Consumer Law & Policy Blog

Dozens of Law Professors Join Letter Supporting Creation of the Consumer Protection Financial Agency

by Jeff Sovern

74 law professors teaching in areas related to consumer and banking law have joined in a letter supporting creation of the Consumer Financial Protection Agency.  The professors, who teach at law schools in 28 states and the District of Columbia, are legal experts who do not have an economic stake in creation of the CFPA but support the agency because they believe it would be better for the country than the current regulatory system. 

The principal drafter of the letter was Professor Norman Silber; I contributed, Profesors Charles B. Shafer, Teresa M. Schwartz, and Alan M. White generously provided cite-checking assistance, and others made thoughtful suggestions. During the last two weeks, the letter was circulated privately among law professors, and many--too many to thank here--passed it on to colleagues.  Though the letter is now public and will be sent to its addressees--Congressional leaders--today, we welcome additional signatories.

As the accompanying press release explains:

The Statement concludes that on balance, the existing regulatory structure places “a higher value on protecting the interest of financial product vendors who promote complex debt instruments using aggressive sales practices, than on protecting the interests of consumers in transparent, safe, and fair financial products.”

The body of the Statement is 8 pages long, single-spaced. It refers specifically to dozens of scholarly articles and studies demonstrating that at “critical moments of consumer confusion and vulnerability,” the existing regulators “have been unwilling to expend resources to develop appropriate rules and guidelines and to police mortgage and credit instruments.” The Statement urges passage of H. 3126 because “consolidated authority and a dedicated consumer-oriented mission would be likely to improve public confidence in the safety and efficiency of the vast consumer financial products marketplace.” It further provides an analysis of desirable aspects of the legislation and points to extensive scholarship supporting the need for a new approach to handling consumer financial regulation.

Update: Coverage at the Banking Law Prof Blog,  Commercial Law Blog, Huffington Post, US PIRG Consumer Blog, and Wall Street Journal Real Time Economics Blog,

Ray Brescia on Improving Financial Sector Practices Through Voluntary Codes of Conduct

Ray Brescia of Albany has written Trust in the Shadows: Law, Behavior and Financial Re-Regulation, Buffalo Law Review.   Here's the abstract:

In the deep throes of the Great Depression, in an effort to restore faith in America’s economy, the Roosevelt Administration promoted the development of voluntary codes of conduct to govern employment and manufacturing practices across hundreds of industries. Compliance with these codes permitted a company to display a Blue Eagle, which was supposed to signify support for New Deal efforts, and that the company was trustworthy. In this way, the Blue Eagle served as a heuristic - a cognitive shortcut - that helped consumers identify those companies engaged in fair practices so that those consumers could show their support for the recovery effort by patronizing compliant companies. Could this Depression-era technique - the use of the Blue Eagle or some similar, useful symbol - serve important ends today? Could it help restore consumer trust in institutions and actors in the financial system so that they might earn consumer trust, and prove trustworthy?

At present, the United States faces a crisis of trust not unlike that which plagued recovery efforts during the Depression. This crisis is one of a lack of trust in our financial institutions. Efforts to restore trust to the financial system are foremost on the agenda of the Obama Administration and Congress. While restoring trust to the financial system will be no small feat, the financial crisis was, in many respects, a product of too much trust: in lenders, brokers and the Bernie Madoffs of the world. And this faith operated within a regulatory philosophy that believed that the market, left to its own devices, could operate at optimal efficiency. In the end, this web of trust fostered predation, overconfidence and unregulated risk; it brought about financial ruin for many and has caused incalculable hardship across the globe. For all the talk of restoring trust in the financial system, the proper focus of such efforts must be the restoration not just of trust, but of trustworthiness. To accomplish one without the other would simply invite the same set of pathologies that helped to bring about the current crisis.

An approach directed at restoring trustworthiness to the financial system will require an appreciation for what makes such a system - and the actors within that system - trustworthy. Informed by the principles of Behavior Economics, psychology and game theory, research shows that there are certain conditions likely to foster either trustworthy or untrustworthy behavior: with weak rules against cheating, and little oversight, it is more likely that people will cheat; that when in long-term relationships in which cooperative behavior can be developed, nurtured and rewarded, individuals are more likely to cooperate in the pursuit of mutually beneficial ends; that in situations with greater social distance between people, they are more likely to act in a less trustworthy fashion towards others; that where communication encourages cooperation, people tend to act in a more cooperative and trustworthy fashion.

