Battle begins for new financial products regulator

Exclusive analysis for FinReg21 by Darrell Delamaide 

The first salvos have been fired in what promises to be one of the major battles of the administration’s regulatory reform program – the creation of a new agency to focus on consumer protection in financial products.

The idea, championed for years by Harvard law professor and consumer advocate Elizabeth Warren, has been adopted by the Obama administration in its proposal for a Consumer Financial Protection Agency.

Warren joined a slew of other experts on both sides of the issue in a hearing this week before the House Financial Services Committee. She claimed such an agency is necessary to fix a “broken” credit market where consumers often don’t understand products they are being offered.

In the meantime, existing regulatory agencies that would lose some of their authority to the new body are lobbying behind the scenes against its creation. The Securities and Exchange Commission apparently has been successful in keeping oversight of mutual funds, which it regulates as securities.

The Federal Reserve, which has regulated mortgage finance and credit cards – the two main categories of products envisaged for the new agency, is also fighting back.

The Fed this week put out a notice seeking applicants for 10 new members of its Consumer Advisory Board, to replace those with terms expiring in January.

The notice calls for “candidates who have familiarity with consumer financial services, community development and reinvestment, and consumer protection regulations, and who are willing to express their views.”

But the other great battle in the reform program will certainly be the proposal to make the Fed responsible for monitoring systemically important institutions, and may be difficult for the central bank to keep its consumer protection role as well.

Elizabeth Warren, meanwhile, in addition to winning over the White House to her idea for a new agency, has gained a strong following among lawmakers for her work as chairman of the Congressional Oversight Panel for the bank bailout fund.

She evidenced the same plainspoken frankness at the hearing this week as she has shown in the oversight panel.

Retail credit, she said, has evolved from earlier, simple days when local bankers vetted creditworthiness of local borrowers.

“Today, the business model has shifted,” she said. “Giant lenders ‘compete’ for business by talking about nominal interest rates, free gifts, and warm feelings, but the fine print hides the things that really rake in the cash. Today’s business model is about making money through tricks and traps.” 

 Warren said that she herself, a contract law professor, cannot understand some of the fine print in these credit products. “Even people who try to understand their contracts and who do their best to live up to their side of the bargain fall into traps and get stuck with well-hidden risks,” Warren said in her testimony.

Warren went on to characterize the credit market as broken, because the activities of the big players make it difficult for smaller banks and credit unions to compete “even when those community banks or credit unions are offering better products with fewer—or no—tricks and traps.”

Warren, who would be the obvious choice to be the first head of the new agency if it is created, tempted the lawmakers with the chance to make history. Just as the Great Depression resulted in the historic enactment of deposit insurance to protect consumers, this financial crisis can also result in important new protections, she said.

“In times of great crisis, narrow interests give way to an American public looking for Congress to get things right,” Warren said. “This is an historic moment, and today you have a rare opportunity to bypass those narrow interests and serve the public interest.”

Committee chairman Barney Frank (D-Mass.) made it clear he backs the proposal and said the committee would mark up legislation specifically for this agency before the summer recess.

Frank said he had always been frustrated that consumer protection always seemed to get short shrift from prudential regulators, who tended to ignore individual complaints when the safety of a big institution was at stake.

Opponents of the proposal had their say as well. Edward Yingling, executive director of the American Bankers Association, made the argument that regulation of products should not be separated from regulation of the institution offering the product.

“Consumer protection is not just about the financial product, it is also about the financial integrity of the company offering the product,” he said. “Simply put, it is a mistake to separate the regulation of an institution from the regulation of its products.”

Alex Pollock, from the conservative think tank American Enterprise Institute, said that if the ultimate goal is to have simpler, clearer disclosure, there is no need for whole new agency to achieve that.

Insurers had what may have been a more convincing argument about the link between their product and the safety and soundness of the insurance company.

“Product design directly affects solvency,” Ralph Tyler, Maryland’s insurance regulator speaking on behalf of the National Association of Insurance Commissioners, said of insurance, “so we do not think supervision of these areas should be separated.” The separation might work in other financial sectors, he added, but “the states believe insurance has unique challenges best handled by a single regulatory department.”

Gary Hughes, general counsel of the American Council of Life Insurers, echoed these remarks, noting that insurance under the supervision of state regulators is already one of the most tightly regulated financial products.

As to variable annuities, the new agency would have to get in line. The SEC has tried for years to get regulation of these life insurance products because they often contain a securities component and are sold by broker-dealers under SEC regulation.

But the message emerging from the administration and from Congress is that there will be some sort of consumer protection agency, dealing at least with mortgages and credit cards and some aspects of the Community Reinvestment Act.

The actual scope and powers of the new agency will be the subject of further battles as the reform legislation moves through Congress.