Dismantling consumer protection – a historyApril 5, 2010Jon Brooks 1 Comment »
One of the sticking points in the Senate in enacting the financial reform bill is the creation of a new consumer financial protection agency, which Republicans have ardently opposed.This post by former World Bank and Federal Reserve economist Barbara N. Opper, on the financial sector policy blog Finance: Facts and Follies, summarizes the dismantling of consumer protections in the mortgage and credit card industries in the 2000s.
Many of the steps violating unsophisticated consumers’ protections against predatory lending came from a cascade of federal, not state, regulatory actions and legislation.
The financial industry’s influence on Washington, evident in the late 1980s when Alan Greenspan went to Chair the Fed, gained momentum between 2000 and 2008 when the industry ‘captured’ the administration and Congress. Investors sophisticated or not lost protection, as did consumers, especially the unsophisticated. As the famous post-Napoleon expression goes, this was “worse than a crime it was a blunder” because US financial institutions’ ability to attract profitable business worldwide rested on the trust that had been the outcome of our once-effective regulation.
To set the stage, in the 1970s a lot of consumer protection came into place. States enacted “Truth in Lending Laws” and the Fed was to handle consumer protections related to bank lending. By then, 64% of residents owned their homes, financed by self-amortizing home mortgages most of which carried fixed rates. With regulators enforcing strict underwriting standards, delinquency and foreclosure rates were very low. Credit cards were issued only to those with very strong credit records.
So when we started hearing about consumers being lured into very disadvantageous credit card and mortgage loans, it was reasonable to ask how so much predatory lending could prevail against Truth in Lending and other consumer protection in place. The answer is two rulings from the Office of the Comptroller of the Currency (OCC). One in 2003 prohibited states from enforcing their own truth in lending laws. Eliot Spitzer, former NY State Attorney General, said “Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye … all 50 state attorneys general and all 50 state banking superintendents actively fought the new rules.” It took until June 29, 2009 for the U.S. Supreme Court to rule in favor of the states. The other, in 2004, prohibited state bank supervisors from inspecting, supervising and overseeing national banks located in their state.
The impact of this regulatory approach on the examination and supervision functions should not be ignored. Examiners used to look at samplings of loan underwriting that would have caught “liars’ loans”, no-down-payment loans, wishful thinking property valuations, and other abuses of the go-go-mortgage lending years from 2003 to 2008. Instead, they focused more on the way banks handled Bank Secrecy Act and Patriot Act laws monitoring customer transactions.
Between 2000 and 2008, the economy was stagnating. Encouraging consumption with ready access to debt evidently turned into a policy tool to maintain economic growth. Household debt doubled. That growth was fueled not just by mortgages but also by credit card use as federal regulators looked the other way while credit cards were issued to youth and other elements of the population ill-equipped to handle such ‘easy’ credit. By then, states could not effectively offset federal regulators’ inaction because of the OCC rulings and the domination of the banking industry by national banks. Also, interest-sensitive home building with its collateral durable goods purchases is always a standard Fed policy tool. With more-than-accommodative monetary policy and lax underwriting standards, home property values rose at a pace never before seen. This was the kind of bubble the Fed was created to prevent. It was possible to track GDP growth with and without consumption fueled by home-equity draws.
Securitization was once a reasonable approach to improving the marketability of a home mortgage portfolio but it became destructive. One reason is lenders’ eliminating the free prepayment option to improve predictability of the payment stream for the investor. That removed a long-standing valuable right of borrowers, especially those who woke up too late to the predatory terms of their mortgages.
Many criticize the patchwork of overlapping banking regulatory authority involving several federal agencies and the state where a bank did business. But these two OCC rulings show the value of that overlap. Federal regulatory functions all had become dominated by political pressure from the providers of services promulgating ‘free markets’ and ‘lifting the regulatory burden’, greased by millions of dollars of campaign contributions and lobbying. If it had not been for these two OCC rulings, state authorities could have prevented the predatory terms foisted on unwitting borrowers.
The United States system had been designed by people who understood the dangers of concentration of wealth and power, moral hazard, conflict of interest and self dealing. It was a lesson learned from the Pecora hearings, and is the lesson to be relearned by the Angelides Commission.