The Test of Real Financial Reform: What Bank Customers Need and Deserve

by Caryn Becker

Last month in his State of the Union Speech, President Obama mentioned the need for "serious financial reform," cautioning that "if the bill that ends up on my desk does not meet the test of real reform, I will send it back until we get it right."

But what exactly should the test of real reform be?

At the heart of true reform is ensuring that financial products are safe for consumers, and ensuring that the financial industry is treating Main Street fairly, as would be the goal of a Consumer Financial Protection Agency (CFPA).  Modeled after the Consumer Products Safety Commission, the CFPA would work to prevent faulty financial products from entering the marketplace.

Real reform means putting consumer protection in the hands of an independent agency with the singular purpose of protecting consumers.

Existing regulators failed to effectively protect consumers because their primary focus has been to ensure the banks' "safety and soundness," i.e., their profitability and financial stability.  Their focus was not on the quality or fairness of the banks' products, but on the banks' (short term) bottom line.  Unfortunately for consumers, unfair and harmful fees and practices typically boost the banks' bottom line - at least in the short run.  For example, regulators have failed to rein in abusive overdraft fees, while banks' profits from these fees increased 35% in the last two years to $24 billion in 2008.  It is essential, then, to separate the consumer protection and "safety and soundness" functions.

Real reform means restoring states' ability to identify and stamp out problems locally.

In recent years, while federal policymakers and regulators failed to stamp out irresponsible lending, states established the most effective lending rules and pursued bad actors.  Unfortunately, federal regulators overruled key state laws through pre-emption and blocked state enforcement efforts against federal banks.  It is essential that federal standards be the floor of consumer protection, and that states be given the flexibility to go further to address local abuses against all actors.

Real reform allows for innovation while also preventing "creative" new predatory lending practices.

The so-called "free market" that has been and continues to be idolized by industry and protected at all costs actually has been a lawless market, lacking effective restraints on excess, recklessness and, in too many cases, downright deception.  The absence of regulation then brought about the most severe credit drought since the Great Depression. 

Even Judge Richard Posner, the father of the free-market-based law-and-economics movement, has changed his tune, coming to accept that you cannot rely upon business to self-regulate and put considerations of the general economy or community above its own self-interest:  "If you're worried that lions are eating too many zebras, you don't say to the lions, 'You're eating too many zebras.'  You have to build a fence around the lions. They're not going to build it."

It is essential that the CFPA have the authority to build a fence around the lions - to declare practices unfair or deceptive, and to create rules that realign incentives in order to create a safer, more sustainable financial market.

Will we get real reform?

In December, the U.S. House of Representatives passed a version of financial reform, the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173).  This bill is a good start towards real reform.  It would create an independent CFPA with the singular authority to protect consumers and oversee the safety of financial products.  However, it exempts some players (like auto lenders), and would still allow federal banking regulators to ignore state law. That must be fixed as the legislation moves forward.

This reform effort has been stalled in the Senate, however, as the financial companies that caused this crisis-and received billions in bailout money from taxpayers-spend hundreds of millions of dollars on lobbying to prevent needed reforms. 

Just before the Washington "snowmageddon," Senate Banking Committee Chairman Chris Dodd (D-CT) announced that he will move forward with his bill to bring reform to the marketplace.  Whether or not American consumers will get a CFPA remains to be seen.  What is abundantly clear is that we need one.

Caryn Becker is policy counsel at the California office of the Center for Responsible Lending.  www.responsiblelending.org

caryn.becker@responsiblelending.org

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