The CFPA and Small Banks

To be clear, I favor the Consumer Financial Protection Agency. I favor it because I think it will be good for consumers. I also like to think that it will be good for small banks relative to big banks. My main argument for this is that should not harm the main competitive advantages of smaller banks, which should be customer service and local underwriting. But I’m still in favor of the CFPA even if it doesn’t help small banks.

John Pottow (hat tip Mike Konczal) agrees on the small bank point. His main argument is that the CFPA should lower fixed regulatory costs by making it easier to get approval for basic products. He also adds this point:

“The current credit market, with its indecipherable multi-page contracts, is not competitive. Actually, that’s not true: It’s perniciously competitive — the competition focuses on better hiding fees in small print. Burying terms in legal documents is an activity where larger banks again hold the advantage. By contrast, a true plain vanilla market would remove the obfuscation and refocus the competition on price. Once more, smaller lenders would benefit from this increased transparency and leveled playing field.”

Now, Stephen Ranzini, an executive at a small bank did write in with this comment on Pottow’s article:

“Since the penalty for offering any product that isn’t ‘plain vanilla’ will be severe if that product is ‘after the fact’ found to be not to the liking of these new CFPA bureaucrats, only plain vanilla products will be offered. Since large banks can leverage economies of scale and a lower compliance burden per dollar of assets to outprice smaller banks and we won’t be able to compete anymore by crafting niche products to serve niche needs, we will be screwed (as will our customers). Gov’t needs to better regulate the non-banks. Michigan has only 15 bank examiners for all the mortgage firms in the state. These non-banks created 95% of the toxic exotic mortgages because they aren’t effectively regulated.

Now, there’s a fair amount of hysteria and blame-the-other-guy in here. First, he throws in the insult of calling CFPA regulators “bureaucrats,” while later in the comment he says there should be more regulators – to regulate non-banks, not him. Note that he doesn’t call those other regulators “bureaucrats;” he calls them “bank examiners.” I agree that non-banks need more regulation, but I don’t agree with the implicit assumption that this can be done by traditional prudential regulators; we’ve already seen where that got us. Also, blaming subprime lending on “non-banks,” is disingenuous, although they did play a major role. Not only did the top 25 subprime lenders include banks such as Citi, Wells, Wachovia, Chase, HSBC, IndyMac, and National City, but most of the others were supported by large banks that provided financing by buying up their mortgages.

Still, though, if the commenter is right that the small bank strategy is “niche products to serve niche needs,” then he may have a point. I’m still skeptical, because his entire argument rests on the premise that regulation will be so severe that it will be chilling to the market – and when have we seen that in the last thirty years? – but there could be something there.

By James Kwak

16 responses to “The CFPA and Small Banks

  1. I think the most reasoned argument for the CFPA is Levitin’s pew financial reform piece.

    http://www.pewfr.org/task_force_reports_detail?id=0015

  2. About the reforms, I’d like to recommend this post from Peston:

    http://www.bbc.co.uk/blogs/thereporters/robertpeston/2009/09/banks_can_learn_from_retailers.html?ssorl=1253112103&ssols=13&ssoc=login

    I’ve read both the Kay essay and Haldane speech, and they are both on the right track: Narrow/Limited Banking.

    The CFPA is a good idea because it will make it easier to find information like this:

    http://blog.affil.org/

    Just as a matter of fact, the info is there, but just not being accessed. The CFPA would help. And it should be paid for by a progressive tax on bank size.

  3. A little chilling now is not a bad idea.

  4. JAMES: Stephen Ranzini actually has a good point.

    Subprime loans, I believe, began with a small bank in New York who lent to recent immigrants in their community. They knew them, and knew they would pay back the loan, even though they did not have good credit scores. Calculated Risk had a story on this a year or so ago.

    It was a profitable and successful product because they bank had identified an ignored market segment, and used its size and credit assessment skill to lend to it. This is what bank innovation should be about.

    I believe that the bank was bought, its acquirer saw how profitable its subprime loans were, and did more of those in markets where it did not have strong credit assessment ability, and the whole thing took off from there.

    The point is that banks should focus on assessing credit risk. They should be barred from secondary markets, they need to keep all the loans on their own books. Having a “consumer protections agency” will have bureaucrats focusing on CYA, just as the ratings agencies became a big game of CYA.

    The public purpose of banks is to make loans that will be paid back. The chief skill they need is assessing credit risk. The best incentive for them to focus on credit risk is to end securitization.

    We know for a fact that the financial sector can generate enough lending for public purpose without securitization. The US had no shortage of housing before the 1970s, which is when MBS started.

  5. One very serious flaw in this logic. The CFPA eliminates federal preemption unless there is a direct conflict – more protective states law trump the CFPA. States are free to enact more stringent regulations and to enforce both federal and state regulations against the covered entity. Given the extremely braod coverage of the CFPA, a retailer operating in 5 states and offering a credit plan would potentially have to offer five separate credit plans. The same for a financial advisor, which is also covered by the act. Hundreds of thousands of businesses that are not “banks” will be swept up by the law.

  6. “niche products to serve niche needs”

    I hope someone asked him to provide an example of the products he is referring to and explain what exactly he is concerned about.

    I’m sure they only participate in the good innovations, though.

  7. Halndane is brilliant.

  8. How is that a flaw?

  9. Seriously, since when did small banks offer “exotic” products?

  10. You mean other than plain vanilla products? Per Mr. Ranzini, it’s the only way they can even compete…

  11. How do you have a plain vanilla product that then has to conform with up to 50 different state laws?

  12. I don’t know, ask the insurance industry.

  13. “Yes. Yes. Only good products. Only good products. Yes. Yes. Only good products. Yes. Yes. Only good products…….#@!$#@!……..Robot need reprogramming. Robot need reprogramming……..Where is Phil Gramm? Where is Phil Gramm?”