After assessing the role these principles can play in informing efforts at re-regulation in several key areas within the financial sector, in concluding this piece I propose that regulatory agencies develop a set of voluntary codes of conduct for financial sector firms. To the extent such firms follow these codes, they will be able to market this information to consumers in an easily communicated manner: in the same way the Roosevelt Administration utilized the symbol of the Blue Eagle to reflect compliance with codes of conduct across a range of industries. These codes will reflect an appreciation for the fact that most lay people will be unable to assess for themselves the extent to which financial institutions are trustworthy or not. Instead, through the development of voluntary codes of conduct, built around the principles that are more likely to lead to trustworthy behavior, consumers will be well positioned to place their faith in those firms following these codes, which will, in the end, generate strong market share for such firms.

New Paper Debunks Industry Arguments that CFPA Should Preempt State Law

NCLC has just released a white paper Preemption and Regulatory Reform: Restore The States’ Traditional Role As ‘First Responder,’that has particular relevance to bank lobbyists' attempts to expand bank immunity from state law in the proposed Consumer Financial Protection Agency.  The paper rebuts claims that allowing states to protect consumers will lead to an untenable regulatory burden.  The paper describes the historic role state consumer protection laws have played in the banking world and why the federal banking agencies’ actions in the last several years to preempt state law were a major factor in the mortgage crisis and other credit abuses. 

 

“Banks like to blame the mortgage crisis on nonbank lenders, but in the peak year of 2006, 32% of subprime loans, 40% of alt-A loans, and 51% of the toxic payment-option and option ARM loans were made by national banks, federal thrifts, or their subsidiaries who were immune from state laws,” said Lauren Saunders, the paper’s author and the Managing Attorney of NCLC’s Washington, DC office.  “Overall, $700 billion of the riskiest loans in 2006 were made by banks who could ignore state law.  Federal law also prevented states from addressing the most dangerous terms of mortgages offered by nonbank lenders.  Credit card and overdraft fee abuses can also be traced to preemption.”

 

President Obama’s plan to establish a new Consumer Financial Protection agency calls for leveling the playing field so that all lenders will have to comply with the same rules.  The plan has run into heavy opposition from bank lobbyists working to expand the immunity of banks from state law.   

 “In 2005, it was estimated that the cost of complying with state predatory lending laws was only $1/mortgage,” Saunders said. “Banks offer numerous niche products for many segments of consumers and are certainly capable of accommodating variations in state laws.  The costs to consumers, the financial industry, and the economy would have been far less if states had not been hindered in protecting consumers.

The paper is available here.  For more information, contact Lauren Saunders, managing attorney of NCLC's DC office, lsaunders@nclcdc.org, 202-452-6252 x 105.

Catholic University Program on Proposed Consumer Financial Protection Agency

Catholic University Law School is presenting what sounds like a terrific program on the proposed Consumer Financial Protection Agency on October 20, 2009 from 5:00 to 6:30 p.m.  Admission will be by reservation only.  Speakers include Michael Barr, Assistant Secretary of the Treasury for Financial Institutions and a drafter of the bill, Oliver Ireland, Partner, Morrison & Foerster, Arthur Wilmarth, Professor of Law, George Washington University, and it is to be hosted by CUA professors Heidi Schooner and Ralph J. Rohner (my co-author).  The program, titled “Inventing a New (or Reviving an Old) Regulatory Structure for the Consumer Finance Marketplace” is not yet final, but here is the tentative description: 

The global financial recession of the past year or so has drawn attention to a host of questions about whether the U.S. adequately monitors and regulates the consumer credit markets and the volatile financial products sold there.  Revelations of bad or questionable practices suggest the need for more conscience, self-discipline, and fairness from market participants.  Among the questions:  Is there too much reliance on disclosure of transaction terms, or can current disclosures be strengthened and improved?  Is there greater need for regulatory authority to proscribe unfair or deceptive practices without waiting for Congress to address them?  Should federal regulatory authority be consolidated in a new federal Consumer Financial Protection Agency (as proposed in legislation introduced by the Administration), and if so what would be the nature and range of its authority?  How much of the federal agencies’ authority would be subsumed in the new agency, and how much would survive outside it?  To what extent would federal laws and regulations preempt state law in order to encourage national markets?  How should enforcement authority be concentrated, or distributed, among the federal agencies and their state counterparts?  How would a revised consumer regulatory structure relate to other proposals for tightened controls in the larger financial markets

 

Almost forty years ago, the National Commission on Consumer Finance recommended creation of a federal “Consumer Credit Czar.”  Is the proposed CFPA anything more than a revival of that un-enacted suggestion?  Are market conditions, and politics, in 2009 and 2010 any more receptive to a regulatory and enforcement overhaul than in 1972?

 

Mr. Barr, one of the drafters of the pending bill, will sketch the case for regulatory and enforcement overhaul.

 

Mr. Ireland will address the likely impact of a new regulatory structure on bank operations, safety and soundness, and profitability.

 

Mr. Wilmarth  will speak to the federalism issues inherent in sorting out federal and state roles in consumer protection.

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.

