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By Nicole Gelinas

After The Fall: Saving Capitalism From Wall Street--and Washington

City Journal

Nicole Gelinas
Dodd-Frank’s Protection Racket
The new Consumer Financial Protection Bureau is both irrelevant and dangerous.
Summer 2012

When President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law two summers ago, standing behind him was Andrew Giordano, a retired Baltimore police officer. Giordano had “discovered hundreds of dollars in overdraft fees on his bank statement—fees he had no idea he might face,” Obama said. Looking on, too, was schoolteacher Robin Fox, “hit with a massive rate increase on her credit card even though she paid her bills on time.” Obama promised that it wouldn’t happen again. “A new consumer watchdog,” he announced, would have “just one job: looking out for people as they interact with the financial system.” People could expect an end to complex mortgage, student-loan, and credit-card contracts in which “pages of barely understandable fine print” contained “hidden fees and penalties.”

The new watchdog is called the Bureau of Consumer Financial Protection but is commonly shortened to the CFPB, with the “bureau” at the end. Its director, former Ohio attorney general Richard Cordray, is a savvy politician, and he has worked to fashion an anti-TSA: a government agency that people trust and like. It is busily making and enforcing rules governing everything from mortgage approval to bounced checks, and it has created a website, consumerfinance.gov, full of handy tips—many targeted to young people—and humble requests for comments and complaints. The bureau has held “field hearings” and town-hall meetings far outside the Beltway, listening to regular Americans’ perceptions of the financial industry. A publicity coup came in March, when New York Times columnist Joe Nocera visited the bureau’s offices and came away gushing about his “inspiring day.”

Despite the good press, however, the CFPB—which will cost taxpayers almost half a billion dollars per year—is useless in some ways and deeply harmful in others. Some abuses that it was designed to curb have already been handled by existing federal agencies, while others are beyond its power to fix. The agency is equally incapable of remedying the worst ailment facing the American financial “consumer”: crushing debt, much of it purveyed by the federal government. Yet at the same time, Congress has given the CFPB the formidable power of banning abusive, unfair, deceptive, or discriminatory financial practices relating to Americans’ everyday financial interactions. Though that may sound appealing, remember how the government, by trying to do essentially the same thing with mortgages, lured poorer people into financial contracts that they couldn’t afford. The CFPB may do for credit cards and other financial products what the government did for mortgages: make the poor think that borrowing lots of money is perfectly reasonable. The CFPB, in sum, is Washington’s new weapon in its war for more debt.

Illustration by Arnold Roth
Illustrations by Arnold Roth

The CFPB’s “field hearings” are a good example of its public approach, which emphasizes empowering Americans, via better education and disclosure, about the vast array of products that the financial-industrial complex wants them to “consume.” The bureau has cleverly chosen to hold hearings not on what caused the financial crisis—loose credit—but on hot-button topics affecting key voting blocs, such as prepaid debit cards for young people and payday loans for poorer minorities.

At one such hearing, at New York’s Hunter College in February, Cordray took to the podium to open “a candid discussion about bank overdrafts,” which could prove “very costly” for those for whom “every penny counts.” Politically, bank overdrafts are an easy target. We’ve all heard the stories about the innocent consumer who buys a cup of coffee with his debit card and then, at month’s end, gets hit with a $35 bank fee because he didn’t have enough money in his checking account to cover the charge. Overdraft fees totaled $38 billion last year, according to the Pew Charitable Trusts. Two cohorts pay the bulk of these fees: the young, often because of inexperience or inattention; and poorer people, who use overdrafts as a form of expensive borrowing from paycheck to paycheck. Cordray acknowledged both groups, noting that “almost half of account holders who are young adults incur overdraft fees” and that overdrafts “disproportionately impact a vulnerable demographic” of “lower-than-average income” consumers.

Then came the next step in the CFPB’s carefully honed PR strategy: the requisite horror story that shows the need for tough government action against big finance. In this case, Sarah Ludwig—codirector of the New York–based Neighborhood Economic Development Advocacy Project (NEDAP), whose mission is to “promote economic justice”—played victim’s advocate. To illustrate how the disadvantaged “experience abusive overdraft protection not as an isolated project but as part of a continuum of exploitation that continues to plague low-income communities and communities of color,” Ludwig told the story of “Ms. Jay,” a hardworking New York City government employee and single mother exploited by a rapacious bank.

