Law Professor Patricia A. McCoy Explores Consumer Protection Options for America

01 Apr

Another View: The Best Way to Protect Borrowers

March 8, 2010, 9:00 am

Patricia A. McCoy, a law professor at the University of Connecticut, makes the case for setting up an independent Consumer Financial Protection Agency.

If the financial crisis proved anything, it is that the country needs an independent federal watchdog to protect people from abusive credit. A standalone agency would put consumers first, not banks. And it would stop lenders from shopping for the easiest regulator by creating one national consumer safety standard for all financial services providers, regardless of their type.

Up to now, federal banking regulators have been responsible for ensuring the financial protection of consumers. They failed miserably at that job.

Federal regulators were acutely aware of the rising tide of reckless loans, but they failed to clamp down. Worse still, they engaged in a race to the bottom to relax lending standards, both to increase their turf and to increase fees from banks.

To prevent this from ever happening again, the Obama administration has commendably proposed stripping federal banking regulators of their consumer protection duties and transferring those duties to a new, independent Consumer Financial Protection Agency. This solution is the right one and it is long overdue. Under the able leadership of Representative Barney Frank of Massachusetts, the Democratic chairman of the House Financial Services Committee, the House approved the creation of the agency in December. Now, it is up to the Senate to finish the job.

Instead, behind closed doors, powerful senators are cutting a deal to scrap an independent Consumer Financial Protection Agency and assign consumer protection to a federal banking regulator. If that happens, consumers beware. These are the same regulators who refused to protect us during the housing bubble.

One Senate proposal would assign consumer protection to the Office of the Comptroller of the Currency, or O.C.C., which oversees national banks. The agency is the only federal regulator that has never accepted public responsibility for the damage that it wreaked on consumers.

That damage was enormous. In 2004, at the bidding of big banks, the O.C.C. adopted a rule that excused national banks from complying with state laws against predatory mortgages. The result was to deny relief to legions of injured borrowers for abusive loans. Its rule fueled the race to the bottom in lending standards. And the rule allowed lax loans to proliferate at national banks because the comptroller adopted no serious controls to stop them.

The agency looked the other way while some of the nation’s largest banks, including Wachovia Bank and Bank of America, expanded into so-called liars’ loans that dispensed with verifying borrowers’ ability to repay. Wachovia Bank failed and Bank of America needed two bailouts totaling $45 billion by American taxpayers to remain afloat. Meanwhile, other national banks peddled disastrous subprime mortgages. One was National City Bank, which capsized as a result. Despite it all, the comptroller’s office never instituted a single formal enforcement action against a big national bank for unsafe mortgages during the housing bubble. And the agency allowed Citigroup to load up on toxic mortgage-backed securities, and it, too, required two bailouts totaling $45 billion under the government’s Troubled Asset Relief Program.

What explains the agency’s shameful performance? The answer, simply put, is money. Almost all of its operating budget comes from fees paid by national banks. If national banks don’t like O.C.C. regulation, they can defect to another regulator. That’s why Countrywide Financial swapped its national bank charter for a federal savings and loan charter in early 2007, shifting its regulator to the Office of Thrift Supervision. (A year later, under the weight of bad subprime loans, Countrywide collapsed into the hands of Bank of America.) So the O.C.C. has obvious reason to make national banks happy to keep them in its fold.

Another Senate proposal would keep consumer financial protection where it now resides, with the Federal Reserve Board. Of all the federal agencies, the Fed had the power to stop subprime mortgage abuses across the board. But its previous chairman, Alan Greenspan, adamantly refused to exercise that power, allowing the mortgage market to implode. While the Fed belatedly adopted pro-consumer rules starting in 2008, under its current chairman, Ben S. Bernanke, there is no guarantee that the economists who run the Fed will be any more sensitive to consumers in the future than they were in the past.

As this sorry story shows, consumers inevitably lose out when federal banking regulators are in charge of protecting them. In their zeal to increase the short-term profitability of banks, these regulators too often dismissed consumer protection out of hand. Instead, the only real solution is an independent Consumer Financial Protection Agency that puts consumers’ welfare first. An independent consumer agency would offer true consumer protection while regulating banks and nonbanks alike. It would also rein in the harmful tendency of federal banking regulators to sacrifice long-term safety for short-term profit at the top of the credit cycle.

Bottom line, we cannot afford to jeopardize the safety of ordinary Americans again by entrusting their protection to federal banking regulators. Instead, it is time for Senator Christopher J. Dodd of Connecticut, the Democratic chairman of the Senate Banking Committee, to secure his lasting legacy in his final months in the Senate by creating an independent Consumer Financial Protection Agency.

Patricia A. McCoy is the Connecticut Mutual Professor of Law at the University of Connecticut School of Law, where she also heads the Insurance Law Center. Her new book “The Subprime Virus,” with Kathleen C. Engel, is forthcoming from Oxford University Press.

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