product pricing, however, is anything by commoditized. That inefficiency is very profitable, however, to financial institutions that are able to craft their products to take advantage of consumer misperception of total cost.
In this marketplace, it is very difficult for financial institutions – such as community banks and credit unions that offer fair, transparent, simple products – to compete. While their products are, in fact, price-competitive, especially when customer service is accounted for, consumers do not recognize this. For example, a credit card lender that listed only one all-in interest rate and no fees would have to list a much higher APR than card lenders that use multiple interest rates and also have multiple fees. That high APR would likely scare away potential customers, even if the all-in cost of using the card was lower than that of other cards.
All of this speaks to a need for regulatory involvement in the consumer financial marketplace to encourage more transparent pricing and thus better price competition to benefit consumers. Federal regulation of consumer financial services is primarily through disclosure regulation. Disclosure has only recently become the focus of serious scientific examination; previously, it was prescribed as a regulatory fix as a matter of faith, not knowledge.
We are quickly learning that while disclosure can have a powerful impact on consumer behavior, the manner in which it is done has an enormous impact on its effectiveness. Done well, disclosure is an important tool producing the information necessary to make markets work. Done poorly, disclosure can actually create market inefficiency. Having an agency like the CFPB that can develop deep expertise on consumer financial products is likely to result in better and more effective disclosures and thus more transparent consumer financial products and more efficient markets.
CFPB accountability
Some members of Congress have expressed concern about the CFPB's accountability. It is hard to understand these concerns as anything other than a cover for a political agenda of gutting the CFPB because there are not the votes to kill off the bureau outright.
As a purely factual matter, concerns about CFPB accountability are puzzling. As detailed below, the CFPB has an extensive and unusual set of oversight provisions that make it more accountable than any other federal financial regulator. The CFPB and other agencies (e.g., the Environmental Protection Agency (EPA), Federal Deposit Insurance Corp. (FDIC), Federal Reserve Board of Governors, Federal Trade Commission (FTC), OCC, OTS, Securities and Exchange Commission (SEC) and Social Security Administration) all share several key oversight devices: the Administrative Procedure Act (APA) rulemaking, APA adjudication, congressional oversight and moral suasion by the administration.
Beyond that, there is variation in oversight devices. The CFPB is not subject to the same additional oversight devices as the other agencies, but it is certainly subject to significant additional oversight via the annual Government Accountability Office (GAO) audit, Small Business Regulatory Enforcement Fairness Act/Office of Information and Regulatory Affairs (OIRA) reviews, a budgetary cap and the Financial Stability Oversight Council veto.
This is far greater oversight than there is for the other federal bank regulators – OCC, the OTS, the Federal Reserve Board, and the FDIC – or for the SEC.
The CFPB is subject to the APA and must follow notice-and-comment procedures for rulemaking and adjudication. This means that the CFPB will be required to take account of and respond to a range of views and concerns on any regulatory issue on which it undertakes rulemaking and that these rulemakings can be challenged in federal court.
OIRA reviews
CFPB rulemaking is subject to the OIRA review for small-business impact. Only the EPA and Occupational Safety and Health Administration are subject to similar requirements.
The CFPB is specifically limited by statute in its rulemaking power. Title X of the Dodd-Frank Act requires that the CFPB make particular findings, including cost-benefit analysis, in order to exercise its authority to restrict or prohibit acts and practices as unfair, deceptive or abusive.
It is also worth emphasizing what the CFPB cannot do:
- force financial institutions to extend credit;
- mandate the offering of any financial product;
- require financial institutions to offer "standard" or "plain vanilla" products if they offer "alternative" products;
- require consumers to purchase financial products;
- cannot impose usury caps;
- cannot regulate non-financial businesses; and
- cannot create private rights of action.
At most, then, the CFPB can curtail the offering of certain financial products. This is a critical point, because it means that it is virtually impossible for CFPB actions to be a source of systemic risk because it cannot force financial institutions to make loans that they do not wish to make.
Statutory budget cap
The CFPB is subject to a budgetary cap, unlike any other federal bank regulator. Unlike most regulatory agencies, federal bank regulators are budgetarily independent; they are not funded through the appropriations process. Viewed in this framework, the CFPB is actually less independent than other federal bank regulators. If the OCC, FDIC or OTS wishes to increase their budgets, they can simply increase their assessments on banks without so much as a by-your-leave to Congress. Similarly, the Federal Reserve can simply print money.
The CFPB, however, is restricted to a capped percentage of the Federal Reserve's operating budget. This means that the CFPB actually has less budgetary independence than any other federal bank regulator.
The budgetary independence of bank regulators and the CFPB represents what prominent conservative legal scholar Richard Epstein has termed "second order rationality" – namely, steps people take to protect themselves against their own lack of self control. It is tempting for Congress to play politics with bank regulation or consumer protection. Thus, if bank regulators' budgets were subject to the appropriations process, the agencies' effectiveness, and thus the president's constitutional obligation to enforce federal laws, could be held hostage by a minority in either house of Congress.
The independent funding of the bank regulators and CFPB is designed to guard against that very possibility. The CFPB's budgetary independence recognizes that federal budgets are complex, negotiated deals that don't allow for proper airing of policy issues. In a federal budget, the CFPB's funding might be held hostage for issues that have nothing to do with the CFPB, such as deficit reduction. One of the insights from the mortgage crisis is that consumer protection is simply too central to economic stability to subject it to the politics of the appropriations process.
The Responsible Consumer Financial Protection Regulations Act of 2011 would subject the CFPB – but no other federal bank regulator – to the annual appropriations process. I strongly urge the committee to reject this proposal. Subjecting the CFPB to the appropriations process would do far greater damage to consumers and the economy than any wayward action by the CFPB. If the CFPB is subject to appropriations, it will be a cyclical – and, ultimately, ineffective agency – as its budget becomes a political football.
GAO review
The CFPB's budget is subject to an annual audit by the GAO, with the results reported to Congress. No other federal bank regulator is subject to such an audit.
FSOC veto
CFPB rulemaking is subject to a veto by the Financial Stability Oversight Council (FSOC). This is unique for federal bank regulators. The OCC and OTS' preemption actions, for example, are not subject to review by other federal regulators, even though they were a key element in fostering the excesses in the housing market. The FSOC veto provides an unusually strong check on CFPB rulemaking, not least because no CFPB director would wish to risk a FSOC rebuke.
Congressional oversight
The CFPB is subject to oversight by Congress itself. The CFPB director must make periodic reports to Congress and appear before congressional committees. This committee's actions, as well as those of the House Financial Services Committee and House Government Oversight and Reform Committee, show that this oversight is serious, diligent and exacting, with no fewer than six hearings in the past four months focused on the CPFB. Congressional oversight is perhaps the best guarantor that the CFPB will not abuse the authority delegated to it.
Moral suasion
The CFPB director may be removed only "for cause" – a standard that also applies to the Federal Reserve Board, the FDIC, the FTC and the SEC. The standard may also apply to the OCC and OTS Ddirector; the U.S. Code is silent in this respect. Even when a for-cause dismissal standard applies, however, a president may exercise considerable moral suasion over the head of an agency. There are few individuals that would refuse a presidential request to resign, even if they were within their legal rights to do so.
Adam J. Levitin is a professor of law at the Georgetown University Law Center. This article was adapted from testimony that Levitin gave before the Senate Banking Committee on July 19. To read the complete testimony, click here.