Ms. Jay “hit some unforeseen financial troubles,” we learned, and resorted to a payday lender. Such outfits pockmark the poorer neighborhoods of American cities, lending money at triple-digit annual interest rates, usually under the condition that the borrower show a recent pay stub as proof of income and hand over a postdated personal check. When the date on the check arrives, the payday lender cashes the check, closing out the transaction—unless the borrower comes calling for a new payday loan, complete with its own hefty fee. Ms. Jay took the second route, as is common, and “one payday loan quickly turned into several.”

Eventually, though, the payday lender presented its check or checks to Ms. Jay’s bank—and there wasn’t sufficient money in the account to cash them. Yet Ms. Jay’s bank allowed the lender to overdraw the account repeatedly and applied overdraft charges as well. Ms. Jay tried futilely to close her bank account and stop the charges, which totaled $1,390 in overdrawn funds and fees. Only after NEDAP involved itself did the bank close the account and write off the loss. But now, Ludwig said, Ms. Jay “will have trouble obtaining an account at another bank,” meaning that she’s been “systemically blocked” from mainstream banking. “It’s yet another way that banks fail to serve low-income communities,” Ludwig concluded.

Yet Ms. Jay’s story raises more questions than it answers—and one is why we need a new federal agency to do what existing rules do. As Ludwig herself admitted, payday lending is already illegal in the Empire State. New York prohibits “criminal usury” by capping interest levies, effectively outlawing a business whose model depends on stratospheric rates. To skirt the law, Ms. Jay probably used an out-of-state payday lender or even one based overseas (one popular Internet payday lender is headquartered in Costa Rica). The remedy here would be better enforcement of the existing law, not the creation of still more rules—though it’s true that no regulator, not even the CFPB, can keep people from giving their bank-account details to murky out-of-state merchants, whether they’re hawking fast money or OxyContin.

Another question: Is it really true, as Ludwig implied, that Ms. Jay entered into the transaction without understanding its ramifications, thus highlighting the need for more consumer education and disclosure? After all, this is a middle-aged woman with a government job and a bank account. (Leave aside the question of why such a person would decide, out of the blue, to exit the legal financial system in order to borrow money at a loan-shark rate.) You don’t need much financial education or disclosure to know that you should write a check only if you reasonably expect to have the money to honor it. To judge from Ludwig’s account, Ms. Jay’s main error was that, after writing checks that she couldn’t pay, she expected her bank to bounce them and leave her payday lender, rather than herself, high and dry.

Finally, will Ms. Jay really be banished from mainstream banking, absent massive new federal intervention? Yes, she’ll take a hit on her credit record, which conveys to future lenders the important and correct information that she’s a lousy risk. But New York State law says that a person with poor credit can walk into a branch of any bank and get a no-frills checking account for a $25 minimum deposit and $3 monthly fee. Like the ban on payday lending, it’s a sound rule, even though it forces banks to accept customers who, like Ms. Jay, pose a risk. In general, people should face penalties for making financial mistakes, but the penalties should not preclude rehabilitation. In Ms. Jay’s case, the penalty of a damaged credit record sounds about right.

To recap: a woman decided, of her own free will, to enter into a dubious financial transaction with a firm engaged in an illegal business. Instead of cheating her creditor out of the loans, as she apparently intended, she wound up on the hook for them, with bank overdraft fees piled on (at least until NEDAP intervened)—results that were foreseeable and hardly cataclysmic. This is why we need the CFPB?

Those two “consumers” who looked on as Obama signed the CFPB into law are also poor examples of the need for a new government bureaucracy. You can watch their stories in syrupy White House videos hosted by Elizabeth Warren, the Harvard law professor (and today Massachusetts Senate candidate) who long championed the agency’s creation. According to one of the videos, Andrew Giordano’s bank mistakenly gave him a replacement debit card that offered overdraft protection, and he failed to realize it. He proceeded to overdraw the account multiple times, enough to result in $814 in fees. “Funds obviously were not there,” his wife says plaintively. “Why would [the bank] continue to accept the charges?” Warren neglects to respond with the obvious question: Why did Giordano have no idea how much money was in his account? Obama’s other video star, Robin Fox, is no more convincing. She became a victim when she racked up long-term debt on a variable-rate credit card and then professed shock when her card issuer exercised its right to raise the rate.

Cordray’s own arguments for the CFPB sometimes make the opposite of the point that he wants to make. At the February hearing, he said that “just under 10 percent” of bank customers, many of them with little income, “bear a whopping 84 percent of all overdraft fees.” But looked at another way, the figures show that for 90 percent of bank customers, including millions of lower- and middle-class savers, the system works fine. As for the payday lending industry, in 2010, just 3.9 percent of American families had taken out a payday loan within the previous year, according to the Federal Reserve. Most earned less than the median income. But the majority of the poor didn’t patronize payday lenders.

