Proposed Regulatory Reform- Wall Street Needs to Respond Carefully
June 25th, 2009 | 
Author: Not surprisingly, parts if the regulatory reform proposal released last week by the Obama Administration have proven to be rather controversial. The plan has attracting criticism from both lawmakers and members of the financial services industry, and praise from consumer advocacy groups. Can the plan prevent future financial crises without overburdening financial institutions with unnecessary and redundant oversight? I believe it has the potential to succeed, but the devil will be in the details that have yet to be determined. Over the coming weeks and months, there will be a great deal of debate, lobbying, and negotiations that will determine what the financial regulatory structure will be going forward.
Arguably the most controversial aspect of the plan is the creation of a new Consumer Financial Protection Agency that will police financial products such as mortgages and credit cards, that have historically only been loosely regulated. The new agency would also play “a leading role” in providing financial information and education to consumers. Some critics are concerned that the agency is adding a new level of regulation that would be overburdening and costly to the financial services industry and, according to financial services attorney Jeremiah Buckley may impair the mortgage lending process:
There is a real danger that this legislation could create uncertainty for secondary market investors, Buckley says, particularly around the consumer protection obligations of lenders and mortgage investors. If these concerns do emerge in the market, Congress needs to offer assurances that this legislation will not substantially increase the legal risks of mortgage investing. If it does, "mortgage credit will be less available and more expensive…exactly the opposite of the result we should be looking for in financial reform," Buckley says.
Buckley sees it will take a long time to set up a functioning CFPA and to integrate all the regulatory functions. "I think that, if Congress goes this way, it should avoid creating some vague liability standard for lenders or investors…that is, until there are clear rules, the new agency should not start making law by enforcement actions, as sometimes happens."
Also, Congress should charge this agency with testing what disclosures work to make sure that consumers are ultimately empowered to make their own decisions. "Care must be taken to avoid going overboard in consumer protection, placing responsibility for every mortgage failure on the lender by arguing that the lender has a fiduciary duty to be sure the outcome is right for the borrower," Buckley says. "We have seen evidence of that in some legislative proposals already." [1]
Another area of concern involves the possibility of eliminating out-of-court binding arbitration as a way of settling investor disputes:
The CFPA would be directed to study mandatory arbitration clauses to see if they “promote fair adjudication” on behalf of the consumer and, if they don’t, the CFPA would have the power to establish conditions for fair arbitrations or simply ban them altogether in “particular contexts.” The only “particular context” example given is mortgage loans, so you can bet what constitutes “particular contexts” will be strong fodder for debate.
The mandatory arbitration clause is mentioned again when the plan lays out “initiatives to empower” the SEC’s ability to protect consumers entering into investment contracts.
Its long been the view of plaintiff’s attorney and self-styled consumer advocates that mandatory arbitration should be banned. And the administration’s overhaul hints that it will probably take exactly this view, claiming mandatory arbitration “may unjustifiably undermine investor interests." The plan proposes to give the SEC “clear authority to prohibit mandatory investment clauses in broker-dealer and investment advisory accounts with retail customers."
That seems a clear way of increasing the costs of broker-dealer and investment advisory costs, which may mean that smaller customers find that brokerages are even less likely to deal with them than before. As usual, there seems to be very little thought given to how brokers will react to having the increased risk of litigation imposed upon them.
What’s more, there are serious questions about whether it makes sense to burden the court system with additional litigation that a ban on mandatory arbitration will sure spur. In effect, a part of the costs of disputes between brokers and their customers are being transferred to the taxpayer who will pay the costs for the extra-burden on courts. It’s far from clear why this shift in cost from the parties to the agreement to taxpayers is warranted. We can squint our eyes and see this as something of a bailout of customers who wind up unhappy with their broker.[2]
The list of supporters and detractors are predictable: Wall Street and Republicans criticize the agency for adding an additional layer of regulation and hampering financial innovation, while consumer advocacy groups and Democrats support the idea, especially in the wake of increasing credit card fees.
U.S. banks are fighting the Obama administration plan to create a consumer agency for financial services as they seek to protect fees, such as credit-card penalties that have almost doubled to $19 billion in five years.
Fees imposed by banks accounted for 53 percent of industry income in 2008, up from 35 percent in 1995, according to R.K. Hammer Investment Bankers, a credit-card advisory firm. JPMorgan Chase & Co., the second-largest U.S. bank by assets, said such revenue doubled in the first quarter. A U.S. Consumer Financial Protection Agency also may add costs by expanding scrutiny.
