Tag Archives: Consumer Protection

Good-Bye, Vanilla Option

I realized I didn’t say anything about the death of the vanilla option from the Consumer Financial Protection Agency proposal. I was going to right something targeted and biting, but it ended up as a much broader column for the Washington Post about the Obama Administration’s commitment to regulatory reform.

Mike Konczal, fortunately, has two good posts on the topic: one a eulogy for plain vanilla, one on the underlying problems that plain vanilla would have helped solve. He also points out at least three ways the federal government can achieve some of the same goals through other means:

  • Banning prepayment penalties on mortgages
  • (Citing Alyssa Katz): using the government’s historically large and now even bigger influence in the secondary market to encourage plain vanilla mortgages
  • (Citing Steve Waldman): a government charge card (think “public option”)

All of those posts are worth reading. If we’re not going to have plain vanilla, we need other new ideas about how to channel innovation into things that provide consumer benefit and put a floor under the quality offered by the private sector. More disclosure won’t work (that already failed).

Update: The Raven compares the Obama administration to the Johnson administration, each with its “devil’s bargain.”

By James Kwak

CFPA and Non-Banks

Elizabeth Warren has a new op-ed at New Deal 2.0 arguing for, surprise, the Consumer Financial Protection Agency, but this time with a different emphasis – non-bank lenders.

The opponents of the CFPA – not only banks, but the head of just about every current financial regulatory agency – argue that consumer protection should be combined with prudential regulation, so that one agency should be both making sure that a bank doesn’t collapse and that it isn’t abusing its customers. Many people have pointed out the flaws with this argument: first, consumer protection invariably slips down on the priority list; second, regulators become hesitant to crack down on abusive practices because those abusive practices generate the profits that make the bank “healthy” to begin with.

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Consumer Protection Redux: The Lessons of History

For your Labor Day reading enjoyment, we bring you this guest post by Lawrence B. Glickman, who teaches history at the University of South Carolina and is the author of Buying Power: A History of Consumer Activism in America.

“We’re proposing a new and powerful agency charged with just one job: looking out for ordinary consumers,” said the president on June 17th.  The centerpiece of his proposed overhaul of the nation’s financial system, the Consumer Financial Protection Agency (CFPA), is designed to end what the president called “failure of…government to provide adequate oversight” by monitoring banking transactions, including mortgages, credit cards and checking and savings accounts. It did not take long for the predictable critics to denounce the agency with predictable rhetoric.  “It’s bad for the consumers,” said Steve Bartlett, president of the Financial Services Roundtable, a lobbying group for banks.  The institution will add “yet another regulatory layer” while advancing “the agenda of activist special interests,” according to the U.S. Chamber of Commerce.  The new agency represents “an unprecedented grant of power to mandate business practices” claims the American Bankers Association.

This is the language of conservative populism, a mainstay of the Republican party from Ronald Reagan to Newt Gingrich to Karl Rove. Conservative populism, wrote Jonathan Chait in the New Republic last year, “dismisses any inference that the rich and the non-rich might have opposing interests” and defines elites in cultural rather than economic terms as  “intellectuals and other snobs who fancy themselves better than average Americans.” Several decades of repetition have made this rhetoric familiar: federal efforts to help ordinary people–consumers–will inevitably hurt them; government is the problem rather than the solution; bureaucracy is “bumbling” (to use the words of a Crain’s New York Business poll about the proposed Agency); federal agencies designed to serve the public good actually serve narrow special interests.  It has been, in no small measure, through the ready deployment of this language that the Republicans have positioned themselves as simultaneously the party of big business and working Americans while denouncing Democrats as representing both intrusive government and elitism. This meme has been devastating for liberals since any expansion of government services can be dismissed with a quip–Bureaucrat!, Red Tape!, Nanny State!– rather than an argument. Recently, for example, Senator Lindsay Graham said that the American people would never tolerate the public choice option in health insurance because “you’ve got a bureaucrat standing in between the patient and the doctor.” For similar reasons, Senator Kit Bond dismissed the CFPA proposal as a “bad idea.”

