The first sign that maybe this much-touted financial overhaul might not be all it was cracked up to be was the reaction from Wall Street. It was just before sunrise on Friday morning that negotiators for the House and Senate gave birth to a new reform package they dubbed the Dodd-Frank bill. Investors greeted the news by driving up the stocks of the biggest brand-name banks.
But consumers should still celebrate the bill, even though banks aren't too shaken by it. At the risk of sounding like Sen. Chris Dodd's (D-CT) press secretary, I'd say this final bill is a pretty remarkable piece of legislation. And I'm hardly the only one. Talk to the consumer lobbyists and other caped-crusader types who for years have been pushing for greater financial protections for consumers. They'll tell you that this reform package nearly 12 months in the making is pretty much exactly what they have been asking Congress to do for more than a decade.
The New Consumer Financial Protection Bureau
Any analysis of the Dodd-Frank bill has to begin with the newly hatched Consumer Financial Protection Bureau. Think of this new watchdog that will live inside the Federal Reserve as a kind of Environmental Protection Agency for mortgages and other consumer loan products.
Until now, responsibility for protecting consumers from deceptive and harmful home loans has been scattered across more than a half dozen federal agencies -- yet not one of them makes the consumer its main focus. If this bill passes, at least one agency inside the federal bureaucracy will be required to put the protection of the vulnerable and financially unsophisticated ahead of the safety and soundness of the banks.
"The bank regulators did little or nothing to protect consumers from these toxic financial products which inflicted such grievous economic harm," said Bill Brennan, a Legal Aid lawyer who has been running the Home Defense Project in Atlanta since the late 1980s. "We've desperately needed an agency like this for 20 years."
The bill is not perfect. Auto dealers, for instance, were granted an exemption from this new agency. (For a sense of why this was a disappointment to consumer advocates, read this piece I wrote for The New York Times or this one that journalist Mike Hudson wrote for The Center for Public Integrity.) But pretty much every other business the consumer advocates wanted in there falls under its purview. That includes payday lenders, check cashers, credit card companies, and even fringe businesses like the tax mills offering instant tax refunds to those so hard up for cash they can't wait on the IRS. The reform crowd pretty much got their way on everything else as well, from an independent source of funding for this agency to an independent director appointed by the President.
"This bill doesn't implement all of the reforms we've been seeking but this new agency pulls together the enforcement of the federal credit laws in one place," said Jean Ann Fox of the Consumer Federation of America. "One of the things we expect to see finally is uniform application of federal laws to all products to all types of providers," from banks to pawnbrokers and every shape and size of storefront lender in between.
Future Subprime Crises Prevented
I've spent much of the past two years reporting on the economic fringes. I've hung out with the characters who invented the payday loan industry. I spent time with people whose lives were gobbled up by a predatory subprime mortgage.
The deeper my reporting took me, the more I became convinced that it's consumer protections, not rules aimed at reigning in Wall Street, that could have been the silver bullet that prevented the worst of the subprime fiasco. And it's on that front where the Dodd-Frank bill is the strongest.
The subprime mortgage crisis boiled down largely to lenders making loans with no regard for a person's ability to pay. So what if the borrower who can barely afford an adjustable rate mortgage at a teaser rate of 4 percent will be drowning once the interest rate resets to 9 percent in two years? By then the lender will have spent its fees and it was the problem of someone running a fund somewhere in Reykjavik or Bonn.
Under Dodd-Frank, at least there now will be a law dictating that a lender is legally responsible for assessing a borrower's ability to pay. The Center for Responsible Lending, a non-partisan policy and research outfit, dubbed the new rule a "strong" and "prudent" one, and there's also the view of Bill Brennan, the Atlanta Legal Aid lawyer. Brennan first got involved in the fight against predatory mortgage lending in 1991, when an 80-year-old woman named Annie Lou Collier walked into his office. She was petrified at the prospect of losing her home of 37 years because she had been hoodwinked, "Tin Men"-style, into taking out a home loan carrying a 25 percent interest rate and with 20 percent in upfront costs. "Basing a mortgage on a person's ability to pay has been the key to this whole thing," Brennan said.
This legislative package addresses another of the bad practices that helped to fuel the subprime disaster by banning what people inside the industry call a "yield spread premium." That's basically a fancy term for the kickback lenders paid mortgage brokers willing to steer customers into higher-priced subprime loans. So what if Mrs. Jones qualified for a 6 percent mortgage? Put her in a higher interest loan carrying more fees and that could mean a commission equal to 2 percent of the loan amount -- a $4,000 bonus, for instance, on a $200,000 loan.
Is it any wonder, then, that a study commissioned by The Wall Street Journal found that more than half of the borrowers taking out a subprime loan between 2000 and 2006 had a credit score high enough to qualify them for a conventional rate loan? Half the subprime mortgage loans, of course, would have meant half the inventory for Wall Street to slice and dice and sell to the unsuspecting manager overseeing a pension or university endowment.
This new legislation, which may pass in both chambers by the July 4th weekend, also limits prepayment penalties, another anathema to consumer advocates. Prepayment penalties have long been a staple of subprime loans, though they had been pretty much eliminated from conventional rate loans by 2000.
Will It Work?
Questions remain, of course. It's unclear how much flexibility the new agency will have to respond to new threats and there are, of course, limits on its powers. Some activists wanted this new watchdog to have the power to set a national usury cap to combat the payday lenders and those selling other high-priced loan products. But the Obama administration and ultimately Congress sensibly thought that it should be our elected officials who make that kind of decision, not the appointed head of a regulatory body.
Yes, Congress didn't do anything this round about Fannie Mae or Freddie Mac. I'm sure they could have done more about the credit rating agencies. There were other shortcomings. But give our much-maligned elected representatives a break. One historic agency with a hodgepodge of other sensible proposals: not bad for a year's worth of multitasking.