Tuesday, July 7, 2009

Obama Administration Financial Regulation Proposal - Part III

A smart businesswoman in the Portland area asked for a synopsis of this proposal, saying, "It seems like everywhere we read doom and gloom doom and gloom. I would like to read some kind of balanced piece for once." Thanks for the suggestion, Kelly. Parts I and II of the proposal were discussed in the previous post. Here's the second installment.

Protect Consumers and Investors

The Administration seeks to protect consumers against fraud and promote understanding of financial products, like credit cards, savings vehicles, mortgages, and the like. This goal is addressed through the creation of the CFPA (Consumer Financial Protection Agency), which is charged with the responsibility to ensure that consumer protection regulations are "written fairly and enforced vigorously." This new agency will have no jurisdiction over financial products governed by the Securities and Exchange Commission or the Federal Trade Commission, but both existing agencies will have new authorities and resources.

When non-traditional mortgage lenders entered the mortgage market after new mortgage securitization produces were developed by Wall St., the regulatory framework that protected consumers of banks and thrifts did not cover those new lenders. Countrywide Mortgage, for example, incented its sales staff to sell mortgage instruments that were not necessarily risk appropriate for borrowers. While other more traditional mortgage products were available, loan agents were encouraged by amount of incentive paid by product to sell Adjustable Rate Mortgages through "no-doc" (no, or low documentation required) programs that had high up-front fee structures.

And, with respect to credit card lending, certain "fine print" issues have arisen that clearly show that, if given the power to raise interest rates for situations unrelated to current repayment history (like applying for additional credit elsewhere), financial institutions can, and will, categorically raise expenses. In the past, this situation could have been rectified by the market, i.e., customers could merely close accounts with more onerous conditions and transfer them to institutions with more consumer friendly agreements. But, as credit lines froze, such alternative credit providers were unavailable.

The mission of this new Consumer Financial Protection Agency is to ensure that

  1. Consumers have the information they need to make responsible financial decisions

  2. Consumers are protected from abuse, unfairness, deception and discrimination

  3. Consumers' markets operate fairly and efficiently with ample room for sustainable growth and innovation

  4. Traditionally underserved consumer markets have access to lending, investment and financial services

The CFPA will be the "consumers' seat at the table" as regards the

  • Truth in Lending Act
  • Home Ownership and Equity Protection Act

  • Real Estate Settlement and Procedures Act

  • Community Reinvestment Act

  • Equal Credit Opportunity Act

  • Home Mortgage Disclosure Act

  • Fair Debt Collection Practices Act

All those Acts were in place during the mortgage crisis. The Administration proposes to solve the lack of understanding by consumers that played some part in this crisis by creating another agency and ensuring a "consumer voice," noting that its mission is to provide "a floor, not a ceiling." This means that the Agency will represent minimum and consistent standard


  • No more "mandatory arbitration clauses."

  • Requiring "plain English" disclosures.

  • Holding brokers to a "fiduciary" as opposed to "suitability" standard.

  • Holding companies responsible to clients, as well as investors.

  • Require "non-binding" shareholder votes for executive compensation.

  • Increase retirement savings incentives.

So where's the "doom and gloom" here, you ask? Well, it certainly isn't in the rhetoric.


I add my voice to this groan. Government agencies are expensive, unwieldy and, judging from the number which existed prior to the crisis, ineffective. The fact remains that, even with those seven agencies listed above, the housing crisis ensued.

I hesitate to unilaterally cry, "Poor little consumer" in every case. Many borrowers who KNEW they couldn't afford a $400,000 house with a $50,000 annual salary, bought one anyway. I cringe at the thought that the we as consumers are too stupid to make up our own minds. Then, I look at my credit card statement, and pause. It's ridiculous. It's incomprehensible.

So, what's the answer? The fact is, it doesn't matter. The consumer has screamed to the top of Congress that every Tom Dick and Harry financial whatever has received a squillion dollar bail-out, and she the individual is left to mind her finances properly and pay her bills on time with no help. Consumer protection is going to be written in this proposal as a political reality.

It is my hope that we don't over-correct. It is my hope that we do not swing to the extreme of the so-called "nanny state," and attempt to hold everyone's hand, make doing business more costly, and become non-competitive in world financial markets. But, reality is reality and consumer protection is the current political reality.

As a matter of full disclosure, I come from the financial industry. As a matter of fuller disclosure, I spent years in "Regulatory Compliance," which was charged with the responsibility of taking recently promulgated regulation and integrating it into daily operations. I admit to reading regulations and thinking, "Have the persons who wrote this EVER been in an actual business?" I admit to seeing the regulatory pendulum swing wildly back and forth, and hating the tendency to over-regulate after a crisis. I predict that this legislation will be analogous to affirmative action, where administrations will use it as a political symbol as "pro-consumer" and "pro-business" stands that will result in its being more or less consumer friendly. It will undoubtedly, however, be expensive. Read on.

It Will Make Financial Institutions Less Profitable

Absolutely right. Between the increase in capital and liquidity requirements discussed in the prior post and the increase in regulation that will require new forms, new procedures, new training, etc., etc., banks will definitely be less profitable. And, since one of the stated goals of this new agency is to give access to traditionally underserved markets, i.e., the poor, non-English speaking residents, etc., the expenses inherent in this proposal will likely result in higher fees paid by the rest of us. Speaking for myself, I will pay higher fees in order that the most vulnerable of us not be subjected to the usurious rates charged by "payday loan" and "rent to own" firms, but I am speaking only for myself. Banking is going to cost more, just as health care will cost more as we insure the uninsured. This is a social, as opposed to business issue. If you think that the poor should not have access to basic financial services, this is not the time to voice your opinion. You're not in the majority

Non-Binding Executive Compensaton Shareholder Votes

Non-binding means that you are not bound by what I say. Non-binding votes by shareholders about executive compensation is a paper tiger. By this, the Administration seeks to let shareholders tell executives that they think they're getting paid too much, but stops before giving them any power to do anything about it. In some ways, I like this, as "capping compensation" is basically wage controls, and anyone who lived through the 1970's will tell you how well that worked out. Also, imagine the press you'll get if you're one of those executives. The 24-hour business channels will be all over you, forcing you to justify your compensation, and making you say why you should have your job. It's an interesting solution. I'm on the fence on this aspect of the proposal, but think public outcry a far superior recommendation than salary caps. We shall see.

That said, this part of the financial proposal has some potential land mines, and I'll be watching it very closely. Hopefully, we won't over regulate and make a bad situation worse.

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