Saturday, June 20, 2009

ABA Consumer Protection conference, financial products safety

Luncheon Address: The Rise of the Consumer in the Obama Administration

Caroline Holland, majority counsel for Senate Antitrust, Competition Policy and Consumer Rights Subcommittee

Agenda: ban reverse payments in patent settlements used to delay the entry of competing generic drugs against the (ex)patentee. Discount pricing consumer protection act, to overturn the recent Supreme Court decision and ban minimum resale price-fixing. Also on the horizon: Railroad antitrust, to remove antitrust exemption that the RR industry currently enjoys.

Eric Stein, Treasury Department, Deputy Assistant Secretary for Consumer Protection (a new title at the department)

If you forget about the consumer, you do so at your peril: if people can’t pay back their loans, that breaks the economy. There’s no sharp distinction between consumer protection and safety and soundness of the banks, but the regulatory agencies looked with a different lens. We learned that we need a consistent voice standing up for consumers: need a single entity that can set standards, reduce gaps in federal supervision, coordinate with the states, and create consistent regulation for similar products. The goal isn’t more regulation but better regulation.

(1) Subject matter is quite expansive: all financial products. Payday lending, mortgages, credit cards, savings products, payment products.

(2) Powers are strong. The ability to write rules. TILA, RESPA, Fair Debt Collection Protection Act, the CRA, etc. exist and the agency will be able to enforce them and to write rules to fill in gaps—level playing field for everyone. Also have the ability to supervise and examine institutions with subpoena power.

(3) Enforcement powers, similar to powers bank regulators have over banks. There’s a feedback loop between rule-writing and enforcement

There is also backstop authority—an agency that used to have authority can enforce its rules if the new agency doesn’t act. The states can also go further than the agency, and enforce state as well as federal rules.

Guiding principles: Transparency, simplicity in products, unfairness (some terms are so unfair they should be banned, or constrained), accountability in access to credit.

FTC and SEC should have expanded powers as well—they’ve been hamstrung before.

Q: the consumer products safety commission got split off from the FTC, and nobody would say that’s a successful agency. Nor is the FCC good at doing consumer protection. Why would a regulatory agency for financial work starting from scratch do better for consumer protection than the FTC?

Stein: The bank regulatory agencies have a division for CRA enforcement; that will come over to the new agency. Feeling: symbiosis of putting them all together that will be stronger than existing authority. Full rule-writing ability, not restricted as FTC is; full ability to sue while providing notice to the Department of Justice.

Q: Resale price maintenance—why not treat it under a rule of reason?

Holland: there’s a concern that the businesses suffering from this don’t have the resources/ability to bring a case to prove it under the rule of reason. Breyer’s dissent: we haven’t seen this bring benefits for consumers, and it worked for 90 years to keep prices lower. The states that banned minimum resale prices had lower prices before the law.

Villafranco: recently approved act out of subcommittee allowing regulation of various lending practices—what are your thoughts on that?

Stein: He’s heard of that bill but doesn’t know its prospects. There are important gaps in regulation. On the fraud side, the FTC can still go after debt settlement fraud, but there is a need for more.

Q: In connection with health care, is anyone looking at McCarran-Ferguson and price competition?

Holland: Sen. Leahy is looking at removing the antitrust exemption, but it hasn’t percolated up as a serious issue. We are concerned about antitrust issues from health care reform.

Q: Preemption?

Stein: Nope.

Q: So potentially 50 different rules.

Q: Would that also cover bank regulation?

Stein: Yes.

Q: Right now there are 7 financial agencies. Washington Post says the Federal Reserve will take the lead—is that what you’re saying?

Stein: Federally chartered banks, supervision will be consolidated. Tier 1 financial holding companies—those that pose systemic risk because of their size, scope, complexity and interconnectedness—would be regulated by the Federal Reserve, which would oversee all those firms and set capital requirements. Their consumer protection division would come over to the new agency. It’s not accurate to say the Federal Reserve would take the lead, but it would focus on these large entities.

Q: The SEC has been attacked as overlawyered. What will ensure that the new entity will not be overlawyered?

Stein: There’s a commitment to be data-driven—all complaints to federal agencies will be funneled to the new agency. It will test disclosures to deal with biases that lenders preyed on; will use behavioral economics.

Q: What do you mean by backstop authority?

Stein: When you disperse authority, people look for gaps or they forum-shop and choose the weaker regulator; there’s a competition and the regulator may market itself as friendly. We want to avoid that. If the FTC sees a bank problem, they’d refer it to this agency, but if the agency didn’t act within 90 days, the FTC could. Similarly, states could act.

Q: Does the legislation contemplate staffing up from ground level?

Stein: No, transferring. All of the agencies but one have separate divisions focused on CRA and compliance; the one used to have a separate division. There will be integration issues, but you can move those people.

Q: what about private rights of action?

