Consumer Financial Protection Regulation: The Winners and Losers

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by Vicki Morwitz and Robert Whitelaw

The Senate today approved the Dodd-Frank Wall Street Reform and Consumer Protection Act. Soon President Obama will sign it, and the Act will become law. One notable aspect of this sweeping financial regulation is the creation of a new Bureau of Consumer Financial Protection (BCFP) as an independent bureau within the Federal Reserve System. The BCFP is charged with aiding consumers in understanding and using relevant information; protecting them from abuse, deception, and fraud; ensuring that disclosures for financial products are easy to understand; conducting research; and providing financial literacy education. But will the new law accomplish these goals? And who will be the winners and losers under the new law?
Consumers win on independence: The independence of the Bureau is important, and its structure as an independent agency within the Federal Reserve System seems to achieve this goal, especially since the associated funding avoids the annual Congressional appropriations process that can serve as a mechanism for imposing undesirable political pressure.

Consumers lose, auto dealers, insurance companies, and small banks win on carve-outs: Ideally, the Bureau would have full rulemaking and enforcement authority over all financial firms and products. While the Dodd-Frank Act does unify much of this authority in the BCFP, there are some troubling exceptions. For example, auto loans and annuities are two extremely popular products where abuses have been alleged in the past; however, auto dealers and insurance companies have been specifically excluded from oversight by the Bureau. Although the Dodd-Frank Act also empowers the Federal Trade Commission, the current regulator for automobile dealers, to more quickly and easily write rules related to auto financing, we still feel these carve-outs leave a significant part of consumers' assets under-regulated. We are also concerned that since the BCFP will not have the power to enforce regulation for smaller banks and financial institutions, if the existing regulators fail to do their job, consumer protection may be inadequate. Worse yet, financial firms may be able to exploit these exclusions by engaging in regulatory arbitrage. For instance, financial firms can redirect their credit supply to less regulated sectors.

Consumers both win and lose on mortgage protection: The bill provides for additional regulation of the mortgage market including (i) prohibitions on steering incentives for mortgage brokers, i.e., payments to brokers for selling specific types of loans, (ii) restrictions on prepayment penalties, (iii) restrictions on high-cost mortgages, and, perhaps most important (iv) a requirement that lenders make a "reasonable and good faith determination" that borrowers have a "reasonable ability to repay" the loan that they are taking out. Elimination of prepayment penalties and restrictions on high-cost mortgages will help to eliminate some of the abuses that occurred in the past, but at the same time will also almost certainly reduce the availability of credit, as will the responsibility placed on lenders to ensure that borrowers have a documented ability to repay their loans.

Consumers and State Attorney Generals win on Federal preemption: It is also important that the BCFP sets the federal floor but not ceiling for consumer protection. State protection laws are often stricter than federal laws, and the Dodd-Frank Act does a creditable job in achieving this goal. In general, the bill does not preempt or annul state law, except in the case of national banks when the State consumer financial law would have a discriminatory effect on national banks relative to State chartered banks, as determined by the OCC in consultation with the BCFP.

Debit and credit card industries lose with micro-regulation. The bill provides additional regulation for debit and credit cards. It requires that interchange fees be reasonable and proportional to incurred costs, as defined by the Fed. The bill also states that payment card issuers and networks cannot include in their contracts with vendors prohibitions on giving discounts for cash, check, or debit card payments. They also cannot prohibit the vendors' decision to refuse to allow credit card purchases for transactions that are below some threshold. The specific language in the bill also permits the BCFP to restrict interchange (debit card) fees. This micro-regulation will increase costs and decrease revenues for firms offering credit cards. In the short run these cost increases or revenue decreases could threaten the profitability and even the viability of some companies. While designed to protect consumers this could become a disservice to consumers who also benefit from active markets with vibrant competition.

Traditionally underserved consumers both win and lose. Regulation can potentially also inadvertently hurt traditionally underserved consumers and communities by limiting their access to financial products and services. While the concerns of over regulation remain, we support the bill's focus on balancing consumer protection with the needs of underserved markets and the viability of firms that offer financial products or services The overall verdict? Our verdict is mixed. One the one hand there is clearly hope that an independent, well-financed and appropriately staffed BCFP will make significant strides in educating and protecting consumers and therefore improving their welfare. But there is also a well-justified fear that the creation of such a bureau, and the external pressures that may come to bear once it is in existence, can potentially subvert this potential and cause more harm than good.

The authors are respectively professors of marketing and finance at NYU Stern School of Business and contributors to the forthcoming book, "Regulating Wall Street: The New Architecture for Global Finance," John Wiley & Sons, 2010.

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The Dodd-Frank Act, signed into law in July 2010, represented the most significant and controversial overhaul of the U.S. financial regulatory system since the Great Depression. Forty NYU Stern faculty, including editors Viral V. Acharya, Thomas F. Cooley, Matthew P. Richardson, and Ingo Walter, provide a definitive analysis of the Act, expose key flaws and propose solutions to inform the rules’ adoption by regulators, in a new book, Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance (Wiley, November 2010).

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Previously, many of these faculty developed 18 independent policy papers offering market-focused solutions to the financial crisis, which were published in a book, Restoring Financial Stability: How to Repair a Failed System (Wiley, March 2009).

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