Proposed CFPA Must Partner with States to Be Successful

From the perspective of local regulation and local law enforcement, the idea of a “new and improved” federal financial products regulator is generally met with skepticism. After all, the mission of consumer protection in the realm of financial products has been one in which state attorney generals, banking commissioners, and local law enforcement authorities have been the center-stage players for at least the last decade. [1]

This center-stage position is partly attributable to the fact that federal regulators have seemingly devoted more focus to preempting state laws that are designed to protect consumers than they have to enforcing or crafting federal protections. This center-stage position is also attributable to plain old better positioning; i.e., it is the natural result of being “closer to the customer” that consumer issues are most quickly and easily identified and resolved at the local level. Likewise, state enforcement officers are directly accountable to their governors, their state legislators, and their citizenry, and are required to respond expeditiously and accurately to consumer protection concerns as they arise.

And yet, despite the fact that state attorney generals, banking commissioners, and local law enforcement authorities have a proximity to the entities they supervise, have a granular knowledge and expertise of the variations in their local communities, and must remain accessible to the citizens in their states, the proposed federal Consumer Financial Products Agency (the “CFPA”) has the possibility and potential of becoming a successful regulatory mechanism in the arena of consumer protection. Although our nation’s other examples of federal protection agencies have been criticized as weak and generally ineffective,[2] there are possibilities inherent in the proposed CFPA that represent at least opportunities for an improved model of federal consumer protection.

Our current system of regulatory architecture contains an invaluable “on the ground” presence in the form of state government. I can think of a useful case study in the state I know best. In my home state of Maryland, as in most states, there have been successive waves of foreclosures, each triggered by a particular set of circumstances. While many of the underlying forces are national and driven by, for example, capital market trends and excessive risk tolerances, other drivers have been localized. Localized drivers include the configuration of our regional and local economies, the type of mortgages our citizens have used, the variety and distribution of mortgage providers, and the state regulatory structure overseeing them. The way in which these circumstances intermingle to produce a particular foreclosure spike differs by state. Certain states have been plagued by option ARMs while others have had virtually none. Certain states, particularly those with high levels of investor properties like Florida, are most affected by negative equity when home values depreciate to such an extent that people owe more on their mortgages than their homes are worth (a situation commonly referred to as being “upside down”). Other states, like Michigan, are more adversely affected by their underlying regional economies as unemployment becomes a major driver of foreclosure. These differences impact the scope of the problem, its timing, and the nature of the policy response required. In other words, the ability to engage in meaningful consumer protection in the foreclosure arena depends on the ability of local officials to perceive the trends, diagnose their causes accurately, and devise policy, regulatory, and enforcement responses, if necessary, to deal with those particular root causes. These must all be done in a timely manner, be tailored to the problem to minimize collateral effects, and address not just the manifestation of the problem but also its root cause.

The foreclosure example is a useful one, but states and localities engage in this exercise not merely in the foreclosure realm, but also in the realm of a host of financial products and providers. Simply stated, this is what state regulators do on a daily basis. These products and providers include check cashiers, debt management companies, payday loans, refund anticipation loans, money transmission companies, credit repair organizations, loan modification products, and debt collectors, to name a few (and some of which are evolving and morphing as this is being written).

For example, the rise in delinquent loans and subsequent government efforts to encourage loan modifications has given rise to a new industry of so-called loan modification consultants. These “consultants” charge exorbitant up-front fees in exchange for promising to obtain a modification for homeowners. Hundreds of consumer complaints later, we have found that all too often nothing has been accomplished while the borrower hurtles toward foreclosure. The result is a waste of money and, even worse, time – time that is better spent getting a real and sustainable modification. Because of the proximity to the ground, states are able to respond rapidly, by using localized investigative authority to gather information. States coordinate their efforts and their expertise to protect their citizens through statutory provisions that require licensing, disclosure, and, in Maryland, a ban of up-front fees. This rapid and local response is critical in attacking an issue such as this which (1) evolves rapidly in response to temporary conditions in the local or even national economy and (2) involves small providers who fly easily under the federal radar for months if not years.

