On June 17, the Obama administration announced a plan to create a Consumer Financial Protection Agency dedicated to adopting and enforcing consumer protection regulations.
The agency would have jurisdiction over all entities engaged, directly or indirectly, in financial activities. Though well intended, the creation of such an agency fails to address the issues that led to the current economic crisis, and it would cause new problems for both businesses and consumers. It would lead to a patchwork of state laws, increase costs, encourage litigation, stifle product development and sweep up a broad group of businesses into federal regulation and examination. Many of these businesses are already adequately regulated. In short, a CFPA would create more problems than it solves.
In connection with the agency, the president's proposal would remove federal preemption of state consumer protection laws. CFPA regulations would serve as a floor for consumer protections, and states would be encouraged to enact stronger restrictions. States would also be permitted to enforce CFPA regulations. As a result, financial service providers that operate in multiple states would be subject to conflicting regulations and would need to spend resources developing programs to comply with multiple regulatory schemes.
Even the federal rules could be subject to varying and inconsistent interpretation by state authorities. Litigation would probably grow from inadvertent state law violations, leading to higher legal expenses and insurance premium costs for service providers, which would be passed to customers in the form of higher rates and fees.
Banks and other financial firms would avoid jurisdictions with more stringent regulations and enforcement activities, resulting in less competition and options for those states' residents. A CFPA would develop standards for "plain-vanilla" products that providers would offer alongside their alternative products. To push these plain-vanilla products on consumers, a CFPA may require financial experience questionnaires and/or "opt in" certificates before a customer may buy alternative products.
Businesses would be discouraged from spending on product development and, as a result, would be slow to respond to changes in financial market demand. Regulations that prevent unqualified consumers from obtaining high-risk financial products are needed, but a CFPA would inhibit the development of legitimate, beneficial products.
A CFPA would impose a duty of reasonableness on financial institutions in connection with their disclosures and communications with customers. Such disclosures and communications would need to be "reasonable," not just technically compliant and nondeceptive. Reasonableness, however, is a subjective standard that would produce additional litigation and related costs. This would also have the unintended consequence of absolving consumers of responsibility for understanding the details of the products they buy.
Customers who default on loans would be given an incentive to assert that the disclosures they received were not reasonable. The not only runs counter to the longstanding legal principle that consumers are responsible for understanding the documents they execute but also suggests that consumers need heightened government protection because they are not smart enough to make appropriate financial decisions.
Certain reform initiatives would also fall under the purview of a CFPA, including the potential prohibition of mandatory arbitration clauses and prepayment penalties. Unfortunately, these also would increase customers' costs. Mandatory arbitration clauses are standard in some documents, remove uncertainty about the interpretation of market-accepted terms and let service providers offer cheaper financial products by avoiding related litigation costs. If mandatory arbitration clauses were banned, businesses would be forced to spend considerably more to defend themselves against frivolous claims.
Similarly, lenders can offer borrowers more favorable terms if they agree to prepayment penalties. This lets lenders control prepayment risk while not affecting borrowers who plan to carry the mortgage through the penalty period. By controlling this risk, lenders can offer lower interest rates.
Many businesses will be surprised to learn that they are "financial institutions" and, therefore, subject to CFPA regulation and examination. The proposal provides a very broad definition of the term and would authorize a CFPA to further expand it. Regulatory authorities often seek to expand their jurisdiction to the greatest extent allowed by law. This broad coverage highlights another major problem with a CFPA: It puts all financial institutions in a burdensome scheme rather than focusing on the holes in regulatory coverage that allowed Wall Street investment banks and largely unregulated local mortgage brokers to race to the bottom of credit quality and severely weaken our economy.
Rather than creating a costly, new regulatory scheme, Congress should develop ways to improve existing consumer protection laws that address the true problem areas and to educate consumers about the consequences of their financial decisions.
