Pro & Con: Do consumers need a new financial protection agency?

Now the industry is fighting against creation of an agency that would protect taxpayers and ordinary consumers from a similarly devastating onslaught in the future. At the same time they are scrambling to raise credit card interest rates and all manner of exploitive fees to build a brand new superstructure of questionable profits on the backs of the taxpayers who came to their rescue.

We’re reaching a whole new level of chutzpah here.

The Obama administration wants to create a Consumer Financial Protection Agency that would shield individuals from deceptive practices and outright fraud by banks and other businesses offering credit cards, mortgages, home loans and other forms of consumer finance.

Protecting the consumer is, of course, anathema to the industry. So it’s preparing for war. The New York Times’ Edmund Andrews neatly summed up the matter when he wrote that “banks and mortgage lenders are placing top priority on killing” the president’s proposal.

The proposed agency developed from an idea offered some time ago by Elizabeth Warren, a Harvard Law School professor.

Warren told a congressional committee last month about the stark difference between the warm and fuzzy advertising approach used by lenders competing for consumer dollars and the treachery that is so often hidden in the fine print.

“Giant lenders compete for business by talking about nominal interest rates, free gifts and warm feelings,” she said, “but the fine print hides the things that really rake in the cash. Today’s business model is about making money through tricks and traps.”

It should be clear by now that it is often the goal of financial institutions to see that the consumer is not well informed. “In the early 1980s,” said Warren, the average credit card contract was about a page long. “Today, it is more than 30 pages. ... I am a contract law professor, and I cannot make out some of the fine print.” She added, “Study after study shows that credit products are designed in ways that obscure the meaning and trick customers.”

There is nothing free or fair about a market in which one side uses double talk and mumbo jumbo to obscure important information and deliberately dupe the other side into making decisions against its own interests.

The Department of Housing and Urban Development has concluded that Americans spend approximately $55 billion each year on closing costs that they don’t fully understand. As Warren noted, “Mortgage lenders furnish reams of unreadable documents shortly before closing, often leaving people with no practical option but to take whatever terms the lender has filled in.”

The family home is the largest purchase most Americans ever make. Paying it off can take much of a lifetime. Everything about that contract should be crystal clear to the buyer.

I had a breakfast interview with Warren on a variety of subjects last week. On the day of the meeting, USA Today had a front-page article that began: “Even as regulators crack down on abusive mortgage and credit card practices, another type of lending threatens to mire consumers in a credit trap.”

The story detailed the ways in which banks are wringing huge profits from overdraft fees that often are sky high and in many cases are handled in ways that are exploitive, if not predatory.

The malefactors of great wealth view an informed consumer as Public Enemy No. 1. The last thing in the world that they want is a fair marketplace, which is why the Consumer Financial Protection Agency can’t come fast enough.

Bob Herbert is a New York Times columnist.

NO: New agency will kill innovation in the name of consumer protection.

By Alton E. Drew

The Senate Banking Committee met Tuesday to consider the creation of a consumer financial protection agency. Treasury Secretary Timothy F. Geithner describes the proposed agency’s mission as a protector of consumers and a promoter of access to financial products.

Geithner says the agency will meet its mission by ensuring financial services companies provide consumers with clear and concise information regarding services; protecting consumers from unfair or deceptive practices; and promoting consumer access to fair, efficient and innovative financial services markets.

The new agency will also try to keep consumers in the market for financial services by monitoring market risks. Financial services providers will be subject to examinations by the agency designed to ensure compliance with new and existing consumer protection statutes and regulations.

While House Democrats are reportedly rearing to get a bill to President Obama by the fall, the more deliberative Senate is contemplating a longer time frame.

Two questions come to mind. Do we need another consumer protection agency? Will the new agency work? The answer is no.

The meltdown in the financial markets specifically and the overall downturn in the economy have created the platform for launching additional consumer protections — or so the argument goes. I think the argument is a weak one.

Consumer protection legislation tends to have protection of the consumer against fraud and deceptive practices as the primary premise.

The Obama administration’s proposal goes beyond fraud and deceptive practices. After giving fraud the obligatory lip service, the proposal moves fast into market intervention.

The first red flag is the attempt to address the promotion of fair, efficient and innovative financial services.

I’m sorry, but market efficiencies are created in response to financial factors such as cost and price of the service.

How government intervention via a supposed piece of consumer protection legislation is to bring this about has not been articulated by Congress or the administration. Creating efficiencies through regulation typically requires government specifying allowances for certain costs, expenses, assets and rates of return.

Do we really want a consumer protection bill to go that far?

Isn’t the financial meltdown also partially to blame on consumers? I don’t expect a consumer protection bill to protect consumers from themselves. There is also only so much blame that we can put on derivatives and other pieces of faulty financial engineering.

Which brings me to my second question: Will this new agency work?

From an operational perspective such an agency may work. I say this for two reasons. First, the bill envisions stripping the Federal Reserve Board and the Federal Deposit Insurance Corporation of their consumer protection responsibilities. This may indeed free up personnel experienced in consumer protection regulation. Second, regarding the proposed agency’s monitoring responsibilities, a number of financial analysts who lost jobs on Wall Street may be able to put their skills and contacts to good use within such an agency.

But from a market perspective, the agency’s two-pronged approach to consumer protection may bring about the market failure it presumes to try to stem. Monitoring risk will lead to regulating risk. It is risk that lies at the base of creating and pricing innovative financial products.

A consumer protection agency that tries to reduce risk will eventually spawn a market that does not provide innovative services and credit to consumers. This is market failure.

The other point of failure would be the lack of consumer accountability. This bill basically takes consumers of the hook for becoming financially literate and disciplined. The bill creates another John Wayne riding over the hill to save the hapless settlers.

It is unclear to me why in a society with so many available and relatively inexpensive sources of information we need an uber-regulator to hold our hands.

Alton E. Drew is a public policy analyst based in Atlanta.