Politics & Policy

Protecting Borrowers from Themselves

Read the fine print on Obama's regulatory offer.

According to President Obama’s preferred narrative for explaining the financial crisis, it is an “indisputable fact” that a lack of adequate regulatory structures allowed the inflation of a housing bubble that brought down the economy when it burst. The centerpiece of his attempt to address this is the Consumer Financial Protection Act, legislation that would create a new Consumer Financial Protection Agency (CFPA). The ostensible purpose of the new agency would be to protect borrowers from unscrupulous lenders, but — since fraud and deception already are against the law — it would be more accurate to say that its purpose would be to protect borrowers from themselves. 

Even though it was mortgage defaults that caused the crisis, the CFPA would have the power to regulate all sorts of financial products, from credit cards to car loans to bill-me-later shopping. The agency “could literally wind up having federal approval required every time your local mattress store says come in and buy a mattress, no payments for 90 days,” explains Rep. John Campbell, a California Republican who sits on the House Financial Services Committee. “The reach that agency could have, the effect that could have on innovation, could be terrible.”

The agency would have the plenary authority to define “unfair” or “abusive” lending practices. It would have the power to assign new duties to lenders, including a duty to act “in the interest” of borrowers, regardless of what those borrowers believe their interests to be. It would have the authority to investigate and compel all kinds of information from lenders. Those found to be violating the new rules could be shamed, sued, or shut down.

But the biggest new power would be the CFPA’s authority to set standards for every class of financial product. For example, the CFPA could set the following standards for mortgages: 30-year term, 20 percent down, fixed rate. All lenders would be required to offer those terms to all borrowers before discussing any alternatives, and this would apply to all classes of financial products.

Wayne Abernathy, an executive director of the American Bankers Association, predicts that this scenario will lead most big banks to stop offering alternative options to avoid risking a run-in with the CFPA. “You end up with two classes of financial institutions,” he says. On the one hand, you would have behemoth financial institutions that operate like utilities. “They get a steady return offering the standardized product, but they aren’t going to introduce anything new, because there isn’t any incentive for the agency to approve anything new,” he says. On the other hand, you would have “small boutique financial-services firms that cater to the very wealthy. Everybody else gets driven out of the banking business.”

Consequentially, Abernathy predicts, financial services for the middle class would become pricey again — 10 cents a check, $50 annual fees on credit cards, etc. — so that the big firms could get better returns. Responsible middle-class borrowers would also have fewer choices. No interest-only mortgage for the couple finishing school — why risk it? And the middle class would pay in other ways. The CFPA is to be funded through assessments on financial institutions, which would inevitably find a way to pass the cost to consumers.

Of all the major parts of the administration’s regulatory-reform agenda, the CFPA is the one that is most likely to make it through Congress. The plan was drafted with the help of Rep. Barney Frank and Sen. Chris Dodd, chairs of the committees that would construct the legislation; unlike other parts of the administration’s agenda — such as the plan to give broad new powers to the Fed — it is relatively uncontroversial among congressional Democrats.

Looking at who supports the idea, one sees why. The National Community Reinvestment Coalition (NCRC), an association composed of more than 600 community-organizing groups (think ACORN, La Raza, RainbowPUSH, etc.), is strongly backing the new agency. A closer look at a little-noticed provision in the bill helps explain why: The legislation would transfer responsibility for enforcing the Community Reinvestment Act (CRA) from existing bank regulators to the new CFPA. The CRA encourages banks to make loans to low-income populations. Banks that don’t do enough CRA lending can be barred from opening new branches, engaging in mergers, or acquiring new businesses.

As it stands, CRA enforcement is left to the regulators responsible for the safety and soundness of banks, such as the FDIC and the Fed. This law would put the authority to enforce CRA into the hands of an agency that would have no responsibility for ensuring safety and soundness. It would, however, have the power to set the terms under which banks lend to low-income borrowers, meaning it could force banks to make riskier loans while taking away their ability to charge commensurately for that risk.

The CRA embodies the kind of politicized lending that created the conditions for the bubble in the first place. Even though the safety-and-soundness regulators had incentives to discourage risky lending, they were pressured by the Clinton and Bush administrations to push banks to increase lending to low-income borrowers, which many did by lowering their lending standards. The practice of offering no-down-payment mortgages to borrowers with no verifiable income went mainstream when the Fed held interest rates below 2 percent for three years and Fannie and Freddie started buying all the garbage the banks could sell.

The CFPA is built on the myth, aggressively promoted by groups like NCRC, that the borrowers were the victims in all this, rather than willing participants in the bubble mania. To be sure, some borrowers signed up for payment plans they didn’t understand, but these borrowers were the exception, not the rule. More common was the borrower who lied about his income to qualify for a mortgage, or the subprime lender celebrated as a champion for minorities during the bubble but then made to play the scapegoat when housing prices took a dive.

The mythmaking continues. During the rollout of his regulatory-reform plan, Obama said, “Even today, folks signing up for a mortgage, student loan, or credit card face a bewildering array of incomprehensible options. Companies compete not by offering better products, but more complicated ones, with more fine print and hidden terms.” Obama offers us absolution, but only if we accept his financial nanny and the loss of freedom it entails. Read the fine print on that offer.

— Stephen Spruiell is an NRO staff reporter.

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