Safety and Soundness vs. Consumer Protection

How to think about the new Senate deal that could create a consumer protection agency within the Federal Reserve

Bipartisan support for financial regulation reform could be within reach if Sen. Chris Dodd can convince Democrats to back a Republican plan to house a consumer financial protection agency in the Federal Reserve.

Before we decide if this deal is acceptable, let's step back and review the basic case for a unified consumer protection agency. There are at least two problems with our byzantine regulatory regime. First, diversity of regulations at the federal and state level encourages regulatory arbitrage and a race to the bottom among regulators jostling for bank charters. Second, consumer protection is divided among a number of alphabet soup agencies* most of whose first order of business is looking after the "safety and soundness" of banks -- ie, their profitability. As a result, consumer protection can either be considered an orphan cause without one real home, or a foster child of parent regulators who don't care for it particularly effectively, because they're focused on their financial institutions' profitability. And companies wouldn't engage in deceptive practices unless they were profitable.

The tug-of-war between "safety and soundness" and "consumer protection" is at the heart of this debate. Consumer advocates want a powerful single-body regulator and enforcer that is distinct from safety and soundness regulators. The conservative response is that it's a very bad idea to have one consumer organization slashing profitable practices -- or promoting risk taking -- divorced from any safety and soundness responsibility.

This Senate deal would appear to centralize rule-making (but not enforcing) in an office under the Fed. You can anticipate at least two objections from the consumer protection crowd. First, it's the Fed -- the ultimate guarantor of the soundness of the financial system. "This is like putting the Consumer Product Safety Commission under the supervision of the Department of the Commerce," says David Balto former policy director of the Federal Trade Commission and a senior fellow at the Center for American Progress. The second objection is that the compromise would keep enforcement of consumer protection rules with other agencies -- agencies, you remember, also charged primarily with safety and soundness. My guess is that Democrats will make a stink, but ultimately swallow this deal under the banner of "let's not make perfect the enemy of barely acceptable."

Speaking to financial services experts on the left and right today, it's fairly clear that the heart of consumer protection is the disclosure of honest information about financial products. This acknowledgment is bipartisan. Pew's Adam Levitin, an advocate for a single agency, said in a Pew report that "the goal [of an independent consumer protection agency] is to make consumer financial products clear so that consumers can make better choices." On the other side of the spectrum, American Enterprise Institute's Alex Pollock, who told the House Committee on Financial Services last year that a single independent agency would be "highly intrusive" and "a major burden," still said the key to consumer protection was simple, plain-language disclosures of risk, like a one-page mortgage form and a one-page overdraft form for new homeowners. "My fundamental point is that America is built on risk taking," Pollock told me. "I'm not against risk. But people deserve to know what risk their taking."

So we all want better disclosure. The question is whether we can expect tough disclosure laws and regulations -- regulations that force some companies to give up profitable schemes; that don't preempt strong state regulations; that don't encourage a regulatory race to the bottom to attract more bank charters -- if consumer protection is housed within the Federal Reserve. We need better disclosure laws, but ahead of that we need an agency with enough backbone to resist the siren call that financial companies' soundness must be pursued to all ends. I'll end with the guy I usually defer to in these stories: Atlantic contributor Mike Konczal. It's about regulation and disclosure keeping up with the times...

Now right now, consumers are facing a range of financial products, from student loans to credit cards to mutual funds, that are much more complicated than they faced in 1933. Some of this complication is innovation, some is meant to synthetically create opacity in the product innovating product differentiation, and some is just regulatory arbitrage. As Dan Geldon has written, the regime of disclosure has been turned into a weapon against consumers instead of the mechanism to let information and competition do its job. So it's time to update that regime to handle the 21st century.

* In case you wanted to know:

--OCC (national banks, federally‐chartered branches, agencies of foreign banks),
--OTS (federal thrifts and thrift holding companies),
--NCUA (federal credit unions and federally‐insured state credit unions),
--Federal Reserve (bank holding companies, state‐ chartered member banks, nonblank subsidiaries of bank holding companies, Edge and agreement corporations, branches and agencies of foreign banking organizations operating in the United States and their parent banks and some aspects of checks and electronic payment systems),
--FDIC (state‐charted insured banks and insured branches of foreign banks),
--FHFA (the mortgage industry in general through Federal Home Loan Banks, Fannie Mae and Freddie Mac),
--HUD (real estate settlement procedures and FHA‐insured mortgage loans),
--VA (VA‐guaranteed mortgage loans),
--IRS (tax preparers),
--FTC (non‐banks, including debt collectors), and
--Department of Justice (residual anti‐fraud authority). Source: Pew.