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May-June 2008
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< previous | 1 | 2 | 3 | 4 Local laws suffer from another problem. As lenders have consolidated and credit markets have become national, a plethora of state regulations drives up costs for lenders, forcing them to include repetitive disclosures and meaningless exceptions even as it also leaves regulatory gaps. During the 1970s and early 1980s, for example, Congress moved the regulation of some aspects of consumer credit from the state to the federal level through a series of landmark bills that included Truth-in-Lending (TIL), Fair Credit Reporting, and anti-discrimination regulations. These statutes tend to be highly specific: TIL specifies the information that must be revealed in a credit transaction, including the size of the typeface that must be used and how interest rates must be stated. But the specificity of these laws works against their effectiveness, inhibiting some beneficial innovations (e.g., new ways of informing consumers) while failing to regulate dangerous innovations (e.g., no discussion of negative amortization). What’s more, these generation-old regulations completely miss most of the new features of credit products such as universal default (increasing interest rates even when customers are meeting all the terms of their credit agreements) and double-cycle billing (charging interest on money that was repaid). Any effort to increase or reform regulation of financial products is met by a powerful industry lobby that is not balanced by an equally effective consumer lobby, so even the most basic efforts are blocked from becoming law. A decade ago, for example, mortgage-lender abuses were rare. Today, experts estimate that fraud and deception stripped $9.1 billion in equity from homeowners, particularly from elderly and working-class families, even before the subprime crisis got into full swing. A few hardy souls have repeatedly introduced legislation to halt such practices, but those bills never make it out of committee. Even after a change in control of Congress in 2006, efforts to rein in lenders have made little headway. Beyond Congress, some regulation of financial products occurs indirectly through the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision—each of which has some power to control certain forms of predatory lending. But their main mission is to protect the stability of banks and other financial institutions, not to protect consumers. As a result, they focus intently on bank profitability, and far less on the financial impact on customers of many of the products the banks sell. The regulatory jumble creates another problem: consumer financial products are regulated based principally on the identity of the issuer, not on the nature of the product. The subprime-mortgage market provides a stunning example of the resulting fractured oversight. In 2006, for example, 23 percent of such mortgages were issued by regulated thrifts and banks, and another 25 percent by bank holding companies (subject to different federal oversight)—but 52 percent originated with companies with no federal supervision at all, primarily stand-alone mortgage brokers and finance companies. This division also triggers a kind of regulatory arbitrage. Regulators are acutely aware that if they push financial institutions too hard, those firms will simply reincorporate in another form under the umbrella of a different regulatory agency—or none at all. Indeed, in recent years a number of credit unions have dissolved and reincorporated as state or national banks, precisely to fit under a regulatory charter that would permit them different options in developing and marketing financial products. If the regulated can choose the regulators they want, it should be no surprise when they game the rules in their own favor. Unfortunately, in a world in which the financial-services industry is routinely one of the top three contributors to national political campaigns, the likelihood of quick action to respond to specific problems and to engage in meaningful oversight is vanishingly slim. This leaves consumers effectively unprotected in a world in which a number of merchants of financial products have shown themselves very willing to take as much as they can by any means they can. A Financial Products Safety CommissionIt is time for a new model of financial regulation, one focused primarily on consumer safety rather than corporate profitability. The model for such regulation is the U.S. Consumer Product Safety Commission (CPSC), an independent agency founded in 1972 during the Nixon administration. The CPSC’s mission is to protect the public from risks of injury and death from products used in the home, school, and recreation. It has the authority to develop uniform safety standards, order the recall of unsafe products, and ban products that pose unreasonable risks. In establishing the commission, Congress recognized that “the complexities of consumer products and the diverse nature and abilities of consumers using them frequently result in an inability of users to anticipate risks and to safeguard themselves adequately.” The evidence clearly shows that the CPSC is cost-effective. Since it was established, product-related death and injury rates in the United States have decreased substantially. The CPSC estimates that standards for three products alone—cigarette lighters, cribs, and baby walkers—save more than $2 billion annually (more than the agency’s total cumulative budget since its inception). So why not create a Financial Product Safety Commission (FPSC), charged with responsibility to establish guidelines for consumer disclosure, collect and report data about the uses of different financial products, review new products for safety, and require modification of dangerous products before they can be marketed to the public? The agency could review mortgages, credit cards, car loans, and so on. It could also exercise jurisdiction over life insurance and annuity contracts. In effect, the FPSC would evaluate these products to eliminate the hidden tricks that make some of them far more dangerous than others, and ensure that none pose unacceptable risks to consumers. An FPSC would promote the benefits of free markets by assuring that consumers can enter credit markets confident that the products they purchase meet minimum safety standards. A commission could collect data about which financial products are least understood, what kinds of disclosures are most effective, and which products are most likely to result in consumer default. It could develop nuanced regulatory responses; some credit terms might be banned altogether, while others might be permitted only with clearer disclosure. A commission could promote uniform disclosures that make it easier to compare products, and to discern conflicts of interest on the part of a mortgage broker or seller of what are now loosely regulated products. For example, an FPSC might review the following terms that appear in some—but not all—credit-card agreements: universal default clauses; unlimited and unexplained fees; interest-rate increases that exceed 10 percentage points; and an issuer’s claim that it can change the terms after money has been borrowed. It would also promote such market-enhancing practices as a simple, easy-to-read paragraph that explains all interest charges; clear explanations of when fees will be imposed; a requirement that the terms of a credit card remain the same until the card expires; no marketing targeted at college students or minors; and a statement showing how long it will take to pay off the balance, as well as how much interest will be paid if the customer makes the minimum monthly payments on the outstanding loan balance. With every agency, the fear of capture by those it regulates is ever-present. But in a world in which there is little coherent, consumer-oriented regulation of any kind, an FPSC with power to act is far better than the available alternatives. Whether it is housed in a current agency such as the CPSC or stands alone, the point is to concentrate the review of financial products in a single location, with a focus on the safety of the products as consumers use them. Companies that offer good products would have little to fear. Indeed, if they could conduct business without competing with companies whose business model is to mislead the customer, then the vendors offering safer products would be more likely to flourish. Moreover, with an FPSC, consumer-credit suppliers would be free to innovate on a level playing field within the boundaries of clearly disclosed terms and open competition—not hidden terms designed to mislead consumers. The consumer financial services industry has grown to more than $3 trillion in annual business. Lenders employ thousands of lawyers, marketing agencies, statisticians, and business strategists to help them increase profits. In a rapidly changing market, customers need someone on their side to help make certain that the products they buy meet minimum safety standards. Personal responsibility will always play a critical role in dealing with credit cards or other loans, just as personal responsibility remains a central feature in the safe use of any other product, but a Financial Product Safety Commission would be the consumers’ ally. And for every family that avoids a trap or doesn’t get caught by a trick—that’s regulation that works. Elizabeth Warren, RF ’02, is Gottlieb professor of law and faculty director of the Program of Judicial Education at Harvard Law School. An earlier version of this article appeared in Democracy: A Journal of Ideas (democracyjournal.org).  
 
 
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