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CFPA Act 2009 Study on Credit
By David S. Evans and Joshua D. Wright Published: 03/12/2010
EXECUTIVE SUMMARY
The U.S. Department of the Treasury has submitted the Consumer Financial Protection Agency Act of 2009 to Congress for the purpose of overhauling consumer financial regulation. This study has examined the likely effect of the Act on the availability of credit to American consumers. To do so we have examined the legislation in detail to assess how it would alter current consumer protection regulation, reviewed the rationales provided for the new legislation by those who designed its key features, considered why consumers borrow money and benefit from doing so, and reviewed the factors behind the expansion of credit availability over the last thirty years.
Based on our analysis we have concluded that the CFPA Act of 2009 would make it harder and more expensive for consumers to borrow. Under plausible yet conservative assumptions the CFPA would:
• increase the interest rates consumers pay by at least 160 basis points;
• reduce consumer borrowing by at least 2.1 percent; and,
• reduce the net new jobs created in the economy by 4.3 percent.
By reducing borrowing the Act would also reduce consumer spending that further drives job creation and economic growth. In addition to restricting the availability of credit over the long term, the CFPA Act of 2009 would also slow the recovery from the deep recession the economy is now in by reducing borrowing, spending, and business formation.
The financial crisis has surfaced a number of serious consumer financial protection problems that were not dealt with adequately by federal regulators. Rather than proposing expeditious and practical reforms that can deal with those problems, the Treasury Department has put forward a proposal that would disrupt current regulatory agency efforts to deal with these issues.
A. How the CFPA Act of 2009 Would Change Consumer Financial Laws and Regulations
The Administration’s Consumer Financial Protection Agency Act of 2009 would:
• Create a new powerful agency that would take over the responsibilities and possibly the staffs for consumer financial services regulation from six federal agencies.
• Enable the new agency to design standard consumer financial products and require lenders to make these agency-designed products available to consumers before or at the same time as the lenders make their own financial products available.
• Enable the new agency to prohibit certain consumer financial products or services or specific product features, as well as control the pricing, marketing, and distribution of those products or services.
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• Provide for the new agency to impose more stringent and intrusive disclosure requirements on providers of consumer financial products and services than existing federal regulators can impose.
• Create a new liability for financial institutions that engage in undefined “abusive” or “unreasonable” practices and enable the new agency to reach different and more expansive interpretations of “unfair and deceptive” practices than found in current jurisprudence.
• Permit and encourage state and local governments to adopt more stringent consumer financial protection regulation than adopted by the new agency.
This paper focuses on the CFPA Act that the Administration introduced in July
2009. House Finance Committee Chairman Frank has proposed changes to this Act which the Treasury Secretary Geithner appears to be willing to accept. However, given that these changes could be reversed or other changes could be made as the legislation works its way through Congress, we focus on the Administration’s original bill rather than a moving target. Chairman Frank’s proposed changes do not significantly alter any of our conclusions.
B. The Consequences of the CFPA Act of 2009 for the Access to and Cost of
Consumer Credit
The Treasury Department proposed this new system of consumer financial protection in its June 2009 white paper Financial Regulatory Reform: A New Foundation.
However, the proposal for the new agency and many of the key principles for how this agency would regulate consumer financial products were presented in articles and reports that were authored by several law professors, including the Assistant Secretary of the Treasury who was involved in the drafting of the legislation. These articles and reports provide the intellectual foundation for modifications in consumer protection regulation on the premise that consumers are irrational and make mistakes systemically in how they borrow money. These writings provide a guide for how its proponents intend the new agency and laws to work.
Based on our research, we have reached three key findings. The CFPA Act would:
• Make it harder and more expensive for consumers to borrow and would risk reversing the decades-long trend towards the democratization of credit.
• Create a “supernanny” agency that is designed to substitute the choice of bureaucrats for those of consumers. And,
• Jeopardize the financial recovery by reducing credit when the economy is fragile and there is already too little credit.