  14. well I do not know about your American banks but our more than pedestrian Volksbank convinced villagers way out in rural Germany to safe haven their money from taxes in Luxembourg promising that there would be no currency risk and evidently pulling it off because if it had not worked a major scandal would have ensued and hardly passed without some media brouhaha

    that was at the same time btw when the media told us that the only way you could do it was by carrying a suitcase full of cash over the border

    a banker is a banker is a banker

  15. To see why the CFPA is just lipstick on the pig, let’s take a peak inside the bubble economy.

    The bubble economy is not new. Its first stage began in the Seventies, when the explosion of petrodollar lending focused on Mexico and South America brought the banking system to the brink of collapse in 1982. The Treasury engineered a bailout of the leading overleveraged top tier banks by demanding participation of smaller banks in new loans to already overextended borrowers covering interest on defaulted loans which allowed the under water banks to maintain a fictional solvency. Meanwhile, the corporate sector was given a tax holiday, savings and loans were deregulated and the consequence was a real estate and stock market bubble in which savvy entrepreneurs gobbled up under valued corporate assets using junk bond financing, while the S&Ls were looted, commercial real estate boomed and then crashed, the stock market staged a two month nose dive and finally recovered only after a convenient war to save Kuwaiti oil sheiks produced a spike in oil prices and a rush to the dollar that morphed into the Clinton stock market boom fueled by the Fed’s bargain basement money sale and the Treasury decision to finance the US debt on a strictly short term basis. This was possible largely because of the move to a common currency in Europe. No longer was US monetary policy required to take account of a strong Deutschmark. Money has to be somewhere. With government debt no longer having a positive yield, money fled into equities on the one hand, and emerging market debt on the other. Of course, the emerging market finance was largely looted by the kleptocratic economies of South Asia and Russia, and the equity bubble had to end as soon as the retail investor was all in, which happened just after the world failed to end on account of y2k and just as stock market pundits achieved relative unanimity on the idea that not even the sky was the limit. After the crash the market staged a semi recovery until the day all hell broke loose over the World Trade Center. Stocks plunged as every equity holder fled to safety in cash. Now we had an excuse for war, and although identifying the enemy was something of a problem there was no shortage of profit opportunities for those looking to cash in on mobilization, a new hysteria for homeland security, and a new round of oil price escalation, which was quickly engineered by the invasion of Iraq and the destruction of enough of that country’s oil infrastructure in forty days to remove the possibility that excess supply would cause the price of that important collateral to crash too. Meanwhile, residential real estate provided a new bubble opportunity. You had Fanny and Freddie ready to guarantee the obligation of any mortgage borrower, and an entire industry of finaglers to create an unlimited supply of paper needing only the signature of some poor sap hoping to use leverage of his own in the only place where he found leverage available, on the house he lived in. Investment banks understood that you could bundle two or three hundred worthless mortgages together and create a security salable to institutional investors desperate for some kind of return in a world where bonds didn’t yield anything worth having. Better than that you could slice these mortgages length wise and create higher and higher rates of return, salable naturally at higher and higher prices, and the only thing these CMOs needed was the seal of approval from a rating agency which was more than happy to oblige at a price. Now you had return without risk. What could be better than that? Of course, everybody in the know knew these things would have to blow sooner or later. That is what credit swaps were for. Offer somebody a high enough premium and he would take the risk off your hands. The insurance company of last resort was called AIG and it was one of the three or four largest concerns in the entire universe, hardly anything the Fed could ever allow to fail, so if you are Goldman and your business is absorbing risk on all this toxic garbage, all you have to do is lay it off on AIG. When you wake up one morning and realize AIG can’t pay, you call your boy at the Treasury and tell him it’s time to scare the s*it out of Congress. He calls the Fed and tells Bernanke it’s time to refuse its commercial paper facility to Lehman. You’ve wanted to kill them off for years and here’s your chance. Lehman goes broke, the credit markets completely seize up and Congress has no choice but to foot the bills for AIG, bail out all the major banks, stand around listening to Barney Frank and Nancy Pelosi talk nonsense and cave in to every single demand of Goldman’s boy at Treasury. Of course the stock market tanks for a while but the first ones to recover are Goldman and JPMorgan Chase, the only people you care about in the first place. The economy is still on it’s a*s, unemployment rises to fourteen of fifteen percent but statistically that amounts to only eight or nine and nobody really cares except those without jobs most of whom continue to blame themselves as well they should The important problem is controlling what is said about all this in the media, which is pretty simple since the newspapers don’t know s*it about s*it, the politicians know less, and buying GE commercial paper keeps that zombie on the air with nonstop bulls*it from morning to night about how recovery is just around the corner. Meanwhile, the banks are flush, perhaps there is no commercial lending going on but you still have a boom in stocks and bonds and lending on that is much safer anyhow since the collateral is all liquid. Top tier banks don’t do much lending anyhow. Major corporations have access to the bond market, real estate is so overvalued you’d have to be an idiot to lend on that. Makes much more sense for the banks to just lend to hedge funds and speculate in the bond and currency markets. Why else would the pound and the Euro be going up except that the banks are hedging against an ultimate collapse of the dollar and its end as a reserve currency? What will happen next of course will be an increase in Treasury bond yields, but once people can get six or seven or eight percent on the Ten Year why on earth would they want to keep money anywhere else? Now, if we can just figure out how to get people without jobs and credit to keep buying stuff…….

  16. Does more government control and less consumer choice sound familiar? The Consumer Financial Protection Agency (CFPA) is a new government agency designed to regulate consumer financial products. We need to support effective consumer protection that ensures concise disclosures about risks associated. Visit http://www.friendsoftheuschamber.com/issues/index.cfm?ID=469