For the sake of argument, though, let’s say that Ms. Jay, Andrew Giordano, and Robin Fox were all treated egregiously. We still don’t need the CFPB, since Washington had already acted on checking-account and credit-card practices months before the bureau was created. In early 2009, the Federal Reserve banned banks from enrolling customers automatically in checking-account overdraft protection; banks now have to ask their customers explicitly whether they want it. Also in 2009, Congress, with bipartisan support, enacted a law requiring credit-card issuers to warn borrowers like Fox before hiking rates and also making them keep the old rate on existing debt. That legislation further requires card issuers to provide a prominent disclosure on customer statements informing borrowers how long it will take to pay off their debt if they pay only the minimum and how much they would save if they paid enough over the minimum to retire their debt in three years. Carol O’Rourke, the executive director of the nonprofit Coalition for Debtor Education, says that the disclosure requirement “has made a difference” in prodding consumers to pay more than the minimum due or at least to slow new spending.

Private lawsuits have also helped fix real consumer problems in the financial system. JPMorgan and Bank of America, for example, recently faced class-action suits charging that they had filed customers’ largest transactions first, thus emptying the customers’ accounts and maximizing the number of overdraft fees. Say you had $100 in your account and used your debit card to buy a $10 movie ticket, followed by a $200 television. If the bank charges you for the TV first, it sends you into overdraft territory immediately and can charge you overdraft fees for both transactions, rather than just one. Each bank paid out a nine-figure settlement—evidence that our justice system can police Wall Street just fine, when Congress lets it.

The argument that the average American is financially illiterate and will remain so without a vast new federal effort is weak. At one recent financial-literacy class that New York City held for welfare recipients looking for work, the students were engaged and knowledgeable. They knew, as one kept repeating, that “you got to read the fine print.” They knew, too, that it’s not smart to take on too much debt. A few recoiled at the very idea of carrying a credit card, having learned the hard way.

The students seemed adept at grasping their role in a competitive marketplace. One student, whom I’ll call Beatrice, said that she had stopped using a local bank and switched to NetSpend, an out-of-state bank offering a prepaid spending card that stores and other merchants accept. She did so after seeing her daughter find NetSpend’s straightforward fee structure easier to navigate than a traditional bank’s array of fees. Further, Beatrice’s daughter chose NetSpend after comparing various prepaid cards, whose fees can differ wildly. The students largely understood that prepaid cards endorsed by celebrities are not bargains, as they can carry the highest fees. The instructor suggested that Beatrice make sure that her account offered protection against a lost card, fraudulent use of the card, and bank failure; Beatrice proudly said that she had already done so. Students also traded tips—for instance, warning one another not to sign up for bank autopay, which can incur an overdraft fee when a utility provider takes money that isn’t yet in the account because of a missed paycheck.

Students who hailed largely from entrepreneurial immigrant backgrounds voiced similar sentiments at a different financial-literacy class, this one hosted by the New York Public Library. These students were suspicious of anything complex—which made them suspicious of banks. Such suspicion isn’t solely the province of the poor. At a CFPB hearing in North Carolina, NetSpend CEO Dan Henry noted that his customers included “5,000 employees of Bank of America, Chase, and Citibank” who preferred his company to their own. “Our customers have not had good experiences” with the big banks, he said. “We provide them with a better solution.” When a consumer advocate criticized NetSpend’s fine-print disclosure, military veteran William Cross, a NetSpend customer who attended the hearing, leaped to the company’s defense. “You said 12 pages” of disclosure at NetSpend, Cross said. “I went to a bank, B. of A., to open up an account. They had a book of regulations.”

There’s a fighting chance that upstart financial competitors like NetSpend will get banks to change their ways. But healthy competition among banks requires a real free market, and the CFPB can’t do much to create such an environment. That’s the job of Congress, the Fed, and other regulators, which should end their ruinous policy of rescuing banks that are “too big to fail.” If a bank is too big to fail, it can compete unfairly against smaller banks for customers, which is partly why the five biggest banks currently hold over half of the country’s banking assets. Customers consequently have fewer choices than they should.

Illustration by Arnold Roth

There is one easy way that the CFPB could protect consumers: make simple, hard-and-fast rules. For example, the CFPB could follow New York State’s lead and ban payday lending nationwide. Some consumer products are too harmful to be legal, and triple-digit loans arguably fall into that category. Similarly, the CFPB could ban bank overdrafts and their attendant fees. After all, charging someone $35 to buy a $4 cup of coffee is payday lending by another name.

