Soaking Customers as a Form of Prudential Regulation

Good for Deputy Treasury Secretary (and YLS alumnus) Neal Wolin for wading into the American Bankers Association to defend the Consumer Financial Protection Agency. According to FinReg21’s article:

Wolin firmly rejected the argument made by American Bankers Association chief executive Ed Yingling in recent congressional testimony that responsibility for consumer protection should not be separated from the responsibility for safety and soundness. . . .

The industry has argued that prudential regulators are careful to preserve a profit margin on financial products, to keep financial institutions sound.

This is a staggeringly cynical argument. Basically it says that you should combine prudential (solvency) and consumer safety regulation because otherwise the consumer safety regulators will reduce profits to the point where banks will not make enough money to be healthy. This logically implies that if there is a banking product or practice that is unsafe for consumers, but whose elimination would threaten banking profits, you should allow that product or practice. Is this really what the industry means?

I couldn’t believe anyone would actually say this, so I tried to find a source. I looked in the most obvious place, which was Ed Yingling’s July 14 testimony before the Senate Banking Committee. To his credit, I couldn’t find that argument in all its brazen glory. However, I did find torrents of partial truths like this one attempting to make the same argument:

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.

Note in passing that the spokesman of the American Bankers Association places all the blame on “mortgage brokers.” More importantly, what Yingling leaves out is that from the perspective of the individual bank there is no contradiction between fleecing customers and making lots of profits (which is what makes you safe and sound). (a) Originate bad loans; (b) pocket fees; (c) sell bad loans to an investment bank for distribution; (d) repeat. What threatened to bring down banks was the fact that they held on to too much of the risk of those loans, either on their balance sheets or in their off-balance-sheet entities.

Yingling’s testimony is page after page of that. This is going to be a real battle.

By James Kwak

18 thoughts on “Soaking Customers as a Form of Prudential Regulation

  1. Grand Banking Poobah Dingaling is against a consumer protection agency. The entire rest of the universe will automatically be for it. They just need to be informe, and given a chance to throw their shoes at the proper target.

  2. Combining responsibility for solvency and consumer protection into the same agency is a classic recipe for regulatory capture.


    As in:

    Tennessee Valley Authority, protect the coal-producers, torpedo pollution regulation, over-invest in expensive capital equipment to maximize cost-plus investment returns type classic…

    As in, TEXTBOOK classic.

    The rules almost invariably become a mechanism for limiting competition to preserve a constant revenue stream.

    EVEN IF the regulatory agency really is pro-consumer, the regulated industries are at an advantage. Companies have private information about their own cost/profit structure. For example, they can shift costs into the regulated offerings, argue that too-low profit margins are threatening the business, and recover these costs by increasing prices in the regulated products to laterally subsidize their other lines of business (or, their bonuses). Mechanisms to elicit information (of which the market is one) are highly unreliable in such a relationship.

    The pressures toward regulatory capture are SO intense that unless we have an agency that has a decidedly pro-consumer bias… we’re likely to end up with something even worse than what we have today.

    The Federal Reserve would become a legal tool for collusion among big banks (even more so than it is now).

    Go Geithner!!! C’mon kid, you can do it! Forget all those bad things I said about ya…

  3. Makes me think of the hundreds of finance offers I’ve gotten in the mail over the last few years from banks. Offering loans at 0% in large print with a 3-4% transfer fee up front in small print.

    Tells us the same thing you’re saying, James. They think everybody else but them is stupid. So it’ll be easy for them to get richer at the expense of all us stupid people out here.

  4. Further on my previous post –

    So what are the bankers sitting in their plush offices & producing? Food, clothing, shelter, transportation, energy or health care? No.

    The bankers are producing these tricky, deceptive letters trying to deceive working people. Why else would they write & mail out such misleading offers unless they thought working people were stupid & easy to deceive?

  5. Sorry to drag this out –

    And how much interest are the bankers paying for this money they’re trying to make us believe they’ll lend to us at 0%, (but actually will lend to us at 3-4% up front)? They’re paying us the taxpayer 0-1/4% (the Fed discount window is actually the taxpayer window). Of course Bernanke thinks that’s his money he’s lending to the stupid, greedy bankers.

  6. All the offers came from big banks. None from small banks. Wonder why that is?


  7. I think you’re being too charitable when you call Yingling’s July 14th statement a “half-truth.” The banking industry created no-documentation (no income or asset verification) loans — the lack of required documentation was an intentional, integral, and advertised feature of the loans. The banking industry categorized these new kinds of non-traditional loans in their own category, Alt-A, and charged a higher rate of interest (or a large prepayment penalty) to compensate for the risk. For the primary representative of the banking industry to testify that the lack of income and asset documentation was a result of due diligence failures or fraud by mortgage brokers rather than an intentional feature of the loans themselves is not a half-truth — it’s an attempt at creating some kind of new, alternate reality. Moreover, Yingling’s statement that the failure to consider an individual’s ability to repay a loan is by definition “poor” or “fraudulent” underwriting is something of an indictment of the banking industry, which created these loans with the lack of income or asset verification as an intentional feature. That’s essentially an admission of negligence or fraud.

