Unsafe at Any Rate
If it’s good enough for microwaves, it’s good enough for mortgages. Why we need a Financial Product Safety Commission.
The Traditional Solutions Have Hit Their Limits The credit industry is not without regulation; credit transactions have been regulated by statute or common law since the founding of the Republic. Traditionally, states bore the primary responsibility for protecting their citizens from unscrupulous lenders, imposing usury caps and other credit regulations on all companies doing business locally. While states still play some role, particularly in the regulation of real-estate transactions, their primary tool–interest rate regulation–has been effectively destroyed by federal legislation. Today, any lender that gets a federal bank charter can locate its operations in a state with high usury rates (e.g., South Dakota or Delaware), then export that states’ interest rate caps (or no caps at all) to customers located all over the country. As a result, and with no public debate, interest rates have been effectively deregulated across the country, leaving the states powerless to act. In April of this year, the Supreme Court took another step in the same direction in Watters v. Wachovia, giving federal regulators the power to shut down state efforts to regulate mortgage lenders without providing effective federal regulation to replace it.
Local laws suffer from another problem. As lenders have consolidated and credit markets have gone national, a plethora of state regulations drives up costs for lenders, forcing them to include repetitive disclosures and meaningless exceptions in order to comply with differing local laws, even as it also leaves open regulatory gaps. The resulting patchwork of regulation is neither effective nor cost-effective. During the 1970s and early 1980s, for instance, Congress moved the regulation of some aspects of consumer credit from the state to the federal level through a series of landmark bills that included Truth-in-Lending (TIL), Fair Credit Reporting, and anti-discrimination regulations. These statutes tend to be highly specific. TIL, for example, specifies the information that must be revealed in a credit transaction, including the size of the typeface that must be used and how interest rates must be stated. But the specificity of these laws works against their effectiveness, trapping the regulations like a fly in amber. The statutes inhibit some beneficial innovations (e.g., new ways of informing consumers) while they fail to regulate dangerous innovations (e.g., no discussion of negative amortization). What’s more, these generation-old regulations completely miss most of the new features of credit products, such as universal default, double-cycle billing, and other changes in credit.
Any effort to increase or reform statutory regulation of financial products is met by a powerful industry lobby on one side that is not balanced by an equally effective consumer lobby on the other. As a result, even the most basic efforts are blocked from becoming law. A decade ago, for example, mortgage-lender abuses were rare. Today, experts estimate that fraud and deception have stripped $9.1 billion in equity from homeowners, particularly from elderly and working-class families. A few hearty souls have repeatedly introduced legislation to halt such practices, but those bills never make it out of committee.
Beyond Congress, some regulation of financial products occurs through the indirect mechanism of the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision. Each agency, for example, has some power to control certain forms of predatory lending. But their main mission is to protect the financial stability of banks and other financial institutions, not to protect consumers. As a result, they focus intently on bank profitability and far less on the financial impact on customers of many of the products the banks sell.
The current regulatory jumble creates another problem: Consumer financial products are regulated based, principally, on the identity of the issuer, rather than the nature of the product. The subprime mortgage market provides a stunning example of the resulting fractured oversight. In 2005, for example, 23 percent of subprime mortgages were issued by regulated thrifts and banks. Another 25 percent were issued by bank holding companies, which were subject to different regulatory oversight through the federal system. But more than half–52 percent, to be exact–of all subprime mortgages originated with companies with no federal supervision at all, largely stand-alone mortgage brokers and finance companies. This division not only creates enormous loopholes, it also triggers a kind of regulatory arbitrage. Regulators are acutely aware that if they push financial institutions too hard, those institutions will simply reincorporate in another form under the umbrella of a different regulatory agency–or no regulatory agency at all. Indeed, in recent years a number of credit unions have dissolved and reincorporated as state or national banks, precisely to fit under a regulatory charter that would give them different options in developing and marketing financial products. If the regulated have the option to choose their regulators, then it should be no surprise when they game the rules in their own favor.
Unfortunately, in a world in which the financial services industry is routinely one of the top three contributors to national political campaigns, giving $133 million over the past five years, the likelihood of quick action to respond to specific problems and to engage in meaningful oversight is vanishingly slim. The resulting splintered regulatory framework has created regulatory loopholes and timid regulators. This leaves the American consumer effectively unprotected in a world in which a number of merchants of financial products have shown themselves very willing to take as much as they can by any means they can.
The Financial Product Safety Commission
Clearly, it is time for a new model of financial regulation, one focused primarily on consumer safety rather than corporate profitability. Financial products should be subject to the same routine safety screening that now governs the sale of every toaster, washing machine, and child’s car seat sold on the American market.
Post a Comment