Among the Administration’s proposals for
Financial Regulatory Reform (FRR) is one for a new Consumer
Financial Protection Agency (CFPA). It is designed to replace the
existing system of consumer protection where authority is fragmented
among different Federal agencies plus 50 states, where some
non-depository firms are regulated loosely or not at all, and where
regulators generally give higher priority to protecting the solvency of
financial firms than to protecting consumers.
I have a strong predisposition favoring
this proposal because I view it as the best and perhaps the only way to
make mortgage disclosures useful to borrowers. The major shortcoming of
existing mortgage disclosure rules is that critical information that
borrowers could use often is not disclosed, and when it is disclosed, it
tends to gets lost in a torrent of garbage disclosures. Borrowers are
swamped with information they cannot use.
The proposal for a CFPA addresses most
of the major causes of garbage disclosures and information overload. A
critical one is divided responsibility, where no one agency has
authority over the totality of disclosures. Divided responsibility
encourages disclosure overload, as well as inconsistencies between
disclosures mandated by different agencies. These problems would be
eliminated by investing sole responsibility in CFPA.
A second problem has been that the
disclosures mandated by existing agencies, which are burdened with other
more pressing responsibilities, are not kept abreast of market changes.
A CFPA whose responsibilities are limited to disclosures, for which it would be held accountable,
A critical problem that is not addressed
in proposals for a CFPA is that much of the existing garbage disclosures are embedded in the
law. While the CFPA would have “sole authority to
promulgate and
interpret regulations under
existing …statutes, such as the Truth in Lending (TIL)…” the disclosure
requirements in TIL are very explicit and can’t be interpreted away. For
example, TIL states that mortgage lenders must disclose the total of
payments over the life of the loan, and the amount financed, which is
the loan amount less upfront lender charges. Both these disclosures are
worse than useless, because they waste space and divert borrower
attention. Unless CFPA can get out from under this type of legislated
garbage, it will be extremely difficult to improve mortgage disclosures.
The authority of CFPA would extend to
all financial products offered to consumers, not just mortgages, and its
powers would not be limited to mandating disclosures. CFPA would also
have “authority to regulate unfair, deceptive or abusive acts or
practices”, and it would have the supervisory, examination and
enforcement powers required for the purpose. These include the right to
“place tailored restrictions on product terms and provider practices.”
This grant of widespread powers is what has made the financial community
apoplectic about CFPA.
The proposal includes examples of how
this authority might be used. These include restricting or banning
mandatory arbitration clauses in contracts with consumers;
banning payments made by lenders to mortgage brokers; imposing a
“duty of care” or a “duty of best execution” on financial
intermediaries; banning prepayment penalties on certain types of
mortgages; and requiring that loan providers offer “plain vanilla”
products alongside whatever other approved products they want to offer.
(Note: The proposal for a “plain
vanilla” mortgage is poorly explained and has been widely
misinterpreted. It refers not to a type of mortgage but to a method of
pricing which can apply to any mortgage. It is clear from the context
that the drafters of the proposal view a “plain vanilla” mortgage as a
no-cost mortgage, where the only price to the borrower is the interest
rate. The lender absorbs all third party charges as well as his own. The
advantage to the borrower is that no-cost mortgages are relatively easy
to shop. Since many if not most mortgage lenders offer a no-cost option
now, the challenge to CFPA would be to make them more prominent.)
I believe that creating accountability
for consumer protection is essential, but I would have preferred to see
the initial powers granted to CFPA limited to mandatory disclosures. A
first rate disclosure system based on modern technology and the insights
of behavioral science, unshackled from the grotesqueries of past
efforts, can take consumer protection a long way. In the future, as the
limitations of disclosure became clear, the agency could request the
additional powers needed to deal with the problems that remained.
The proposed wide-ranging grant of
powers to CFPA makes me nervous. To be sure, the proposal is not to
require CFPA to take any of the drastic measures cited above, but to
give it the authority to do so if it decided that less intrusive
measures would not work. The trouble is that it is far easier to, e.g.,
ban prepayment penalties than to find creative ways to disclose
penalties so that they become a useful option to borrowers. Nowhere in
the proposal is CFPA put on notice that options are generally good for
consumers, and that the agency should impose a rigorous burden of proof
on itself before taking one off the table.