On July 21st, we marked the one year anniversary of the passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act, the Democratic Congress’ legislative response to the catastrophic financial collapse of 2008.
Dodd-Frank failed to end the Too-Big-To-Fail doctrine. Quite the opposite. By creating a new category of “systemically important institutions” Congress has put a gold star on institutions which will always be bailed out.
Congress has institutionalized a system of privatized profit and socialized loss. What Dodd-Frank did do was to set up a new regulator, the Consumer Financial Protection Bureau (CFPB).
President Obama’s first CFPB head, Elizabeth Warren, has been attacked by some conservatives (and many lobbyists) as a dangerous zealot. The Obama administration gave up trying to confirm her, and last week withdrew her nomination in favor of the former Attorney General of Ohio, Richard Cordray (whom Warren had hired as head of enforcement for the Agency).
The irony is: Elizabeth Warren was probably a better choice from the conservative point of view.
The main organizing idea for the CFPB is to consolidate statutory authority already in existence under current law and house it in a regulator devoted exclusively to consumer protection. The existing banking regulators, especially the Comptroller of the Currency, are rightly believed to care much more about protecting market share for banks then protecting customers from banks.
CFPB has jurisdiction over two main products – credit cards and home mortgages. In the case of home mortgages, the rules which the CFPB is working on require banks to lend to customers who have some ability to pay off the loan and to disclose to the customer in plain English the nature of the obligations he or she is assuming under the loan. Neither of these rules has its precedents in the Communist Manifesto. Since the taxpayers are the insurers of last resort for all home mortgages, we have a strong interest in seeing that persons to whom home loans are being extended can actually pay them back. We currently own or guarantee over a trillion dollars worth of home loans in default on the balance sheets of Fannie, Freddie and other significant financial firms which did not bother to assess whether the borrower could actually pay back the loan. Because Dodd-Frank exacerbated the risks associated with the-too-big to fail doctrine, as a second best solution, a federal suitability requirement for borrowers serves to provide some protection to taxpayers from acquiring another portfolio of nonperforming assets.
In the case of credit cards, the main thrust of the CFPB’s rules go to the disclosure of the fees and interest being paid by customers. Some in the Agency would like to impose a suitability requirement on financial firms for the ability of customers to pay off their card balances. Given that such a rule would result in a significant diminution of credit availability to low income (and no income) persons, disproportionately important groups to the Democratic collation, that rule, one suspects will not get very far.
Data from last year indicated that over 75% of credit card holders revolve a monthly balance, the balance averages about $7800 per cardholder and the average interest rate paid on those balances was about 16.5%, when including late fees and other penalties disproportionately paid by this group of cardholders. (Lacking access to a Bloomberg terminal in my summer watering hole I have not been able to update these numbers, the interest rate is almost certainly lower, I am not sure about balances given the economic distress that many of these cardholders may be experiencing). Conservatives can agree that it’s a legitimate purpose of government is to prevent persons from being defrauded. Do we really want the bulk of the population to be carrying consumer debt, often incurred frivolously, without any understanding of the long-term cost, at usurious rates of interest?
Elizabeth Warren’s most widely known scholarship (profiled on Sixty Minutes no less) indicated that commercial banks derived as much as 70% of the profits of their entire consumer banking operations from the tranche of credit card holders who revolved large balances but did not default, instead paying monthly minimums indefinitely, becoming increasingly buried in indebtedness. I don’t know if her numbers were correct (they were widely disputed) but given the vigor with which she was attacked by the representatives of the big commercial banks, I suspect she was on to something. Most of these cardholders are financially naïve, have short time horizons and are prone to consuming more than they produce. Disclosures that will cause some of them to alter their behavior so that they produce less negative savings may also align their interests with a broader fiscal conservatism.
The critique of the CFPB from the right is as follows: (1) its theoretical jurisdiction is enormous – encompassing extensions of credit to consumers generally; and (2) it is unaccountable to Congress and to the political process because it is run by an Administrator rather than by a Commission (in which there is minority representation) and it is funded by money made in the open market operation of the Federal Reserve (Washington speak for ‘the Fed prints its budget’) rather than being subject to a Congressional appropriation. The first critique is correct; its theoretical jurisdiction is vast. So too is that of the Federal Trade Commission, which has jurisdiction over “unfair and deceptive trade practices” in commerce (exempting financial services firms and common carriers, which had sufficient lobbying stroke to be carved out). A solution would be to limit its jurisdiction to insured depositary institutions and their affiliates (and probably pawn shops and pay day lenders as a give to the left). It could also be constrained by the case law interpreting unfair and deceptive practices developed under the FTC Act.
Senator Richard Shelby of the Senate Banking Committee and Chairman Spencer Bachus of the House Financial Services Committee have proposed legislation to make the CFPB a Commission and make its budget subject to an annual appropriation. Both proposals are eminently reasonable. Making the CFPB a commission was supported by Henry Waxman during the consideration of the legislation that became Dodd-Frank. (It was dropped in the Senate because of opposition from consumer groups). The left has said the Republicans will defund the CFPB. An obvious solution would be that its budget should begin by being an amalgamation of the consumer protection budgets of those agencies whose jurisdiction was transferred to the CFPB (and said agencies budgets should be reduced accordingly, no net new spending, though don’t hold your breath on banking regulators giving up budget authority even if they have lost jurisdiction).
The area in which the CFPB jurisdiction was altered from that of the regulators whose authority it subsumed was in the area of enforcement. Specifically, the Board’s rules can be enforced by State Attorneys General. (Most Federal banking rules can only be enforced by Federal officials). Many State Attorneys General on the Democratic side have tight relationships with their local trial bar. A number will deputize plaintiff lawyers to act on behalf of the state in bringing actions and will pay them by means of a percentage fee of the recovery. The potential for our friends in the trial bar to view a potential new set of deep-pocketed defendants in the form of too-big-to-fail banks should not be underestimated.
The bulk of Elizabeth Warren’s work focused on regulatory solutions to protecting consumers. She certainly will know the empirical evidence indicating the minimal benefits to consumers of litigation. Richard Cordray, the Attorney General of Ohio until the landslide of 2010, approaches questions from the perspective of enforcement in the courts. The literature is clear that the costs of private enforcement are overwhelming borne by shareholders and customers of financial firms and the benefits to consumers are usually nil. The Act contained this because of the central support the trial bar gives to the Democrats and their ability to ram it though the House in the Senate in the last Congress with essentially no Republican support. I suspect Warren would have been more focused on the readability of disclosures to ordinary consumers (which can change behaviors). Cordray may be more inclined towards a litigation-focused regime that could garner support from the national trial bar for a potential challenge to Ohio Governor John Kasich in 2014. A deal in which the Shelby-Baucus legislation moved in exchange for an up or down vote on Warren would not have been a bad one.