The Fed's Failure to Act and the Proposed CFPA

by Jeff Sovern

Opponents of a new Consumer Financial Protection Agency sometimes argue that the power to be given to the proposed CFPAs can be exercised by existing agencies, and so it's not necessary to create a new agency.  But, as others (e.g., Travis Plunkett and Edmund Mierzwinski) have pointed out, the Fed had considerable power to prevent the issuance of toxic mortgages, and chose not to exercise that power.  It's worth reviewing the statute giving the Fed that power.  15 U.S.C. § 1639(l)(2), enacted as part of HOEPA in 1994, provides:

The Board, by regulation or order, shall prohibit acts or practices in connection with--

(A) mortgage loans that the Board finds to be unfair, deceptive, or designed to evade the provisions of this section; and

(B) refinancing of mortgage loans that the Board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower.

The phrase "otherwise not in the interest of the borrower" is really quite breathtaking, and the use of the word "shall" suggests that Congress wanted the Fed to use that power.  Nevertheless, the Fed did not use that power until last year, far too late to prevent borrowers from entering into loans on which they would later default.  Even worse, during much of the time that it could have used that authority, states were enacting anti-predatory lending statutes and other federal agencies were preempting application of the state statutes to national financial institutions.  North Carolina passed the first such statute in 1999, and many other states followed.  So the Fed must have been on notice that some states thought action was called for and were frustrated in taking that action, and yet it didn't act.

We'll never know if the Fed could have prevented or ameliorated the foreclosure flood and the ensuing economic meltdown by using its broad authority.  History doesn't often permit reruns.  What we do know is that the Fed didn't use its power, and the consequences have been dreadful.  We'll also never know if the CFPA would have done better if it had been in existence.  But we do know that such an agency would not have multiple missions, as the Fed did and does, and so we can infer that it would have been more likely to focus on consumer protection than macroeconomics.  Those arguing that existing agencies are enough to protect consumers have a heavy burden of showing why that is so when the Fed failed to act.

Comments

[Troy Doucet]

In 2006, a group of federal agencies published the "Interagency Guidance on Nontraditional Mortgage Product Risks" which set out guidance on interest-only and subprime loans. It would have been great had that been implemented as a rule instead of guidance.

Here is a link to the document: http://www.federalreserve.gov/boarddocs/srletters/2006/SR0615a2.pdf

It was joined by:
Office of the Comptroller of the Currency
Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
Office of Thrift Supervision
National Credit Union Administration