Support your new Alphabet Soup Agency

A central component of the Obama administration’s Wall Street reform policy is creation of the Consumer Financial Protection Agency (CFPA). He mentioned it earlier this week in his speech as well as today in his radio address. The banks are not happy about the agency. I thought I’d spend some time on what is being proposed.

Obama emphasized the need for the legislature to move quickly to enact a centerpiece of his plan, the Consumer Financial Protection Agency. (This sentence links to the bill.)

“Part of what led to this crisis were not just decisions made on Wall Street, but also unsustainable mortgage loans made across the country. While many folks took on more than they knew they could afford, too often folks signed contracts they didn’t fully understand offered by lenders who didn’t always tell the truth,” Obama argued. “That’s why we need clear rules, clearly enforced. And that’s what this agency will do.”

The legislature making the CFPA a legal entity is pending in the House. The responsibility for passage and creation of the bill lay with Congressman Barney Frank (D-MA) and the Financial Services Committee. Frank is the principal author. The LA Times has a succinct explanation of what the plans are for the new agency.

Why should you care? What might the agency do for you — or to you? Here’s a quick overview:

To begin with, be aware that the agency’s powers and oversight would extend far beyond mortgages and real estate — into all credit cards, debit cards, consumer loans, payday loans, credit reporting agencies, debt collection, stored-value cards and even investment advisory and financial advisory services, to name only part of the list.

It would have the authority to alter long-common practices that nettle consumers, such as mandatory arbitration clauses in the fine print of contracts that automatically send business-consumer disputes to arbitrators rather than to courts. The agency could ban or limit such clauses in specific products if they are shown to tilt against consumers’ interests.

The agency would write the user-safety rules for virtually all consumer financial products and would have the legal firepower to levy huge fines — tens of thousands of dollars a day per violation in some cases — and prosecute lenders, brokers and others who break the rules.

The agency would be the dominant federal consumer protector in all home real estate settlements. It would regulate “affiliated” title, escrow and financing businesses connected with realty firms and builders. It would oversee equal credit opportunity and fair housing, and would set standards for all mortgage offerings, whether from the biggest national banks or the smallest local brokers. Generally it wouldn’t seek outright bans on mortgage products that carry elevated risks — interest-only loans, for instance — but would require that lenders restrict such mortgages to well-informed applicants who can document that they understand the risks and can afford the payments.

Within its first year, the agency would be tasked with creating consumer-friendly, uniform disclosures for all home purchase and financing transactions, starting with a combined “good-faith estimates” and truth-in-lending statement.

The core idea behind the proposal, supporters say, is to pull together consumer oversight powers that are now scattered among various agencies, and to put consumer interests where they should be — much higher on the priority list than they were during the years leading up to the housing and credit bubble and bust.

Professor Elizabeth Warren, the TARP Goddess, warns that bank and especially nonbank financial institution interests are gearing up to fight the creation of this agency. As the President has noted, the primary purpose of the agency is to ensure that you can no longer bury the real contract details in lawerly fine print. In this way, the bill extends Truth-in-Lending laws to organizations outside the old legislation. Warren recognizes that the banking industry has become a noncompetitive market and is gleaning monopoly-sized profits. She argues that this agency is a necessity in that circumstance. These market frictions are considered by economists to be a prime sign of a failed market that requires regulation. Even Adam Smith, creator of the invisible hand and the term laissez-faire economics, realized the need for government regulation of certain markets. This is not creeping socialism despite its portrayal as such by corporate cheerleaders like CNBC.

Despite widespread agreement about the problem, the U.S. has never made a sustained, systemic effort to regulate non-bank lenders. As lending abuses became more obvious, there was no effort to close regulatory gaps and loopholes or to devote federal resources toward the oversight of non-bank institutions. The reasons are many, but one of the most benign explanations is that policymakers for too long assumed that states could deal with the non-banks because the non-bank lenders are often small and often operate locally (although Countrywide showed that state-based organizations can metastasize rapidly). As it turns out, the states actually faced several limitations in reining in these lenders.

States, just like the federal government, were subject to intense lobbying by creditors. In short order, many states changed their rules to undercut basic protections. For example, the consumer finance industry succeeded in rewriting state interest rate regulation to allow for massive increases in allowable effective rates – even when the advertised rate looks far lower and obscures the true cost of credit. In many states, making an end run around local usury laws is now as easy as running around a single fencepost. At the same time, state legislatures face the perpetual lag-behind problem. They are unable to adjust to a rapidly changing financial services market, too slow to identify problems and not capable of changing the laws quickly enough to head off serious problems.

I support this legislation and believe it is important that it get through the committee as quickly as possible with few changes. The Federal Reserve is probably the logical place for such a commitment since they have been the arbitrators and regulator of choice for the Truth in Lending Laws. They have procedures in place and trained staff that would allow them to gear up for the extended duties. This extends their jurisdiction to other types of Financial Institutions. This means that the Board of Governor’s auditors will get into the books of a lot more entities than it used to and that can only be good for a translucent and more efficient market for lending.

I urge you to watch this bill as it moves through committees to the floor. Do not allow K Street Lobbyists to morph this into an industry-owned-monopoly enabler. Giving it to the FED puts the agency outside the ebb and flow of K Street money and this, I believe, is the best place for it given the dependence of pols on corporate sponsorship.

Moreover, resources are always constrained at the state level, and the enforcement of consumer credit laws competes with a wide variety of other state obligations. When consumer credit laws were violated, states often lacked the capacity to undertake serious investigations or to prosecute offenders. Some states made heroic efforts, but others left consumer financial issues far down their priority list.

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