Yet the CFPB is unlikely to do anything so simple. Instead, it will busy itself with the nitty-gritty of hidden fees, wordy contracts, and other bugaboos. The reason is prosaic: Congress. Uniform definitions and rules governing the financial industry would render lobbying from both the financial industry and consumer advocates irrelevant, a development that would upset current lobbyists and future lobbyists—that is, today’s congressmen. And another important constituency would balk: middle-class Americans, who increasingly see loose lending as a government entitlement. That’s why, at the Hunter College hearing, Cordray didn’t say that overdraft fees were outrageous and unacceptable but instead that “overdrafts can provide consumers with needed access to funds.”

The CFPB is equally unlikely to make tough, simple rules in another area under its control: home mortgages. In the three decades leading up to 2007, mortgage debt exploded, quintupling (after inflation) even as the population grew only by a third. That’s a real crisis—the one that led to the 2008 blowup, in fact. So Congress invested the CFPB with the authority to write a rule that will require banks and other mortgage lenders to offer home loans only to borrowers likely to repay them.

But what kind of rule, exactly? One that requires home buyers to pay a minimum-percentage down payment would be a simple, effective option. People who have been able to save, say, 10 percent of a house’s value demonstrate financial discipline. Further, a family that has equity in a house can refinance easily to get out of a bad mortgage; such a family also has the flexibility to move, if a breadwinner has the opportunity to take a better job in another city or state. And creating a minimum down-payment rule would be fast and easy—a major benefit, since continued uncertainty about financial rules is contributing to banks’ reluctance to lend and thus to today’s sluggish economy.

Yet the CFPB almost surely won’t take such an obvious step, and again, the fault lies with Congress. The Dodd-Frank bill didn’t specify a down-payment rule because such a rule would push house prices down further—anathema to Congress. Moreover, a down-payment requirement would run afoul not only of America’s debt-carrying middle class but of the affordable-housing and minority-group advocates who want poorer Americans to enjoy the same dream of indebtedness that the middle class enjoys. As Orson Aguilar, executive director of the nonprofit Greenlining Institute, puts it, any mortgage rules that would require homeowners to have a good job, good credit, and a hefty down payment are “problematic.”

So Dodd-Frank, instead of imposing minimum down payments, instructed the CFPB to tell banks to lend only to borrowers with the “ability to pay” the mortgage back. Such a rule sounds good, but it crucially depends on how the CFPB defines “ability to pay.” A family that can’t afford an overpriced house in practice may nevertheless theoretically have the “ability to pay” for it— if the family never takes a vacation, never allows a spouse a few years off to care for a small child, never invests money for retirement, and so on. If banks’ lending criteria are that loose, mortgage debt could rise instead of fall, and homeowners could remain locked into an overvalued housing market for decades to come.

Mortgage debt exemplifies yet another problem with the CFPB: in some of the areas under its jurisdiction, it’s outmatched. The CFPB has no jurisdiction over the government-controlled mortgage merchants Fannie Mae and Freddie Mac, which (along with smaller government agencies) are now responsible for most home lending. Nor does the CFPB have any control over the tax code, which encourages indebtedness by letting mortgage holders reduce their tax burden as they increase their debt burden. Similarly, the CFPB can’t fight the Federal Reserve and the Federal Housing Administration as they continue to entice Americans into a still-plummeting housing market—the former by indirectly setting today’s low mortgage rates, the latter by insuring mortgage loans even when they’re backed by tiny 3 percent down payments. Finally, the CFPB has no authority over the real-estate industry itself. Even the simple, one-page mortgage agreements that Elizabeth Warren has long touted will be no protection against an effusive real-estate broker who insists that home prices have nowhere to go but up, so just ignore those warnings.

The CFPB faces the same problem when it comes to student loans, another area theoretically under its jurisdiction. Like mortgage debt, student-loan debt has exploded; this year, it topped out at $1 trillion. Just since late 2008, according to the Federal Reserve, it has risen by more than a third after inflation, even as credit-card debt has declined markedly. Congress gave the CFPB authority over the private student-loan market to deal with this problem.

