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ZYWICKI: Bureau of Consumer Protection must put consumers first

Congress should reform the reform before it is too late

- The Washington Times - Friday, May 6, 2011

As the effective date for the new Bureau of Con- sumer Financial Pro- tection approaches this summer, observers are expressing mounting concerns about its unprecedented power and lack of oversight. Newly empowered House Republicans have introduced several legislative proposals to trim the sails of the new agency, most notably House Financial Services Committee Chairman Spencer Bachus' proposal to change the bureau's single-director management structure to that of a five-member commission.

While those efforts are expected to fail in the Democratic-controlled Senate for now, there are several much-needed reforms Republicans could propose to further the bureau's consumer-protection mission while protecting consumers and small businesses from the unintended consequences of regulatory overreach by an unaccountable bureaucracy that would raise credit costs, restrict access to credit and do nothing to address the underlying problems of misaligned incentives that caused the financial crisis.

The bureau's structure itself may be unprecedented in American government: an independent agency within another independent agency. Although headquartered within the Federal Reserve, it remains largely unaccountable to oversight by the Federal Reserve Board or any other entity except through a cumbersome and limited oversight process by a council of regulators - which even then can act only if two-thirds of the council thinks a proposed action by the bureau would imperial the safety and soundness of the nation's financial system. Moreover, it is headed by a single chief appointed by the president rather than a multimember commission, leaving the agency's actions subject to the whims of a single individual.

As an unaccountable bureaucracy with a single head, the bureau will be susceptible to bureaucracy's worst pathologies: a tunnel-vision focus on the agency's regulatory mission, undue risk aversion and agency overreach. While a more coherent consumer-protection regime is needed, consumer-protection goals often can conflict with other goals, such as promoting competition, lower prices and expanded choice for consumers; and ensuring safety and soundness. For example, the law gives the bureau new authority to regulate slippery mortgage brokers. Although stricter regulations of mortgage brokers theoretically could reduce fraud (although there is no evidence that this is the case) brokers also provide a salutary competitive check on traditional bank lenders. Research by economists Morris Kleiner and Richard Todd finds that overly restrictive regulation that reduces the number of mortgage brokers in a given market results in higher prices and lower quality for consumers. An effective consumer-protection regulator must be able to balance consumer protection against other benefits to consumers and the economy of greater competition, lower prices, and enhanced safety and soundness. The current CFPB is not structured to weigh those broader trade-offs.

A better model is the Federal Trade Commission, the primary consumer-protection regulator for most of the American economy. At the FTC (where I was director of the Office of Policy Planning from 2003-04) the mission of the Bureau of Consumer Protection is virtually identical to that of the CFPB, focusing particularly on unfair and deceptive marketing. But the final decision on whether to act rests not with the director of the consumer-protection bureau, but with the five-member bipartisan commission to which the bureau reports. Moreover, by combining under its roof the Bureau of Competition and the Bureau of Economics, the FTC has a broader scope to weigh the consumer-protection bureau's narrow focus on consumer protection against the larger impacts on competition and economic efficiency (and vice versa).Yet no one contends that this broader focus, greater accountability and internal checks and balances weaken the FTC's effectiveness as a consumer-protection watchdog. Instead, FTC officials uniformly recognize that consumers benefit from lower prices and greater choice as well as consumer protection. No FTC veteran whom I know believes consumers would be made better off if the director of the Bureau of Consumer Protection were unleashed to litigate and regulate without accountability to the commissioners. Yet that's precisely how the CFPB is structured.

Second, the CFPB has the power to regulate and punish not only "unfair" and "deceptive" lending practices (the FTC's standard) but also "abusive" loans and loan terms - a legal term that appears to be novel in this context. The contours of this new basis for liability are vague, but it seems potentially to hold lenders responsible for a subjective standard of understanding and competency by some categories of borrowers in at least some circumstances.

More dangerously, the new superregulator would seem to have power to ban loan terms and products anytime the bureau chief thinks consumers lack the ability to comprehend the full risks of a product. The bureau chief could effectively ban many nontraditional lending products, such as payday lending, if he thinks, for example, that consumers using that form of lending are too dumb to appreciate the full cost and risk of those products - even if the consumers fully understand the risks and even though research shows that consumers overwhelmingly are satisfied with their choices and use payday loans because those loans are superior to the real-world choices available.

Third, Congress should roll back the heightened standard for federal bank regulators to pre-empt state regulatory and enforcement authority over federally chartered banks. The threat addressed by pre-emption is long-standing - the effort of populist state legislatures and would-be Eliot Spitzers to score political points by attacking out-of-state federally chartered banks. But the consequences are heightened by the national character of the modern banking system, which has grown in large part because of the power of federal regulators to pre-empt parochial state laws. Moreover, if the rationale for heightened pre-emption standards is justified, it was because of a fear of inadequate federal enforcement - but that rationale was eliminated by the creation of the new federal bureau itself. Instead, the weakening of pre-emption threatens a nightmare regulatory dystopia: a new federal regulator that reaches down to the level of local payday lenders and small merchants while simultaneously empowering state regulators to attack national banks.

The new CFPB promises higher costs and reduced access to credit for American consumers - the only question now is how much of an impact will be felt. Congress should take steps to build greater accountability and mission focus into a new consumer-protection regulator. Or consumers will be the losers in the end.

Todd J. Zywicki is a George Mason University law professor and scholar at the Mercatus Center.

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