The U.S. economy needs strong, independent CFPA

With derivatives regulation, the two sides will agree on broad principles and the action will be over arcane exemptions and definitions. With consumer protection, the two sides fundamentally disagree over whether the new agency should exist or have any power. It is also the section of the bill most likely to inspire popular interest, with one side calling for protection of ordinary people from ruthless banks and predatory lenders, and the other decrying the creation of a new bureaucracy.

We have been and remain advocates of a strong, independent CFPA for familiar reasons: the increasing use of product complexity as a way to hide fees; the vastly unequal bargaining power between consumers and the oligopolies that dominate many financial products; the need for uniform standards that apply to non-bank institutions as well as traditional banks; and the abject failure of existing regulators to enforce those laws that did exist.

Opponents such as Alan Greenspan have argued that a lack of consumer protection did not cause the recent financial crisis, and that therefore new regulations are not necessary. This is at best half-true and misleading. First, Greenspan’s argument that not the “origination of subprime mortgages” but “demand for securitized subprime mortgage interests” lay behind the financial crisis is high-class sophistry. Tighter regulation of mortgage lending would have restricted the supply of the raw material that Wall Street needed for the securitization pipeline.

It is true that a bubble can be based on many different types of assets, not just consumer loans. But even if the crisis would have been possible without predatory lending, stronger consumer protection limits one source of bubbles … and is good in and of itself. Would Greenspan say that taking advantage of customers is fine so long as it does not threaten the financial system?

Given the political appeal of stronger consumer protection, it may be difficult for opponents to take a strong line against a new agency (although the Chamber of Commerce has done its best). So opposition will most likely focus on weakening consumer protection behind the scenes.

One attack will likely be an attempt to subject the CFPA to “adult supervision.” Section 1023 of the current bill, “Review of Bureau Regulations,” already allows the Financial Stability Oversight Council, a committee of regulators, to override any CFPA regulation it finds would endanger “the safety and soundness of the United States banking system or the stability of the financial sector.”

This is a curious provision. As Raj Date has pointed out, it’s not clear what problem this is meant to solve, since “there is no empirical evidence that the over-protection of consumers ever has created systemic risks,” and there’s no precedent for giving heads of regulatory agencies veto power over the actions of a different agency.

It also allows a group of regulators who have historically been far from consumer-friendly to veto the decisions of the CFPA. As currently drafted, this section makes it relatively difficult for the FSOC to override the CFPA. However, opponents of consumer protection will probably attempt to widen the scope of this veto in order to make the CFPA subservient to traditional regulators.

Another threat involves federal preemption of state law. Preemption means that if a state attempts to set a higher regulatory standard than the federal government, the federal standard prevails. During the housing boom, federal banking regulators chose to preempt state laws against predatory lending that might have reined in subprime lending, replacing them with lax or nonexistent federal standards.

The Obama administration proposed to end federal preemption and allow states to set their own consumer protection standards. However, as described by Stacy Mitchell, author of Big-Box Swindle and a senior researcher with the New Rules Project and its Community Banking Initiative, financial sector lobbyists are hoping to cut a deal that restores federal preemption. Expanding preemption could effectively allow the Office of the Comptroller of the Currency to undermine the intentions of the CFPA.

Our economy needs a financial system that serves its customers, not one that sees them as marks to be taken advantage of. This should be one pillar of reform that everyone can agree on. But since everyone can’t agree, supporters will have to be vigilant against attempts to cripple the agency in its infancy.

Johnson and Kwak are co-authors of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, and of the economics blog