The Consumer Financial Protection Bureau opens for business next month. Without question, the agency could help reduce risk, increase transparency, and prevent the kind of bad lending that led to the current recession. In creating the CFPB, though, lawmakers missed an opportunity to address the simple fact that U.S. financial regulation remains too fragmented and too complex.
All financial services providers should be subject to the same set of rules. Regulators should be guided by a simple principle: Anything that does what a bank does should be regulated like a bank.
While current financial regulations are supposed to apply to both banks and nonbanks, enforcement against nonbanks — many of whom contributed to the financial crisis — is often weak or nonexistent.
Some politically connected industries have managed to win exemption from CFPB regulations altogether. Auto loans are the second-largest source of debt for Americans, but they are largely exempt from scrutiny by the CFPB. There is no reason to treat dealers who make auto loans differently from regulated lenders. Consumers should get the same level of protection at a car dealership that they get at a bank.
We are setting ourselves up to make the same mistakes again. By allowing certain providers to operate out of sight of regulators, we are creating risks to our financial system.
The collapse of several insurance companies during the financial crisis proved this industry can pose a systemic risk to the economy. Yet insurers have basically gotten a free pass from the government during the spate of regulatory reforms following the crisis. Insurers are still governed by an inconsistent patchwork of state regulation — an approach that failed spectacularly in the years leading up to financial downturn.
Lacking strong oversight, insurers were able to move their riskiest activities to less-scrutinized areas of the economy. In particular, credit default swaps, a form of insurance against bad loans, wound up severely compounding financial losses when the housing market went south. Yet these instruments had gone virtually unregulated by state insurance commissioners because they weren’t called “insurance.” And the U.S. Securities and Exchange Commission ignored them because “swaps” aren’t “securities.”
The swaps market exploded in the mid-2000s. And no one was checking to see if insurers actually had enough capital to make good on their policies. When catastrophe hit, some insurers went under and taxpayers got stuck with a massive bill.
There’s also a dangerous regulatory gap in the mortgage market. There are sensible regulations that apply when banks make mortgages. Yet there’s effectively no regulation when mortgage brokers make loans. Not surprisingly, mortgage brokers were responsible for the bulk of subprime loans in the run-up to the financial crisis.
Mortgage brokers aren’t inherently less morally trustworthy than bankers. But because they in essence get to pick which state laws to operate under, they naturally choose the states with looser regulatory environments. Thus government regulation often has had the perverse effect of diminishing protection for consumers.
The patchwork regulatory structure we have today is something nobody would design on purpose. The CFPB has the opportunity to establish a regulatory system that holds all lenders equally accountable. No doubt, there will be criticism from industries that would like to protect their privileges, but the CFPB should hold strong against them. The government safety net already has failed us once. We must not let it do so again.
Arkadi Kuhlmann is president and CEO of ING DIRECT USA.
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