Saturday, May 14, 2011

We Need a Real Consumer Protection Agency

Financial FAQs

Why is there such an ongoing debate on whether to nominate Harvard Professor Elizabeth Warren as head of the new Consumer Financial Protection Agency that is mandated under the Dodd-Frank banking act? To put it bluntly, there are no regulations with teeth at present that protect consumers from many of the practices of the major financial institutions who control most consumers’ deposits and investments.

The Federal Reserve is attempting to force banks to clean up their foreclosure practices with a recent consent decree signed by 10 of the largest banking institutions. But that doesn’t protect consumers from the abusive practices that spawned all those liar loans and almost caused another Great Depression.

Professor Warren has been making headway with community banks on the necessity to oversee the largest financial institutions. In fact, she told a group of community bankers in San Antonio, Texas that they weren't the bureau's main target. Instead, the biggest part of its budget will be used to police 80,000 nonbank firms that are involved in payday loans, student lending, debt collecting and the mortgage business, but that now largely escape regulation. She also said the agency would be more focused on supervision and enforcement than on writing new rules.

The community banks "are worried, and I don't blame them for being worried," Ms. Warren says, in a recent interview. "So I try to talk to them about the regulatory philosophy of the agency, whether we're an agency that's going to come in and try to say rule, rule, rule or an agency that says let's focus on what we're trying to accomplish by using more of a principles-based approach. We're trying to make these markets transparent, which makes it easier for community banks to compete both with large financial institutions and with their nonbank competitors."

Her message is simple: the consumer “market” for financial products does not operate like a proper market because leading firms (bigger banks and also nonbanks, like some payday lenders) have figured out how to make a great deal of money by confusing their customers.

Of course, there are many honest players – mostly in credit unions and smaller banks.  But when the playing field has been unfairly tilted towards cheating, honest bank executives struggle to stay in business (or to keep their jobs).

“If someone attempted to sell boxed cereal in the same fashion that many financial products are now sold, that person would be drummed out of the cereal business.  The norms of that sector (and many other nonfinancial sectors in the United States) would not stand for this degree of deception and malpractice”, said one critic of the Republican campaign against her nomination.

Transparency is an issue with all financial markets, not just mortgages, of course. The multi-trillion dollar derivatives’ business is controlled by a self-appointed consortium of the major banks. And they are resisting providing a record of their transactions to a central clearing house, a provision of the Dodd-Frank bill that is still being developed.

Why? For the same reason that mortgage lenders could hide the true costs of mortgages until the latest reforms enacted by the Federal Reserve that regulate the disclosure of loan fees and costs.

And, as two Nobelists, economists George Akerlof and Joseph Stiglitz have researched, markets driven by nontransparent or ‘asymmetrical’ information—where insiders have access to information about the investments that general market participants do not—destroys those markets. It in fact drives out the honest investors, causing a general loss of confidence on all financial markets.

So we can see Professor Warren is on a virtuous crusade. She wants to save the financial institutions from themselves—and their own propensities to promulgate the ‘buyer beware’ policies so prevalent on Wall Street that almost caused their own downfall.

Harlan Green © 2011

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