Philadelphia Inquirer Coverage of Consumer Protection Issues

I'm delighted to report that the Philadelphia Inquirer's Jeff Gelles is now covering consumer protection issues regularly.  He's already published an interview with Elizabeth Warren on the proposed Consumer Financial Protection Agency and a column on Chase's increase of the minimum payment on credit cards. 

Menu Labeling--From a New York City Experiment to Part of the Health Care Reform Bill

by Deepak Gupta

In today's mail, I received my copy of the August issue of ABA Journal magazine, which has an article on the mandatory disclosure of calorie counts on fast-food menus. We've blogged several times here about the legal battle over the New York's first-in-the-nation menu labeling rule (here, here, and here), in which I represented Congressman Henry Waxman, former FDA Commissioner David Kessler, the American Medical Association, and a bunch of other health groups and professors of nutrition, medicine, and public health. The litigation involved constitutional challenges by the fast-food industry based on preemption and the First Amendment. 

The ABA article quotes my modest defense of the policy against charges of paternalism -- it's just information, and if you want to go on eating high-calorie stuff you're free to do so.  It also quotes industry lawyer Kent Yalowitz, who asserts that the rule is "untethered to any science whatsoever."  But as Ezra Klein notes in a recent Washington Post print column (and on his blog), preliminary data from Los Angeles shows that calorie labeling on the menu may have a dramatic impact. Kent conveniently forgets that New York City produced strong scientific support in response to the industry's lawsuit. And the Center for Science in the Public Interest, whose Margo Wootan has been deftly leading the legislative advocacy on menu labeling nationwide, has posted a wealth of additional data.  (In any event, as Richard Posner points out, the obvious impossibility of proving the net effects of the policy in advance of its enactment does not justify rejecting it.)

The disclosure of calories on chain restaurant menus is no longer just a question of local policy; it is now--due in no small part to Margo's efforts--a part of the pending health care reform legislation.  If health care passes, so does menu labeling!  What's remarkable to me is how quickly the policy has progressed in just a couple years -- from a mere proposal among public health advocates, to a controversial regulation in a single city, to a measure that's been adopted by local governments nationwide, to a component of one of the most important pieces of federal legislation in a generation. Even the chain restaurants are supporting the legislation (though of course they'd like it cover non-chains too and are motivated as much by a desire to preempt local variation as anything else). As a Washington Post editorial said over the weekend, it couldn't come soon enough.

Posner v. Thaler on Behavioral Economics and the CFPA

by Deepak Gupta

Although his views on economic regulation and the conservative movement seem to have evolved over the years, and aren't always easy to pin down, Richard Posner is at bottom a proponent of old-style neoclassical economics premised on rational choice theory.  

So perhaps it's no surprise that Judge Posner has come out strongly against the proposed Consumer Financial Protection Agency, and that he takes particular exception to the behavioral-economics insights on which the proposal is based.  Still, check out this zinger of a closing line from Posner's recent Wall Street Journal op-ed on the CFPA:

"Behavioral economists are right to point to the limitations of human cognition. But if they have the same cognitive limitations as consumers, should they be designing systems of consumer protection?"

Is it just me, or is this a phenomenally dumb argument?  There are so many faulty unstated assumptions here that it hardly seems worth cataloguing them.  But perhaps Posner, who is anything but dumb, does not really mean this as a serious argument so much as a bald ad hominem.  Just before the quoted passage, he singles out behavioral economist and fellow Chicagoan Richard Thaler and suggests that Thaler's past advocacy for all-stock investment portfolios disqualifies him -- and by extension, anyone who values research on actual consumer economic behavior -- from shaping rules to protect consumers in credit markets.

Thaler has now come back with a restrained and thoughtful response to Posner's jab.  After pointing out how Posner's op-ed badly mischaracterizes the CFPA proposal itself, Thaler makes his case for regulation based on actual human behavior rather than false ideals of perfect rationality:

Elizabeth Warren on Why We Need a Consumer Financial Protection Agency

This has been making the rounds, but we somehow neglected to post it here. Professor Warren also recently identified three myths perpetuated by critics of the new agency, along with her responses. The most complete account of Warren's argument can be found in her Penn Law Review artice (co-authored with Oren Bar-Gill), Making Credit Safer.

Obama Administration Divided on the Consumer Financial Services Agency

You knew that the proposal to establish a Consumer Financial Services Agency was backed by the Obama Administration. After all, it's the Administration's bill. You also knew (or at least suspected) that the banking and other industries would be lobbying against a new regulator. But what you may not have known is that key agency heads disagree about major aspects of the bill. For instance, Federal Deposit Insurance Corporation head Sheila Bair does not want to empower the agency to enforce new regulations. Treasury Secretary Tim Geithner attributes the disagreements to other agencies trying to protect their turf. Check out the New York Times story and the Washington Post story.