Do Consumer Protection and Systemic Safety Conflict?

Writing about the politics of the Senate's financial reform push on Sunday, I mentioned some of the major issues concerning Republicans. One of those is the possibility that consumer protection could be given priority over safety and soundness of the overall economy. I explained that Republicans want greater parity between a CFPA and systemic regulator:

For some tasks, the systemic risk council requires a two-thirds majority, which means it might be difficult for this regulator to assert itself over the CFPA if there's some conflict. Republican might insist that consumer protection isn't given priority over systemic safety and soundness.

The more I think about it, the harder it is for me to identify a situation where there would ever actually be an issue between consumer protection and prudential regulation. As a result I was delighted to see an article examining whether such a conflict could exist from "American Banker" yesterday. Senator Dodd's (D-CT) Banking Committee staff liked it so much that they sent it around as an e-mail bulletin. So you can probably guess which side the piece argues in favor of: that no such conflict exists.

The article takes the form of posing this question to a number of industry experts, including a former Treasury official, NY Fed official and Comptroller of Currency John Dugan. All agree that such a conflict would be rare to nonexistent. It does, however, provide the following example from Dugan of such a possibility:

"One area that stands out is loan underwriting," Dugan said in an e-mail. "For example, a consumer agency might think that down payments on house purchases should be limited to 5% to promote homeownership, while a safety and soundness regulator might believe a higher minimum could be needed to ensure lenders don't make loans that won't be repaid. Given the significant role that loose underwriting played in the financial crisis, I think it makes sense to provide an exemption from the consumer agency's jurisdiction for credit standards."

I find this a poor example, because I simply can't fathom a CFPA putting a cap on down payments. Instead, I would imagine the opposite. During the housing bubble, consumers were harmed by wacky mortgage products, like option-adjustable rate mortgages. Those consisted of little or even negative equity where the payments increased after a specified period of time. That sounds great for consumers in terms of expanding credit -- until you realize it the products will result in default more often than not. Of course, this is bad for both consumers and the broader economy. No conflict here.

A more realistic possibility comes from former OCC official Ray Natter:

"For example, from a consumer protection standpoint, you would want to give borrowers every opportunity to cure a default, and might mandate repeated 'second chances' to bring a loan up to date before repossessing the car or canceling a credit card," he said. "That's great for the consumer, but the bank is losing money, and these costs will be passed on to the entire economy through higher interest rates and fees."

The article explains that a CFPA would not proactively seek to push for policy goals like this. I think that's right, but even if it isn't I'm completely unconvinced that such policies would threaten systemic risk. As indicated, banks would just be forced to make up that difference in earnings through such regulatory changes by charging higher interest rates and increasing fees. That, after all, is exactly what we saw with the recent credit card regulation -- a response that doesn't appear to have heightened systemic risk.

But maybe then the CFPA would respond by putting limits on those rates and fees? Banks would answer by curbing credit to riskier borrowers. The CFPA would then force them to give those borrowers credit anyway, etc. I guess if you imagine that the CFPA as a never-ending arch-nemesis of the banks, then you might worry about such scenarios, but I think (or hope anyway) that such worries are misguided.

I refuse to believe that consumer protection can't coincide with responsible and profitable banking. There are banks out there that do not attempt to take advantage of consumers but still make money. It's a pretty cynical view to assume otherwise. And ironically, the banking lobby is the loudest party citing this fear. Do it mean to suggest that banks can't exist without taking advantage of consumers? I doubt it; thus, it shouldn't be the case that a consumer advocate would make it impossible for banking to remain profitable.

So I still remain unconvinced that a conflict between consumer protection and prudential regulation is something to worry about. But, as always, I welcome plausible examples that demonstrate otherwise.