Last week's Supreme Court decision in Cuomo v. the Clearing House Association and OCC marks a significant victory for states and consumers after many years of preemption court losses over such issues involving insurance, operating subsidiaries and third-party bank agents. But banking isn't a zero-sum game, and what's good for states and consumers isn't necessarily bad for the financial services industry.
Prior court decisions on a variety of preemption-related issues had the unfortunate effect of encouraging the Office of the Comptroller of the Currency and Office of Thrift Supervision to adopt ever broader interpretations of the National Bank Act and the Home Owner's Loan Act, respectively. Agency position on preemption, in turn, fueled new litigation by some in the federally-chartered financial services industry aimed at moving out the edges of an already expansive doctrine. These efforts posed problems for the industry in at least two ways.
Overbroad preemption doctrine threatened our long-standing dual banking system. In this system, state-chartered institutions originated and developed numerous financial services products that consumers now take for granted (think checking accounts and ATMs). Recent preemption policy disrupted the balance between the state and federal components of this system by favoring federal charters over state charters. The resulting imbalance threatened to harm a system that has been a proven laboratory of innovation. The Cuomo decision serves as a check on that harm because it rejects portions of overreaching OCC policy. Because of prior Supreme Court precedent (the Chevron case) courts don't often reject agency interpretations of statutes the agencies administer. When it happens it gets noticed. This is particularly true when the rejection comes from the Supreme Court itself. Moreover, when and if new suits are filed relating to unanswered questions, states and consumer advocates can harvest useful language from the Cuomo decision to counter the banner crops that supporters of broad preemption have enjoyed from other recent court decisions. Indeed, pro-preemption forces wasted little time in making the most out of the Supreme Court's 2007 Watters decision. Watters dealt only with whether national bank operating subsidiaries enjoyed the same preemption protections as their national bank parent institutions. Nevertheless, advocates for broad preemption used the decision to quickly rack up new court victories in several federal appellate courts concerning such issues as whether third-party agents of federal financial institutions also had the same protections. Absent congressional intervention, the preemption policies validated in those decisions, right or wrong, are likely to remain the law of the land.
Aggressive preemption doctrine also contributed to more serious problems that have damaged our financial system and shattered consumer confidence in the banking industry. Broad preemption policy kept state watchdogs at bay. This made it easier for some unscrupulous market participants to develop and sell option adjustable-rate mortgages and other questionable products that contributed to the subprime debacle that sparked the Financial Crisis. As an unfortunate result of what was probably inadequate federal regulation, the financial system has now been compromised and financial institutions in general have lost credibility in the public's eye. The public has not discriminated by sparing from its condemnation institutions that had little to do with unsound products and practices. Instead, the good have been lumped in with the bad to everyone's mutual disadvantage.
It's here that the Cuomo decision can have the most important beneficial effect of improving public confidence in our financial system. It can do this in at least two ways. First, by stating clearly that states can enforce their own valid laws against national banks (a position two lower courts had rejected), the decision opens the doors to additional checks and balances that state regulators can provide using their own additional resources. Yes, they will have to do so in the confines of the court system. But their ability even to exercise that basic power was in serious doubt until the Supreme Court decided Cuomo. Discount the naysayers who warn that banks can't function if they have to comply with sometimes varying state laws. These variances are often minimal and, besides, banks need not do business in states with onerous or overly anti-business laws.
Second, the decision also provides an important legal (and thus political) boost to the Obama administration's proposal to permit states to be more involved in protecting consumers. Wavering senators and representatives may now appropriately feel somewhat more comfortable about the propriety of enhancing state involvement in protecting the public when it comes to federal financial services products and practices. In the long run, even if those policies aren't enacted precisely as proposed, an additional layer of enforcement should reduce the risks that irresponsible products and practices can pose to our financial system.