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Vermont, Texas, and Subprime Loans

The Wall Street Journal has a story about Vermont and subprime loans:

…For the past five years, as home loans went to even Americans with poor credit and no proof of steady work, Ms. Todd couldn’t get a mortgage in spite of her good credit and low debt. Vermont banks told the self-employed landscaper that her income stream was unreliable. The 32-year-old changed careers, taking a permanent job as a teacher, to boost her chances.

Vermont’s strict mortgage-lending laws largely prevented the state’s residents from signing the types of dubious home loans written in other markets across the country. Its 1990s legislation made mortgage lenders warn customers when their rates were relatively high, and put the brokers who arranged loans on the hook if their customers defaulted. Now, by at least one measure, the state has the lowest foreclosure rate in the U.S…

These tendencies help explain how, in the 1990s, the state moved to rein in mortgage lenders based on just a few instances its chief regulator says raised red flags. According to Vermont’s Department of Banking, Insurance, Securities and Health Care Administration, one broker solicited customers through newspaper classified ads, charging up to $5,000 for referring customers to a lender. Another searched property records for owners’ tax liens, a town clerk reported, searching for what the department believes were people who could be desperate to borrow….

In laws passed between 1996 and 1998, Vermont required lenders to tell consumers when their rates were substantially higher than competitors’, with notices printed on “a colored sheet of paper, chartreuse or passion pink.” And in what officials believe is the first state law of its kind, Vermont declared that mortgage brokers’ fiduciary responsibility was to borrowers, not lenders. This left Vermont brokers partly on the hook for loans gone sour…

Vermonters didn’t see the same sharp rise in home ownership that swept much of America in recent decades, which, despite the bust, buoyed economic growth. And while part of the increase in U.S. home ownership reflected excesses in lending and borrowing, some of it represented real progress in the form of more Americans achieving the cherished goal of getting — and keeping — a home of their own. By 2007, the percentage of owner-occupied households as a whole reached 68.1%, up from 63.9% in 1990, according to U.S. Census data. Vermont started at a higher base but saw ownership rise just 1.1 percentage points in that span, to 73.7%.

Daniel Indiviglio follows up it with an in-depth comparison to Florida, while Tim Duy goes through the article and ends with this fantastic note: “according to the article, the ‘pitfalls’ amount to: Informed consumers, fewer foreclosures, healthier banks, higher rates of homeownership, and virtually no impact on average growth. Those are some ‘pitfalls’ – truly, greater consumer financial protection would spell ruin for us all.” Ha!

Two additional things:

Prepayment Penalties To go back to an old soapbox of mine, it’s worth noting that Vermont has outlawed prepayment penalties. Why is this important? My own thoughts, and the research is finding this as well, is that “lenders designed subprime mortgages as bridge-financing to the borrower over short horizons for mutual benefit from house price appreciation…Subprime mortgages were meant to be rolled over and each time the horizon deliberately kept short to limit the lenderís exposure to high-risk borrowers.” The prepayment penalty is what made these bad-faith loans profitable to the lenders, and with house prices increasing, prepayment penalties allowed lenders to bet directly on this housing appreciation.

To put it a different way, banks, instead of underwriting borrowers, were betting that house prices would increase, and paying consumers to sit in the houses. The fees and prepayment penalties were the payout that made this bet profitable (with that consumer getting what’s left over in housing appreciation). Banks don’t normally bet on house prices – they have exposures, but they are secondary exposures related to recoveries and risks – they bet on consumers. Getting rid of these prepayment penalties keeps them from taking that side bets. It also helps markets actually do their job, by allow borrowers to shop between outfits and products while reducing this transaction cost – and allow the innovation of interest rate risk management to make things a little easier for the consumer.

Texas Like Vermont, Texas has some of the strictest mortgage regulations on the books. No prepayment penalties, no balloon mortgages, etc., and as a result of the Homestead Act of 1839 and subsequent laws strict rules on Home Equity Loans (pdf).

I mentioned earlier in the year, that these consumer protection laws may have played a major role in keeping Texas from having a major housing bubble. I did not know at the time that there was a study at the Dallas Federal Reserve, Why Texas Feels Less Subprime Stress than U.S., that also came to the same conclusion:

Due to the state’s strong predatory lending laws and restrictions on mortgage equity withdrawals, a smaller share of Texas’ subprime loans involve cash-out refinancing, which reduces homeowner equity and makes default more likely when mortgage payments become unaffordable….

