New Consumer Financial Protection Agency A Mixed-Bag

The Obama administration unveiled their plan for creating an agency to regulate the financial products offered to consumers. Measures from the government to attempt to protect consumers from products leading to unfair or deceptive lending are not novel. But this agency hopes to take consumer protection a step further by intensifying such efforts and promoting access to financial products as well. I applaud the administration's desire to protect consumers but wonder if its dual purpose will lead to internal conflict.

Let's start with the good. This new agency will implement and enforce new transparency standards for consumer lending. That's important. Even the most brazen of free marketers will have trouble arguing that clarity and simplicity are not valid goals for regulations. If individuals do not have full, clear and accurate information, markets cannot work.

How does the government plan to reach that goal? The government tried to achieve clarity with the truth-in-lending disclosure. It did little good with wacky mortgage products. For that reason, the government will reduce the freedom of lenders to create complex products. Instead, it intends to promote guidelines for "Plain Vanilla" products.

Regulating away complex lender practices is a little more controversial than simply providing clearer disclosure language, but Washington feels it has broad support for such measures. Less complexity will prevent lenders from being as innovative with their financial products. That means tighter credit. This might be seen as a negative, but tighter credit is not necessarily a bad thing, given the nation's addiction.

A statement about the new agency released by Senator Dodd explains their philosophy:

The Administration is addressing the colossal failures that led to the economic crisis with a bold and aggressive plan. Creating an independent agency whose sole focus is protecting consumers - be it credit card holders, anyone with a bank account, or families with mortgages or student loans - is really the key to creating the foundations for a stronger economy.

That's true if you believe that most homeowners who defaulted on subprime mortgages were taken advantage of. I'm skeptical. I think the majority were probably guilty of drinking the same kool-aid that Wall Street was chugging: they thought the housing market and economy were in the clear, so it would all work out in the end.

But even if you do believe that most homeowners with questionable mortgage products were swindled, would the new agency really have helped? Some additional color from the New York Times might imply otherwise:

The proposal would also give the agency the power to restrict or prohibit "unfair and deceptive practices" and it would enforce existing laws against discrimination. The agency would be in charge of enforcing the Community Reinvestment Act, a law that prods banks to make loans in low-income communities.

Lenders certainly shouldn't discriminate based on characteristics like race, sex or sexual orientation. But they absolutely should discriminate against people who cannot afford the loans they seek. That's called having underwriting standards.

Yet, this same agency meant to protect consumers might also coerce banks to provide loans to consumers who cannot afford them. Isn't that part of what got us into the subprime mess in the first place? I'm not one of those who believe the CRA deserves all of the blame for the subprime debacle. Yet, I find it hard to refute that it played some part.

In any case, consumer lenders have one kernel of good news: this new agency won't get off the ground anytime soon. They'll have plenty of time to brace themselves. Also from the Times article:

The House Financial Services Committee is expected to take up the bill as soon as Congress returns from its Fourth of July recess, and the committee chairman, Representative Barney Frank of Massachusetts, is broadly in favor. But the House is not expected to vote on the bill until this fall, and the Senate is expected to move even more slowly.