With statements from Congress and the administration and a Supreme Court case pending on preemption, it is a good time for the banking industry, consumer groups and policymakers alike to have a civil conversation.
I think we will quickly come to a consensus that preemption is both necessary and in need of repair.
It would be ironic if, just as Europe and other parts of the world eliminate national barriers to commerce, we in the United States re-create state barriers. And it is folly to think that we can have a patchwork where not only the states but also every city and county can adopt its own rules, on top of whatever the federal government enacts. The only people who will benefit are the lawyers, who on both sides will derive substantial incomes from endless litigation.
Take credit cards. If a cardholder moves from New York to Florida, are the old credit card balances subject to New York's protections and the new balances to Florida's? How do you allocate those balances if a portion is rolled over from one month to the next? What if there are joint account holders with different states of residence?
These are examples of the hundreds if not thousands of issues that will require rules ad nauseam. And for what purpose?
Similar issues would arise if we have a patchwork of rules governing mortgages and other consumer loans. And at least some readers will remember when we once spent huge amounts of time to determine the "choice of law" in multimillion-dollar commercial transactions, flew boards of directors to a designated state, required payments all to come to that state etc. Do we really want to go back to that Neanderthal era?
But preemption as it currently exists has serious shortcomings. The doctrine was largely developed in the 1970s in connection with the fixed-rate mortgage crisis of that period. About $1 trillion of the nation's $3 trillion of banking assets were insolvent, since institutions were holding mortgages yielding something like 4% but suddenly were paying 20% or more for funds. The preemption doctrine was developed as a way to address the havoc that existed in the nation's fixed-rate mortgage system, leading to a U.S. Supreme Court decision known as de la Cuesta that upheld the sweeping preemptive authority of the relevant federal regulator, the Federal Home Loan Bank Board, now known as the Office of Thrift Supervision.
The thrift regulator was created during the early years of the Depression. Because it was not clear then what powers would be needed, the legislation used few words but was sweeping in scope. It directed the FHLBB to adopt such rules and regulations as might be needed, "giving primary consideration to the best practices of local mutual thrift and home financing institutions" throughout the United States. In other words, the FHLBB could do pretty much anything it wanted in regulating federal thrifts but was to look at what was working at the state level and adopt federal rules based on these best practices.
In recent years we have been trying to graft preemption atop a deregulated system, and this will not work. It is like grafting a 100-foot tree atop a thinly rooted shrub. With the slightest wind, it will topple.
My mentor, Bill McKenna, largely invented the preemption doctrine, and before Bill would argue preemption in court, he insisted that there be a federal rule regarding whatever was at issue (due-on-sale clauses, late charges, prepayment fees etc.).
Bill understood that preemption was both a legal and a political matter. He did not think preemption would survive if a judge were to say, "I agree that the supremacy clause [in the Constitution] makes national law supreme. So what are the comparable federal laws you want me to enforce instead?" Imagine if the response was, "There aren't any federal rules, your honor. You just need to wipe out the state rules that otherwise would protect these people."
There likewise was a political concern. Preemption is a highly charged doctrine, as we are again witnessing. Neither state nor federal elected officials can long tolerate a system in which their voting constituents feel they are not being treated fairly.
For the system to be fair, there must be (a) rules and regulations in areas subject to abuse, (b) a forum where consumers can bring their claims and (c) a remedy. In recent years, we have lacked all three elements.
This does not mean the federal government should try to write regulations covering every possible issue that might come along. Rather, we need to watch for what actions are causing real harm. In those cases, the federal agencies need to decide whether there should be an appropriate federal rule. And the starting point is to see what might already be working at the state and local levels.
We also need a forum that has the power to hear a case and enforce a remedy. Congress or the federal agencies could create hearing offices, they could consider alternative dispute-resolution processes (such as the bank ombudsman offices in Britain, Canada, Australia and elsewhere) or they could allow the cases to be heard in state or federal courts. Serious concerns arise in deciding the best approach, but this does not obviate the need for a forum and a remedy.
Meanwhile, state attorneys general and others are arguing that they have a role to play in all this, an issue that is before the U.S. Supreme Court with respect to visitorial powers. No matter which way the court rules, we should realize that an effective solution was included in the case on which much of preemption is based.
That case, People versus Coast Federal, was decided in 1951 when the California attorney general wanted to stop a federal thrift's allegedly deceptive advertising practices. Not coincidentally, the government lawyer who argued the case was Bill McKenna. He was at the time the FHLBB's assistant general counsel, and the court adopted virtually his entire argument, including his now often-quoted assertion that the FHLBB had sweeping power over every federal thrift "from its cradle to its corporate grave."
But the federal court also discussed a concept known as "exhaustion of administrative remedies." Put simply, this doctrine says administrative remedies should be pursued to their conclusion before a dispute comes into court.
The point was that the California attorney general could — indeed, should — have taken his complaint first to the relevant federal agency and tried to obtain a remedy there. Failing that, presumably he could come to court.
That is exactly what we should consider today. And as a legal and political matter, imagine the impact if the federal agencies fall consistently short in addressing legitimate problems the state authorities keep bringing to them.
It's a good system. It was designed exactly as it should be. It's time we implemented it — again.