Stein: 15 or so statutes are transferred over; left alone in terms of whether there’s a private right of action. There would not be a private right with respect to the agency’s new gap-filling regulations.

Q: homeland security problem: how do we get these different agencies to work/think together?

Stein: Will be an integration challenge, no doubt. Strong leadership and single mission will help.

Q: Has the legislation described the agency structure?

Stein: Not yet! Early next week. It doesn’t depart from the white paper’s description of the consumer agency.

Q: Former FTC commissioners spoke about a time when the agency did a lot of unsuccessful rulemaking. That takes agency time and focus; think about unbridled authority to write rules by unelected officials.

Stein: inherent issue with administrative agencies. Core principles: access to credit preserved through data-driven measures. The Federal Reserve was quiet for a long time on mortgages. Congress delegated the ability to issue mortgage rules, and the Federal Reserve did a rule to provide targeted protections for subprime mortgages; widely welcomed and overdue. As the crisis has evolved, it could go further. It will be a thoughtful, long process. Banning will be a last resort: disclosure and tailoring will be the watchwords.

(Everybody talks about disclosure; and yet as Alan Levy told us, it does so little for us! Though I think Levy might well agree that mortgages are a place where information-seeking goes into enough depth for good disclosure to help.)

Consumer Protection in Financial Transactions: The Need for a Financial Products Safety Commission

Moderator: Dana B. Rosenfeld, Bryan Cave LLP, Washington, DC

Adam J. Levitin, Georgetown University Law Center

States traditionally took care of consumer protection; feds took over regulation of banking, but left consumer protection behind, creating gaps. The architecture of regulation determines the tenor of the substance. We have a real problem of regulatory architecture in financial services. The FTC has no authority over banks, thrifts, credit unions. Authority for consumer protection for banks is spread out over a bunch of different agencies. They’re focused on safety/soundness of the banks. Soundness requires profitability, and abusive lending is often profitable, at least in the short term. That presents a tension for regulators, who are judged on their performance in insuring safety and soundness; consumer protection almost always loses.

Regulatory arbitrage: deciding whether to be a thrift or another kind of institution—so banks seek out the weakest regulatory institutions, and some of the institutions are in active competition with each other to gain regulatees and avoid being phased out. Countrywide was induced to choose a particular structure by the promise (fulfilled) that it would be able to choose its own oversight.

Congress has rarely done things in this area. Deregulation happened within the agencies, in opinion letters, in failure to take enforcement action, and in active litigation against states to assert preemption of any interference with financial services.

What to do? Regime change may help, but not all agencies are under direct political control. And it’s neither a guarantee of change in regulation nor a permanent feature—administrations change. Another possibility: put the states back in the game; that doesn’t seem to be the way we’re headed. Finally: reorganize consumer protection on the federal level.

That’s got potential, but the risk is that you’re gambling all your eggs in one undiversified basket. Example: consumer product safety commission, dropped the ball on lead in children’s toys; the director fought against congressional appropriations to fund the agency. No regulatory system is fail-safe. Current proposal seems open to intervention by the states. Though not all states will act, even one Eliot Spitzer can do a lot of good for consumer protection nationwide.

There are costs to duplicative regulation, but there are also costs to abandoning consumer protection, which we’re seeing right now.

Angela K. Littwin, University of Texas School of Law

Why we need regulation: there is lots of misunderstanding of the products consumers are buying; subprime borrowers didn’t understand even the basic terms of their mortgages; the evidence is the same for credit cards. Contracts and practices change so quickly that the usual failsafes don’t apply—the credit card contract changes over the life of the loan, so Consumer Reports can’t come in and rate the loan, and consumers who invest in educating themselves are less likely to help them in the long term.

Disclosure needs to be done more uniformly, more effectively. Harder question: why we need more than disclosure. Answer: psychology/behavioral economics. Consumers are using lending products in ways they regret in the long term. Study of women in public housing: self-identified as using credit cards in ways against their long-term interests. They couldn’t have done that kind of spending without access to credit cards. Oren Bar-Gill calls this “use transparency”—people mis-predict how they’ll use products. People think they’ll never be subject to the late fee. Long known a problem in credit cards; increasingly seen to be a problem with mortgage loans and payday loans.

People often use products in ways that objectively cost them more money—people who borrow with teaser rates frequently don’t change when the teaser rate expires, even though it would have saved them $250. Consumers prefer shorter teaser rates that are slightly lower even when longer, slightly higher teaser rates are better deals. Issuers know this. The business models here aren’t accidents. Lenders use to make their money off transaction fees and people who paid on time; now, consumers, especially in the credit card industry, can’t pay off the whole loan but end up paying a lot in small payments over time. An agency that truly did its job would address those problems and force lenders back into the model in which consumers had to pay back their loans.

Administration’s white paper: A new agency, as outlined in the 20 pages of the paper devoted to consumer protection, goes a long way towards addressing these problems.