In Maryland, in the case of local modification consultants, we were able to identify this problem and launch a response virtually immediately. Even before consumers specifically complained about consultants, my department noticed that more and more consumers facing foreclosure often paid a “consultant” an average of $2,500 before they had filed a complaint with the state regulator’s office. Armed with a statute that prohibits such up-front fees, we were able to launch consumer outreach and investigations of these “consultants” as early as August of 2008. Further, the advance work done by the states in identifying and proposing methods for dealing with predatory loan modification consultants in our communities became a relevant policy tool to the Obama administration and the federal agencies as they developed the “Making Homeownership Affordable Plan.” [3]

This is an example of a successful federalist system of financial supervision that draws upon the expertise and resources of both state and federal regulatory authorities. Financial supervision is most successful and seamless when a certain pattern is followed. First, state authorities, relying upon local knowledge and accountability, identify threatening products and practices as they emerge. Second, the state warns consumers and reacts through either regulation or legislation to curb the practices or products in an effort to protect citizens and maintain the integrity of the state’s financial system. Finally, if the troublesome products or practices emerge on a national scale, and if a state’s reaction has been successful, the federal government will implement a similar regulation or statute on a nationwide scale. This model allows the states, which by their very nature are able to act more rapidly than the federal government, to experiment with regulatory fixes to emerging threats.

While the states are much better positioned to detect such emerging financial products, the problems associated with such products often become federal in scope. This clearly was the case in the problems associated with subprime mortgage products. These products, which state regulators began to detect at least a decade ago, were fueled by funding in secondary markets and by mega financial institutions to such an extent that a federal response would have been desirable had one emerged in a timely way.[4]

Presumably, this absence in providing a timely federal response is what the proposed CFPA would be designed to handle. The goal of the CFPA legislation is to address the flaws in the regulatory architecture that have inhibited effective federal responses to substantive problems of consumer protection.[5] The CFPA would be authorized to gather data, promulgate rules, and bring regulatory enforcement actions. It would have jurisdiction over the broad swath of consumer financial products. Significantly, the proposed CFPA would preserve for state attorney generals and financial regulators the ability to continue to respond quickly and effectively: the proposal provides that federal standards promulgated by the CPFA would constitute a “floor” for state action.[6]

In the vast world of financial products, the “floor – not ceiling” approach is critical for ensuring that consumers – no matter where they live in the United States – be afforded at least some level of minimum protection, and for providing a scaled, national response where appropriate. At the same time, if those national standards are absent (as historically they have been for most financial services), or if those national standards are too slow in evolving (as is often the case, since a federal bureaucracy is almost by definition, very slow to act), or if those national standards are too weak (as they may be in an attempt to be balanced or in an attempt to minimize collateral effects), then residents will want to be able to prevail upon their state legislatures and other elected officials to force their state regulators to raise standards for their own residents.

States are suspicious of federal regulatory power in the realm of financial products. In the words of Professor Adam Levitin of GeorgetownLawSchool, consumer protection at the federal level has historically been an “orphan” mission.[7] That is, since no federal agency has an exclusive mission to provide consumer protection in financial services, there is a dangerous tendency for consumer protection to fall between the cracks. The result has been that states have been left to fight the evolving practices and products that had consumer protection ramifications.

In the rapidly changing and dynamic mortgage market, the states fought alone. As complaints began to mount regarding subprime mortgage products, state authorities attempted to craft regulatory and legislative responses, only to be challenged in court by aggressive federal banking agencies concerned about how the regulation of these activities would impact the business plans of their supervised entities or would undermine their own authority. Congress, too, was caught up in a deregulatory fervor, giving the federal agencies wide berth in crafting necessary consumer protections. For reasons that have more to do with regulatory capture than good policymaking, the result was a federal absence of regulatory protections of the greatest magnitude in the mortgage context.[8]