The supervisor “would be an additional, parallel regulatory system representing a major burden, a potentially punitive approach, and significant indefinable regulatory risk,” Alex Pollock, a fellow at the Washington-based American Enterprise Institute, testified yesterday at a House Financial Services Committee hearing on the proposal.
Banking trade groups such as the American Bankers Association said Obama’s “highly controversial” agency will raise costs for responsible consumers and mandate the types of products banks and financial institutions should offer. ABA President Edward Yingling yesterday testified the agency will “saddle consumers and providers with a new regime of fees.”
The agency will have the power to write rules strengthening consumer protections, supervise and police a bank’s compliance and force institutions to offer “plain vanilla” products that are easy for consumers to understand. The Federal Reserve and other regulators would cede consumer oversight to the agency.
“We’re concerned about the potential impact on the ability to innovate, on competition and on efficiency,” said James Mahoney, director of public policy at Charlotte, North Carolina- based Bank of America Corp., the largest U.S. bank by assets.
Banks may have benefited from dispersed consumer protection activities among the Fed, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and the Office of Thrift Supervision, which are required to ensure the institutions they oversee remain healthy and solvent.[3]
I am somewhat disturbed by what appears to be speculation that there is a direct correlation between the credit card fees and industry concern with the proposed agency. Careful reading of the article does not present any facts to support such a correlation, which leads me believe that this is nothing more than another case of irresponsible journalists presenting their speculation as unbiased, factual news. You can read the entire article here and come to your own conclusions: http://www.bloomberg.com/apps/news?pid=20601087&sid=agR2UE7gabLM
Having said that, I am sure that banks are concerned about protecting their fees, and that may be part of the reason for their opposition to the agency. But that is conjecture on my part, and I would never present that as fact without evidence to support my theory. The banks are well aware that they need to improve their public image and gain public confidence in the wake of the subprime crisis, and the largest industry trade group is embarking on a public relations campaign to improve their image:
In memos of confidential meetings with top financial executives, the Securities Industry and Financial Markets Association said it began this month the “execution phase” of the operation, which pledges to “embrace change” and accountability. The plan targets policy makers and the media in New York, London, Washington and Brussels and calls for a “city-by-city, grass roots” approach.
The securities industry “must be perceived as part of the solution, which will allow it to better defend against populist overreaction,” the documents, prepared for a June 17 meeting of SIFMA’s board, said.
The board meeting minutes and staff-written papers, obtained by Bloomberg News, outline the program crafted by polling, lobbying and public relations companies paid at least $85,000 a month. The memos provide a glimpse, in often candid language, into how Wall Street is grappling with its pariah status.
“It is imperative that in this historic period of reform, the industry be recognized as playing a positive role in seeking change and providing solutions to the problems we face,” one of the documents said. “There is currently widespread skepticism about the industry’s commitment to this needed change.”[4]
The industry faces an uphill battle in their efforts to improve their image, and they need to be careful about how they address proposed regulatory reform to avoid undermining their own efforts to improve their relations with the public. Creating a separate consumer protection regulator was in the Treasury’s Blueprint for a Modernized Financial Regulatory Structure that was released in March of 2008, and has been in most recommendations for regulatory reform that I have read. I think the creation of this agency is inevitable, and the industry should stop fighting it and should focus on ensuring that it is created in a manner that would address their well placed and legitimate concerns.
The banks’ reaction reminds me of the NRA arguments for not banning assault rifles. The NRA was not in favor of putting assault rifles in the hands of the public, but was afraid that such a ban would lead to further restrictions in firearm ownership. I believe this created a credibility problem for the NRA, just as I feel that the wholesale condemnation of a consumer protection agency by the financial services industry will further harm the public image of Wall Street.
What are your thoughts?
[1] Linda McGlasson, “Regulatory Reform reactions: ‘Ambitious’.” Bankinfosecurity.com, June 18, 2009.
[2] Erin Geiger Smith, “The End of Mandatory Arbitration?,” The Business Insider, June 22, 2009.
[3] Alison Vekshin, “U.S. Banks Fight Obama’s Consumer Agency to Protect Their Fees,” Bloomberg.com, June 25, 2009.
[4] Robert Schmidt, “Wall Street Begins Campaign to Thwart ‘Populist Overreaction’,” Bloomberg.com, June 25, 2009.
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