On June 24, in "Financial Regulatory Reform: III," I blogged on the proposal in Financial Regulatory Reform--the Administration's blueprint for revamping the regulation of the financial industry--that Congress create a Consumer Financial Protection Agency. A few days ago the Administration issued a 152-page draft of a proposed statute establishing such an agency, and the draft helps to clarify the Administration's thinking and in doing so it reinforces the doubts I expressed in my earlier blog entry. The length of the draft is deceptive; pages have only 23 lines, the print is large, and the margins are generous; more important, most of the draft is taken up with bureaucratic details, involving for example the transfer of staff from other agencies. I shall ignore those details (though they may be minefields) and focus on what seem the key provisions of the proposed statute.
The objectives of the proposed statute are stated broadly, and to a degree inconsistently, as well as (of course) redundantly. The principal objectives are that "consumers [of financial products] have, understand, and can use the information they need to make responsible decisions," and "are protected from abuse, unfairness, deception, and discrimination," but also that "markets for consumer financial prodducts or services operate fairly and efficiently with ample room for sustainable growth and innovation" and that "traditionally underserved consumers and communities have access to financial services." The inconsistency lies in the fact that the more consumers are protected (largely from themselves) from being abused, deceived, and so forth in the purchase of financial products, the more those products will cost and so the less rapidly the market will grow and underserved consumers--a disproportionate number of whom are poor credit risks--will have access to it. The clearest example is a separate provision of the proposed statute that authorizes the agency to forbid arbitration clauses in consumer finance contracts. These arbitration clauses are inserted by the credit-card companies or other lenders, and so presumably--since consumer finance is a competitive industry--the clauses reduce the lenders' costs and therefore interest rates.
Oddly, although high credit-card interest rates are a focus of complaints about consumer credit, the proposed statute forbids the agency to establish a "usury limit," that is, to limit interest rates, unless explicitly authorized by law to do so.
The proposed statute confers the broadest possible authority on the new agency to require reports from providers of consumer financial products and to conduct surveys, for example of the consumers themselves, to determine the risks to consumers and consumers' understanding of those risks. Given the number of sellers of financial services to consumers, not to mention the number of consumers, the potential costs of the reporting and monitoring function, both to those providers and to the agency, are likely to be very high.
The statute authorizes the agency to prevent, both by rulemaking and in administrative enforcement actions, "unfair, deceptive, or abusive acts[s] or practice[s]." To declare a practice "unfair," the agency must determine that it "causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers and such substantial injury is not outweighed by countervailing benefits to consumers or to competition." This vague standard confers enormous discretion on the agency; and there is no attempt to define "abusive" ("deceptive" is reasonably self-evident).
Of particular significance, the agency may prescribe rules to ensure "effective disclosure or communication to consumers of the costs, benefits, and risks associated with" any consumer financial product; risks and costs must be communicated in a manner "designed to promote a consumer's awareness and understanding of the risks and costs, as well as to use the information to make financial decisions." The agency is to "consider available evidence about consumer awareness, understanding of, and responses to disclosures or communications about the risks, costs, and benefits of" consumer products.
In an earlier era, all this could probably have been dismissed as hot air. Ever since the late 1930s, the Federal Trade Commission has had the authority to prevent "unfair or deceptive acts or practices," but in practice this has usually meant nothing more than preventing false labeling and advertising. What is new in the proposed CFPA statute though not mentioned in it is "behavioral economics," which is the application of cognitive psychology to economic phenomena. The literature of behavioral economics, which appears to be influential with the Administration, emphasizes cognitive deficiencies that make it difficult for even people of normal intelligence and good education to act in their best interest even when fully informed. One can easily imagine the insights of behavioral economics being used by the new agency to go far beyond typical consumer protection measures, which involve forbidding false information, and often also requiring true information, to be provided to consumers.
That this is likely to happen is suggested by the grant of authority to the new agency to create "standard" consumer financial products, which means products designed by the agency itself. These products (a mortgage for example) are not only to be "transparent to consumers" and "facilitate comparison with and assessment of the benefits and costs of alternative consumer financial products or services," but they are also to "contain the features or terms defined by the Agency for the product or service." If this language is taken literally, it means that the CFPA could draft a mortgage loan contract that provided for a 30-year nonrecourse 100 percent (that is, zero equity) fixed-rate mortgage loan, or for that matter a 25-year fixed-rate 80 percent loan. The mortgage banker or other seller of the mortgage would be required to offer the prospective mortgagor the agency-created mortgage at or before offering its own alternative financial product. One concern the "standard" creates is that the seller's own financial product, if it departed substantially from the standard product, might be deemed abusive or unfair.