It took the harms associated with the beginning of our current crisis to prompt Congress to respond, in part, with the passage of the so-called SAFE Act (the Secure and Fair Enforcement for Mortgage Licensing Act of 2008). The SAFE Act set uniform, minimum standards for the licensing of mortgage originators in this country. These standards were a floor, not a ceiling, thereby allowing state legislatures to adopt more stringent statutes if they see fit. Falling in line with such federal guidance, 49 states and the District of Columbia have enacted or introduced legislation to implement these minimum mortgage lending standards within one short year of the SAFE Act’s passage. And while critics of the CFPA’s anti-preemption provisions claim that enactment of the CFPA as proposed would create a “patchwork” of varying state laws and regulations, this argument becomes largely unconvincing as state after state adopts the provisions of the SAFE Act in a manner consistent with the federal standards. Put plainly, if federal standards are sufficient, states will not be obligated to implement more appropriate – and sometimes more stringent – standards.

As in the case of the federal consumer protection standards set through the SAFE Act, state regulators would likely welcome the articulation of such standards in the realms of loan modification consultants, check cashiers, payday lenders, debt management companies, debt settlement companies, refund anticipation loans, and advanced litigation funding products. Consumers could benefit from the articulation of federal standards in contexts in which their state legislatures or regulatory officials are, for whatever reason, inadequate or ineffective. This ability to set by rule a minimal standard will be a powerful pro-consumer protection mechanism

At the same time, state authorities do not want to be hamstrung in their efforts to protect consumers. They are the cops on the beat, and they are ultimately responsible to their fellow state residents. Therefore, they must be able to react swiftly and correctly. By establishing a floor and not a ceiling, the CFPA can provide explicit safeguards, while preserving the local presence and power that remains flexible to adjust to ever-emerging financial industry practices and products.

[1] This proximity to the supervised entity and the ability to act quickly is reflected in the number of enforcement actions taken by state regulators. In 2007 and 2008 alone, states took approximately 13,000 enforcement actions against mortgage brokers and mortgage lenders. These actions, together with thousands of other enforcement actions against non-mortgage financial service providers, were initiated at the same time that states became increasingly excluded from consumer financial services regulation. In other words, despite the obstacle imposed by preemption – enacted either by legislation, by agency regulation, or by court rulings – state regulators and law enforcement officials have been active proponents of consumer protection. Unfortunately, and to the detriment of our country, preempted state protections have not been replaced with equivalent federal protections. See Adam J. Levitin, Hydraulic Regulation: Regulating Credit Markets Upstream, 26 Yale J. on Reg. 143 (2009).

[2] Among the federal bank agencies, no single one has an exclusive role of consumer protection. The Federal Trade Commission has consumer protection as its primary role. However, it has limited jurisdiction in financial services in that it cannot regulate federally-chartered or insured banks, thrifts, or credit unions. The Securities and Exchange Commission distinguishes itself as having a mission that promotes investor protection rather than consumer protection. And the consumer Product Safety Commission has been criticized as hobbled by a lack of resources.

[3] U.S. Department of Treasury, Press Release, Federal, State Partners Announce Multi-Agency Crackdown Targeting Foreclosure Rescue Scams, Loan Modification Fraud, April 6, 2009, available at http://www.ustreas.gov/press/releases/tg83.htm.

[4] Robert Berner and Brian Grow, “They Warned Us About the Mortgage Crisis,” Business Week, October 9, 2008.

[5] Adam J. Levitin, “The Consumer Financial Protection Agency, PEW Financial Reform Project, Briefing Paper #3: The CFPA,” Aug 6, 2009.

[6] In the loan modification area, the beginning of such an approach is taking place: the Federal Trade Commission has joined several states in dealing with the problems associated with the larger loan modification consultants that have emerged.

[7] Levitin, Briefing Paper, at 4

[8] For example, anti-predatory lending laws have been enacted in 35 states and the District of Columbia. In contrast, Congress has not enacted a federal anti-predatory lending law in the last decade. To underscore the absence of federal protection against predatory lending, it is worth noting that these state anti-predatory lending laws are not effective against federally chartered institutions because of the interpretations of preemption by the Office of the Comptroller of the Currency and the Office of Thrift Supervision. Accordingly, fewer consumer protections exist than might be suggested by the number of state efforts in this regard.