  8. A good place to get the testimony is C-Span. It’s free and has video of many of the more important hearings and testimony. It tends to be extremely drab and boring. But you can kind of see the heads of these different agencies “staking out territory” here. And also see the politicians attitudes on things. You can see for example some Democrats are definitely not fond of giving this power to the Federal Reserve since they’ve had it since 1994 and have totally dropped the ball. In essence Bernanke is arguing: Ya, the Federal Reserve totally f__ked this one up, but the Fed has the best people to handle these things. And not many people are buying that one.

    Here is one with Sheila Bair from the FDIC, Mary Schapiro from the SEC, and some guy from the Fed. July 23 I think. And I think maybe Bair testified again today (24th July)?? After reading about Bair in The New Yorker it’s interesting to see her talk for herself and get more detailed on policy.
    It’s 2 and 1/2 hours long, but if you’re really interested in these things and have time you can watch it here is the link.

  9. As usual StatsGuy, I agree with 99% of what you have to say, but I have to differ on those last 3 sentences. Should we believe Geithner would be fighting for the Consumer Financial Protection Agency (CFPA) if he was now Chairman of the Federal Reserve?? Geithner is like most of them, he sings whichever tune serves his self-interest. As the former head of the NY Fed, my guess is he felt the toe of President Obama’s shoes on his posterior before he gave those remarks supporting the Consumer Financial Protection Agency (CFPA).

    The end result, a fully empowered and enforcing CFPA will be good for taxpayers and consumers, but let’s not give any haloes to Geithner.

  10. Right you are, Bob. And the upshot of these millions of fraudulent, semi-fraudulent, and just plain insanely stupid loans? All houses got bid up and millions of honest people will be underwater for many many years. THEIR dishonesty, OUR problem!!!!

  11. Well, now, could it be that a change in the status quo (i.e. real regulation) might mean that banks have to be more smart than cunning in how they make money. As the saying goes, but maybe they’ve forgotten that they “can make money the old fashioned way, they can EARN it” by actually offering transparent products of value tha customers both understand and want. What a novel concept!! But, I can dig the complaints. Every con man on a street corner with a shell game, hates to be shut down, so usually moves rather than finding an honest way to make money. We are trying to shut down their shell game, and they HATE it.

  12. James writes:

    This logically implies that if there is a banking product or practice that is unsafe for consumers, but whose elimination would threaten banking profits, you should allow that product or practice. Is this really what the industry means?

    Simple answers to simple questions:


  13. James knows if he expresses that mindset of the bankers as a statement, he will be portrayed as a nutjob. So he expresses it as a rhetorical question. Sometimes when you state something in question form, the answer will become more obviously true. We have major problems.
    But you know, no voters in this country cared when they repealed The Glass-Steagall Act. No voters batted an eyelash when they passed Gramm-Leach-Bliley Act in 1999. So people think they can read the sports section, read what Britney Spears is wearing under her skirt lastnight, and government will function properly. It doesn’t work that way. You need to know how your representatives in government are using their powers.

  14. Yep, I’m pretty sure the pimp mortgage broker who tried to get me to convert from a 30-year fixed to an “interest only” ARM, when I didn’t need to or want to refinance, is not the problem, that’s for sure. At least he’s not anymore, as last time I checked he was no longer in business.

    The second “This American Life” segment on the economy, reference in Beginners, talks about another one of these guys, recruited out of a bartender job, is another example. Pretty sure he’s back at his bar and not testifying before Congress.

    Banks blaming brokers is like the Columbian cartels blaming dime bag corner sellers for the drug epidemic.

  15. “Why else would they write & mail out such misleading offers unless they thought working people were stupid & easy to deceive?”

    Well, most working people are stupid and easy to deceive. That’s why *they* write and mail out misleading offers.

    *They’re* not stupid.

  16. State insurance departments throughout the country already concern themselves with both consumer protection and prudential regulation. This is well understood to not really be the “other side of the coin” so much as a recognition that prudential regulation is itself a form of consumer protection: if not required to maintain adequate reserves and pricing, insurers would be much more prone to blow up and leave policyholders with worthless paper. But obviously there’s theory and then there’s practice. Insurers often complain that solvency concerns are subjugated to political pandering in the name of “consumer protection”. Sometimes they’re right (see Florida’s broken homeowners’ insurance market for a particularly egregious example). On the other hand, when push comes to shove many state insurance departments are only too happy to put the interests of important corporate residents ahead of solvency & consumer protection. (See the various concessions on capital requirements made to life insurers by their regulators during the recent crisis, including those made by CT for Wolin’s previous insurer, The Hartford, or in particular the NY insurance dept’s risible pre-bailout proposal that AIG be allowed to borrow billions from its operating subsidiaries.) The bankers’ argument isn’t as crazy as it sounds. The only problem is the wrong and self-serving answer. They are right that solvency concerns can’t be separated from consumer protection, but that in no way implies a consumer protection agency is unnecessary. It just means the proposed agency ought to consider the whole picture when it defines consumer protection.

  17. Everyone (almost) deserves a chance for redemption…

    While cursing Geithner is fun, I would rather have him suddenly demonstrate amazing integrity and leadership and be forced to swallow my pride than see him fail.

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