But as Willie Sutton might say, private student loans aren’t where the money is. Eighty-five percent of outstanding student debt came, either directly or indirectly, from the U.S. government. Jonathan Mintz, the head of the New York City Department of Consumer Affairs, inadvertently illustrated the problem while lauding the CFPB for taking on the issue of private student debt. Mintz cited the example of a 28-year-old New Yorker who had amassed a $110,000 debt burden only to find a $30,000-a-year job. But that young man owes nearly two-thirds of his debt to the federal government, not to private lenders.

Sure, the CFPB can help prospective student borrowers understand how much they will have to pay per month when they graduate, and it can help them compare loans. But just as with mortgages, it cannot fight a government intent on increasing debt. It has no control over an education industry that wants tuition to keep rising, let alone over the pervasive idea that borrowing tens of thousands of dollars for school is a good bet. Nor can it change the bankruptcy code, which currently prohibits students from discharging either public or private student-loan debt in bankruptcy. If bankruptcy were allowed, lenders might hesitate to throw money at students, imposing some free-market discipline on the government-created debt machine.

Government-subsidized debt is America’s untouchable middle-class entitlement, but the CFPB will affect the lives of poorer Americans as well. The bureau has the power to do for various lending markets what the government did long ago for mortgage markets through such mandates as the 1977 Community Reinvestment Act, which pushed banks to lend to poorer borrowers, largely for housing (see “Obsessive Housing Disorder,” Spring 2009). That is, the CFPB is likely to encourage poorer people to take on debt that they cannot afford.

The bureau can do so because Congress gave it the responsibility to enforce some “fair-lending” laws. As Congress put it, the CFPB must study “access to fair and affordable credit for traditionally underserved communities” and ensure “nondiscriminatory access to credit for both individuals and communities.” The probable result will be to strong-arm the financial industry to lend money cheaply to the poor—and when something is cheap, people buy more of it, even if they shouldn’t.

The CFPB is already moving aggressively on this front. Though it has kept the public’s attention on its friendly-looking hearings, it will spend the biggest share of its budget next year—58 percent, or $261 million—on “Supervision, Enforcement, and Fair Lending and Equal Opportunity,” compared with $126 million on “Consumer Education / Engagement and Response.” In April, the CFPB’s deputy director, Raj Date, told consumer advocates at a Greenlining conference that the bureau would work assiduously to make sure that “lenders are not creating conditions that make loans more expensive, or access more difficult, for certain populations.” Date said, too, that Cordray wants to attack “disparate impacts,” meaning that when financial practices “have an unintentional but unlawful discriminatory impact on a segment of the population, the bureau will intervene. Simple as that.”

The “intervention” could come in a few ways. The CFPB has the authority to conduct lengthy examinations of financial firms, asking for data on approved credit-card applications, for example, or on marketing materials. A bank that advertises its higher-interest-rate credit cards to an audience that is disproportionately Hispanic could face a bureau-led civil suit; so could a bank whose chronic overdraft-fee payers are disproportionately black. Such disparate-impact cases could invite private class-action lawsuits, too, if the bureau decides to ban banks from requiring customers in some cases to bring disputes to arbitration rather than to court. That’s another incentive not to forbid, say, overdraft fees outright. Why outlaw something that’s bad for people when you can get a press conference and a half-billion-dollar settlement out of it?

Aggressive enforcement of “fair lending” mainly hurts low-income people, encouraging them to take on more debt than is prudent. But it also harms competition in the financial industry by favoring the largest institutions. Big banks have vast experience with teams of government officers conducting full-scale examinations of their paperwork, and they can absorb the costs. Smaller banks aren’t as able to shell out money on high-priced lawyers, consultants, and accountants to greet and massage the visitors from Washington.

The crisis of 2008 exposed huge failures in the way we govern our financial system. We certainly need better rules and enforcement, and Washington would be perfectly justified to change many practices affecting consumers. But it can do so directly through Congress and the existing federal bureaucracy. For example, the Federal Reserve and the Federal Deposit Insurance Corporation should apply an old rule to new financial products, making sure that all prepaid debit cards carry FDIC insurance and credit-card-style protection against theft. Congress should require federal agencies dealing with mortgages to put into place a minimum down-payment rule. Existing regulators and law enforcement agencies could do better at policing deception and fraud—and show that they’re willing to shut down repeat offenders, even big ones. And lawmakers should start phasing out Fannie and Freddie, so that government dominance no longer distorts the housing market.

Instead of doing any of these things, Congress has created a shield for itself, a useless and destructive agency that it can point to when the public justly blames it for failing to fix our ongoing economic problems. Whether the CFPB can protect Congress in that event is unclear, but one thing is certain: despite its name and lofty goals, it can’t protect consumers.

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