State data on subprime mortgage delinquencies suggest that housing prices and local economic factors are still the primary drivers of subprime default rates. Even so, mortgage characteristics also matter—from the incidence of ARMs to the purpose for which the loan was taken out. In general, cash-out refinancing loans are more prone to delinquency than loans for outright purchases.

Recent tightening of credit standards in the mortgage market has put a lid on the growth of subprime and exotic mortgages. Nevertheless, a sharply deteriorating economy, weak home sales and a continued downward trend in housing prices suggest that delinquencies and foreclosures will continue at a high level.

I find it very ironic that places like the AEI are using Texas as the role model for The Way States Should Conduct Themselves in the future, which is by association bootstrap-tugging laissez-faire financial capitalism. The research produced at the Dallas’ Federal Reserve, by economists on the ground, points out the exact opposite – consumer protection is a major reason why Texas isn’t Arizona or California or Florida. Consumer protection allows a baseline of financial safety, a net where the work of building our real economy can take place.

A CFPA Research Brief

I want to point out this research brief on the Consumer Financial Protection Agency (pdf file) from Law Professor Adam Levitin. At 16 pages, it’s the best one-stop paper I’ve seen for understanding why CFPA needs to pass.

As opposed to specific practices, Levitin focuses on four key structural issues that are broken with our current system.

1. Consumer protection conflicts with, and is subordinated to, safety-and-soundness concerns.
2. Consumer protection is a so-called “orphan” mission.
3. No agency has developed an expertise in consumer protection in financial services.
4. Regulatory arbitrage of the current system fuels a regulatory race-to-the-bottom.

The first point is key and informs the rest of them. “Safety-and-soundness” means that regulators currently are focused on making sure the banking system is sound, part of which means that banks have lots of money. So if Americans are paying a mind-boggling $38.5 Billion dollars in overdraft fees a year (more than the GDP of Kenya, as a comparison) that just means regulators can sleep a little more soundly at the wheel.

If having giant banks dedicated to soaking and misleading consumers was creating a safer and more sound financial system, that would be one thing, though preliminary evidence says no:

Since protecting large banks at the expense of consumers is the current goal of the regulatory structure, other goals such as collecting data on actual experiences of consumers (something researchers have a difficult time finding, and have to use poor substitutes like aggregate consumption diaries), having in-depth knowledge locally on scene, and fighting regulatory arbitrage among the current 11 agencies that investigate this material fall by the wayside.

Levitin also brings up this point, mentioned again and again (and worth mentioning again): “Most consumer financial products differ in their class primarily on price, not functionality, but product pricing structure is designed to make comparison shopping difficult in order to avoid commoditization (and inevitably lower profit margins). Better disclosure should encourage commoditization and price competition, which should actually bring down prices.”

If you are in the business of reading or disseminating research papers, I’d recommend that Levitin paper. Though health care is rightfully focusing our minds and attentions these days, this is another piece of necessary reform that could get easily thrown under the bus.

Has Anyone Taken Responsibility For Anything? (Weekend Comment Competition)

With the anniversary of the Lehman-AIG-rest of the world debacle fast approaching, it seems fair to ask: Who accepts any blame for creating our excessively crisis-prone system?

Friends and contacts who work in the financial sector freely discuss their participation in activities they now regret.  But where is the mea culpa, of any kind, from a public figure – our “leadership”?

I suggest we divide the competition into three classes.

  1. Policymakers who now admit that any of their actions or inactions contributed to the Great Credit Bubble.  Blaming China gets a person negative points; this may hurt Fed officials.
  2. Private sector executives who concede they made mistakes or misjudged the situation so as to lose a lot of Other People’s Money.  Blaming Hank Paulson also earns negative points (too obvious). Continue reading

Can the Federal Reserve Protect Consumers?

Ben Bernanke, chairman of the Federal Reserve, insists that the Fed can protect consumers effectively against defective or dangerous financial products.  He and his allies are therefore signaling opposition to – and even defiance of – key parts of the Treasury’s plan for regulatory reform, which involve setting up a new Consumer Financial Protection Agency.

The Fed is a well-regarded institution in general and Bernanke is currently riding a wave of personal popularity and prestige, but are these claims vis-à-vis consumers plausible?

Not really. Continue reading