Washington insiders are once again casting blame on the states for failing to adequately regulate the nonbank financial industry. It's as if the federal regulators did a bang-up job of ensuring safety and soundness in big banks with federal charters and our entire financial system crashed due to mortgage brokers gone wild.
Such a notion is silly. Federally regulated financial institutions played a significant role in nontraditional mortgage lending directly and through brokers, participated in nontraditional securitizations and acted as warehouse lenders to the nonbank mortgage industry. Pointing the finger at the states is an awfully good idea if your goal is to increase federal turf and consolidation of financial services into a few megabanks. It is an awful idea if you care about consumer protection or responsible lending.
In the past decade there were exactly zero federal laws enacted to protect consumers from predatory mortgage lending. Yet 10 years ago, states like North Carolina and New York were enacting major legislation to rein in predatory practices. In response to those laws, the big banks and their federal bank regulators aggressively sought preemption of those state laws.
In the past decade there have been major multistate enforcement actions taken against Household, Ameriquest and Countrywide. Furthermore, state regulators took more than 7,000 mortgage enforcement actions in 2008 alone. Though the state system has not been perfect, no one can argue that states have not aggressively fought abusive lending practices. On the other hand, federal regulators did little to rein in mortgage lending excesses. The myth that major banks did not engage in unsound lending practices is believable only if one equates the paucity of enforcement actions by federal bank regulators with an absence of lending problems.
As Congress considers various proposals to restructure financial regulation, it should ensure that states continue to play an important role in both protecting their consumers and providing a check against what can be a slow, rigid and insulated federal bureaucracy.
In the past, Congress has wisely recognized the benefits of federalism, and the norm of consumer protection statutes has been to preserve the ability of states to set a higher bar. For instance, the federal predatory-lending law (HOEPA) enacted in 1994 permitted states to pass more protective laws that have served as the model for current proposals in Congress.
If Congress and the federal bank regulators do their jobs in setting an appropriate balance between access to credit and consumer protection, then states will have little need to act. But if Washington once again becomes paralyzed, as it did for the last 15 years while intoxicated with "innovations" in mortgage finance, then states will once again fill the role of first responders and push to raise the bar of consumer protection.
Of course, states should be held accountable for their regulation of the nonbank arena. One working model is the recent federal law requiring minimum standards for mortgage loan originator licensing. Congress enacted the SAFE Act just last year and gave states one year to enact legislation to meet or exceed that standard or else face a federal takeover of mortgage licensing. With this federal prod, 48 states and the District of Columbia have enacted legislation to comply with the SAFE Act.
This model is directly applicable to the proposed federal consumer protection regulator. Congress could set up a consumer protection regulator to exercise backup examination and enforcement authority over the nonbank sector. If the states do a competent job of supervision and enforcement, then the federal agency will have no need to duplicate oversight or enforcement of consumer protection standards. If the states fail, then the federal consumer protection regulator can and should step in.
