Consumer Financial Protection--the Good, the Bad and the Ugly

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On Thursday the Senate passed its version of the financial reform bill, and the reconciliation process with the previously passed House bill will now begin. What are the implications for consumer protection? The similarities between the two bills in the area of consumer protection and more notable than their differences, but there are some distinctions to keep in mind and some troubling issues common to both bills. Consumer protection is a worthy goal, especially given some of the documented abuses leading up to and during the financial crisis, but bad regulation may be worse than under-regulation.

First, the Senate bill has an independent Consumer Financial Protection Bureau housed within the Fed, with regulations subject to veto by an oversight council, while the House proposes a completely independent Consumer Financial Protection Agency with no overrides in place. The former looks like a signal that bank solvency comes before consumer protection, which may seem reasonable, but it also sends the curious signal that there is a conflict between these two goals, something that is far less obvious. Appropriate consumer protection should not adversely affect financial institutions, but perhaps housing the bureau in the Fed is a warning as to how likely we are to see "appropriate" regulation.

Second, both bills exempt certain non-bank providers of financial services, but these exemptions are less prevalent in the Senate bill, with auto dealers and their loan business attracting the most attention. In general, including exemptions is a dangerous game because of the possibility for regulatory arbitrage. As we saw in the crisis, regulating banks can simply push banking activities to the unregulated shadow-banking sector.

Finally, there are the efforts, in one or both bills to micro-manage financial institutions. Eliminating pre-payment fees on mortgages, as both bills recommend, may seem like a win for consumers, but it isn't. In the long run it will only limit the variety of loans offered, thus limiting access to credit. The Senate bill also includes a provision requiring the Fed to limit "swipe" or interchange fees--the fees charged for using debit or credit cards. Again, this type of regulatory price control is sure to have a host of unintended consequences that could be detrimental to consumers.

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