We briefly explain each of our findings.
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C. The CFPA Act Would Make It Harder and More Expensive for Consumers to Borrow
The CFPA as it is envisioned by the U.S. Department of the Treasury and its proponents would likely:
• Prohibit lenders from offering some credit products and services that consumers want and benefit from. The CFPA would have the power to do this and the proponents of the agency have argued that many common products, including subprime mortgages and credit cards, are of dubious benefit to consumers.
• Impose significant additional costs on lenders that would be passed on to borrowers. These costs would include exponentially higher litigation and regulatory costs that would result from allowing states and municipalities to adopt more stringent regulations and imposing new and untested liability standards on lenders. They also include the costs of complying with the stronger regulations that the CFPA is supposed to apply.
• Require lenders to push consumers towards lending products designed by the CFPA. The CFPA would have the power to impose significant costs on lenders offering innovative lending products and the consumers who want them. The CFPA’s proponents strongly advocated this paternalistic approach in which the government provides soft or hard “nudges” to get consumers to take an option these proponents prefer. There is no reason to believe that products designed by
a regulatory agency would be better than those designed by lenders and freely chosen by consumers. (The CFPA may have sufficient powers to “induce” lenders to provide products of its design even without the ability to require lenders to offer “plain vanilla” products.)
These aspects of the CFPA would result in consumers losing access to methods of lending that the agency prohibits or that lenders withdraw as a result of the higher costs they incur. Lenders will also pass on the higher costs resulting from federal and state regulation of lending products to consumers in the form of higher interest rates and fees.
These aspects of the CFPA Act would likely reverse the decade long trend towards the democratization of credit. The increased cost of lending combined with requirements to offer agency-designed products is likely to result in a significant reduction in credit availability, particularly to people who have historically had more difficulty obtaining access to credit. Finally the increased cost of credit and reduced availability would impose collateral damage on small businesses that often rely on consumer financial products.
D. The CFPA Act Would Create a “Supernanny” that is Designed to Substitute Bureaucratic Choice for Consumer Choice The CFPA Act, as explained by its proponents, is based on the findings of “behavioral law and economics” that consumers make bad decisions when it comes to financial services products and would be made better off with the government steering them to better decisions. A CFPA premised on this paternalistic view would be prone to replace what consumers believe is in their interest with its own views. It is doubtful that even the most well educated bureaucrats could design sustainable and profitable products better suited to satisfy consumer needs than those designed by lenders. Similarly, it is
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unlikely that any group of regulators could make better decisions on how and on what
terms to borrow than the consumers with the greatest stake in the loan.
E.The CFPA Act Would Jeopardize the Financial Recovery The CFPA Act poses especially severe risks to American households and to the economy over the next few years. The American economy remains fragile. Credit availability to households is restricted, which has hurt them directly. The credit crunch has also affected the economy through decreased economic activity, harming consumers indirectly as a result of fewer jobs and reduced incomes. In addition to the long-run effects the CFPA Act would have on credit availability, the proposed legislation would also especially dampen credit availability in the nearer term because financial institutions would face a great deal of uncertainty over the scope and risks of the new regulations.
That reduced credit availability would likely slow the economic recovery and especially impact job creation as a result of the multiplier effect of consumer spending on economic activity. It would also dampen the formation of new businesses that generate most of the economy’s net new jobs. Adopting a new regulatory system for consumer financial products that could make it harder for consumers to borrow in 2010 and 2011 is a very bad idea.
F. Conclusion
The CFPA Act of 2009 is a misguided attempt to erect a supernanny agency that
could substitute its own view for those of consumers on how and under what circumstances consumers should be able to borrow money. Short term the CFPA would tighten the credit crunch that still threatens the economy. Long-term it would reduce the availability of credit generally to consumers as well as small businesses. Most unfortunately, the CFPA-induced reduction in credit availability would reverse successful efforts to democratize credit by which all segments of American consumers have increasingly been able to borrow to meet their short-term and long-term needs.