Bad Reasons to Oppose the Consumer Protection Agency

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Have you heard the rumor that the Consumer Financial Protection Agency would jack up interest rates and put a stranglehold on job growth after the recession? If you did, you might be able to trace it back to David S. Evans, of the University of Chicago Law School, and Joshua D. Wright, of George Mason University School of Law, who wrote the study The Effect of the Consumer Financial Protection Agency Act of 2009 on Consumer Credit. (h/t Volokh Conspiracy.) In it, they make some pretty bold claims about the effect of the CFPA on the greater economy. But do the claims hold up to scrutiny? Let's take a look.


One can read the paper by clicking 'Download' in the link above. Here's the Executive Summary:

The U.S. Department of the Treasury has submitted the Consumer Financial Protection Agency Act of 2009 to Congress for the purpose of overhauling consumer financial regulation. This study has examined the likely effect of the Act on the availability of credit to American consumers...Based on our analysis we have concluded that the CFPA Act of 2009 would make it harder and more expensive for consumers to borrow. Under plausible yet conservative assumptions the CFPA would:

• increase the interest rates consumers pay by at least 160 basis points;

• reduce consumer borrowing by at least 2.1 percent; and,

• reduce the net new jobs created in the economy by 4.3 percent.

Increased interest rates by 1.6%! Reduced net new jobs created by 4.3%! Those are some bold conclusions. If they proved that net new jobs created during the economic recovery would be reduced by over 4% I'd be picketing this in the streets. We all should be! That's insane, and not worth any tradeoff. I wonder what kind of model they used to predict this though. If they are using historical data, over what time frame? Let's see what their argument is for this (my underline):

Startup firms with fewer than 20 employees accounted for 86.7% of net job creation in the United States from 1987-2005...We do not believe that it is implausible that the CFPA Act could result in a significant number of aspiring new small business owners not being able to obtain the consumer credit necessary to get their businesses off the ground...Suppose that the increase in credit prices and reductions in the availability of credit results in a 5 percent reduction in the number of aspiring entrepreneurs were not able to start their firms. If we focus just on firms with fewer than 20 employees, that could lead to the elimination of roughly 4.3 percent (.05 x .867) of net new jobs.

Umm. Suppose some numbers that equal 4.3%, and thus 4.3%? That's it.

This line of argument reminds me of when Owen Wilson's character Eli from the movie The Royal Tenenbaums says "Well, everyone knows Custer died at Little Bighorn. What this book presupposes is...maybe he didn't."

I have no problems whatsoever with provocative thought experiments, but the idea that this 'conclusion' leads as a scare statistics in the Executive Summary is quite misleading. I can already hear talking heads saying someone has proved that this will destroy 1 out of every 20 new jobs, though the proof offered is entirely unfalsifiable.

There's a better argument for why interest rates would go up over 1.6%, which they use to justify the previous results:

The 1994 Interstate Banking and Branching Efficiency Act (IBBEA) allowed bank and bank holding companies to expand across state lines; prior to its passage there had been virtually no interstate branches. The IBBEA, however, preserved states' rights to impose various costs on the expansion of out-of-state banks in their states and some states did so. Rice and Strahan estimate the effect of these state-imposed restrictions on the interest rates paid on bank loans by small businesses by comparing bank lending in states that imposed restrictions with those that did not. These authors find that the interest rates paid by small businesses were 80 to 100 basis points higher in states with the most restrictive rules on bank expansion compared with the states with the least restrictive rules.

We take this 80 basis point regulatory penalty as a lower bound on the effect of that the CFPA Act would have on interest rates.

This is an interesting result. But is the IBBEA comparable to the CFPA? Historically, they are up to very different things. IBBEA allowed for states to create roadblocks to bank themselves, not the practices of banks. Rice and Strahan (pdf) look at specific practices by states to put restrictions on new banks entering their states ("some states took advantage by forbidding out-of-state banks from opening new branches or acquiring existing ones, by mandating age restrictions on bank branches that could be purchased, or by limiting the amount of total deposits any one bank could hold.") I'm curious how the authors of this research would respond to similarly sophisticated research (Bank Consolidation and Consumer Loan Interest Rates (Kahn, Pennacchi, Sopranzetti)) that shows that concentrations of large banks react asymmetrically to interest rate movements, screwing consumers.

Regardless, this has nothing to do with what the CFPA would be trying to accomplish. The CFPA isn't trying to limit the creation of banks across states, which would necessitate roadblocks that end up hurting small businesses the most. It's about monitoring products offered to consumers, and removing the responsibility of consumer protection from the responsibility of those who enforce safety-and-soundness of the banks, because these are in conflict at a fundamental level. And there are arguments that exist for why this would actually favor smaller banks as opposed to larger banks, as most regulation does not.

If these are the strongest arguments against having a robust Consumer Financial Protection Agency, why aren't Democrats lining up to see who can endorse it the most?

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Mike Konczal is a fellow at the Roosevelt Institute.

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