New agency is useful, instead of new laws: lender practices change so fast; Congress can’t keep up. New credit card legislation is helpful, but card issuers can figure out workarounds.

Also keeps financial institutions from shopping around for regulators. Another factor of importance: the agency would be evidence-driven. Regulations must be studied 3 years after enactment. Section of the white paper is devoted to the agency’s data-collection powers. White paper requires regular testing of any disclosure regulations the agency enacts, tested in the field. Exemptions from regulations can be granted on the basis of testing evidence. This is important because theory has outstripped evidence in this area—the theory that all regulation reduces access to credit, for example.

Financial education isn’t sufficient—most lawyers can’t understand their own credit card contracts--but in context of better disclosures and regulations, it would make sense, especially with a standard of reasonableness instead of deceptiveness. The paper also advocates going back to “plain vanilla” products. There could either be a positive label for simple products, or a negative label for risky, complicated ones.

The white paper also tackles specific problems, like yield spread premiums, prepayment penalties, and mandatory arbitration.

She is cautiously optimistic. The concern is how strong the agency will actually be in protecting consumers. Will there be a revolving door between industry and regulators? Strong conflict of interest provisions are needed. Could be exacerbated by explicit mission to balance cost of regulation in access to credit against benefits of regulation.

One way statutes deal with capture risks is through private rights of action; the current proposal is neutral. Selective preemption addresses this risk as well.

Thomas Pahl, Assistant Director for Advertising Practices, FTC

Standard FTC disclaimer: his own views, not official. Consumer protection is more prominent now than ever—recent credit card reform legislation; new proposal to combine functions of current agencies.

What could we expect from the president’s plan? FTC could play a greater role in protecting consumers outside financial products—the president’s plan recommends adding power to the FTC to engage in notice-and-comment rulemaking under the APA, instead of the Magnusson-Moss restrictions. Also recommends enhanced penalties under section 5. And the plan calls for more resources.

Does substantially contract FTC authority over financial services, transferring it to the new agency. But apparently the FTC would have backup authority for the things over which it currently has jurisdiction, and would retain concurrent authority over fraud in things like credit repair and foreclosure rescue. Not clear exactly what role the FTC would play.

Rosenfeld: Suppose we just increased FTC authority—arguably we wouldn’t need a new agency.

Levitin: He’s agnostic: could do a lot with granting FTC authority. Two issues: (1) would it put too much on FTC’s plate; (2) agency culture: if you move consumer protection out of safety and soundness regulators, it doesn’t end the tension but just changes the stage—from intra-agency to inter-agency conflict. If it’s an independent agency, then in theory the White House doesn’t resolve it but the courts do, and maybe that’s right; but recent experience suggests politics come into play. The CFTC chair wanted to regulate derivatives under Clinton (looks like a good idea from where we are now!). CFTC is technically independent, but got enough administration pressure that it backed down. So there is a concern about whether the FTC can stand up to Treasury/the Fed, though there’s no guarantee a new agency could do better. Levitin is not expressing any opinion on FTC’s backbone himself!

Pahl: Another question to add to the pros and cons: if you want change fast, the FTC already exists and has substantial experience, including in research, and could immediately bring that to bear on financial products. However, supervising financial institutions is not something FTC has experience with and is labor-intensive. Rulemaking in financial services would also be new to the FTC.

Littwin: Agency devoted to consumer protection may also get funded more than a subdivision of an agency.

Q: is the vision to include small business customers in the scope of “consumer protection”?

Littwin: She didn’t see that in the white paper, but that would be an important question for actual legislative language. The white paper seems to take more functional approach to who gets considered to be a financial institution; it would also make sense to treat small business credit cards like individual consumer credit cards, since they’re so similar and often identical.

Pahl: The FTC sometimes acts for small businesses—we do include them as consumers.

Q: Why single out financial services for a new agency? There are other areas of business practice. Also concerned about the difficulty of ramping up a new agency. See: Homeland Security.

Levitin: It’s an easy-to-understand political move to deal with a crisis. We do have consumer protection agencies for other areas already; there isn’t an acute crisis in other areas, like a problem of exploding toasters. Next, there’s a different level of expertise needed to understand financial products: what makes a financial product unsafe is just different from what makes a toaster unsafe. A 2/28 ARM may have some benefits and some harms; harder to figure out.

Littwin: A lot of the specific mechanisms that lead consumers to make bad decisions seem small, but the interplay between decisionmaking problems and lack of regulation has enabled the huge growth of the subprime mortgage market, which is causally linked to the banking implosion.


Michael HD Smith said...

The creation of yet another federal agency with oversight on America's financial service providers is scary and should concern all Americans.

This agency will regulate interest rates so low that lenders will only lend to those who are very low risk. The rest of Americans will not be able to borrow money to start a business or purchase their first home.

Nick Smyth said...

Thank you Professor Tushnet for these incredibly helpful notes on these panels. I really appreciate you posting them for us all to see.