Archives For financial regulation

Why the Federal Trade Commission (not the Consumer Financial Protection Bureau) Should Oversee Consumer Protection in Financial Markets

Alden Abbott —  8 March 2017

On February 28, the Heritage Foundation released Prosperity Unleashed:  Smarter Financial Regulation, a Report that lays bare the heavy and unnecessary burdens imposed on our economy by defective financial regulations, and proposed market-oriented regulatory reforms that would benefit American producers, consumers, and the overall economy.  In a recent Truth on the Market blog commentary, I summarized the key findings and recommendations set forth in the Report’s 23 chapters.  In this commentary, I explore in greater detail chapter 19 of the Report, “How Congress Should Protect Consumers’ Finances,” co-authored by George Mason University Foundation Professor of Law Todd J. Zywicki and me.

Chapter 19 makes the case for legislative reform that would eliminate the U.S. Consumer Financial Protection Bureau’s oversight of consumer protection in financial markets and transfer such authority to the U.S. Federal Trade Commission (key excerpts with footnote references omitted follow):

Free-market competition is key to the efficient provision of the goods and services that consumers desire. More generally, the free market promotes innovation and overall economic welfare. Imperfect information can, however, limit the ability of competition to be effective in benefiting consumers and the economy. In particular, inaccurate information about the quality and attributes of market offerings may lead consumers to make mistaken purchase decisions—in other words, consumers may not get what they think they bargained for. This will lead to the distrust of market processes, as sellers find it harder to differentiate themselves from their competition. The end result is less-effective competition, less consumer satisfaction, and lower economic welfare.

Fraudulent or deceptive statements regarding product or service attributes, and negative features of products or services that become evident only after sale, are prime examples of inaccurate information that undermines trust in competitive firms. Accordingly, the government has a legitimate role in seeking to curb fraud, deception, and related informational problems. Historically, the federal government’s primary consumer protection agency, the U.S. Federal Trade Commission (FTC), has taken the lead in bringing enforcement actions against businesses that distort markets by engaging in “deceptive” or “unfair” practices when marketing their offerings to consumers. In recent decades, the FTC has taken an economics-focused approach in these areas. Specifically, it has limited “deception prosecutions” to cases where consumers acting reasonably were misled and tangibly harmed, and “unfairness prosecutions” to situations involving consumer injury not outweighed by countervailing benefits (a cost-benefit approach). In other words, although the FTC may have erred from time to time in specific cases, its general approach has avoided government overreach and has been conducive to enhancing marketplace efficiency and consumer welfare.

However, Congress has not allowed the FTC to exercise economy-wide oversight over consumer protection, in general, and fraud and deception, in particular. For many years, a hodgepodge of different federal financial service regulators were empowered to regulate the practices of a wide variety of financial industry entities, with the FTC only empowered to oversee consumer financial protection with respect to the narrow category of “non-bank financial institutions.” As part of the 2010 Dodd–Frank financial reform legislation, Congress created a new Consumer Financial Protection Bureau (CFPB), loosely tied to the Federal Reserve Board. While Dodd–Frank mandated shared CFPB–FTC consumer protection jurisdiction over non-bank financial institutions, it transferred all other authority over the many separate consumer financial protection laws to the CFPB alone. The CFPB is simultaneously one of the most powerful and least-accountable regulatory bodies in United States history. In marked contrast to the FTC’s economics-based approach, the CFPB intervenes in financial market consumer-related practices in a heavy-handed arbitrary fashion that ignores sound economics. The upshot is that far from improving market efficiency, the CFPB reduces market efficiency, to the detriment of consumers, producers, and the overall economy. In short, the CFPB’s actions are a prime example of government failure.

The substantive powers of the CFPB are vast and ill-defined. The CFPB has power to regulate the terms and marketing of every consumer credit product in the economy. And, because many small businesses use personal credit to start and grow their businesses (such as personal credit cards, home equity lines of credit, and even products like auto title loans), the CFPB possesses substantial control over much of the allocation of small-business credit as well. The CFPB has the power to take enforcement and regulatory action against “unfair, deceptive, and abusive” consumer credit terms, an authority that the CFPB has exercised with gusto. Moreover, the CFPB has deliberately eschewed regulatory rule-making that would clarify these terms, preferring to engage in case-by-case enforcement actions that undermine predictability and chill vigorous competition and innovation. Yet despite the broad authority granted to the CFPB, its appetite is broader still: The CFPB has taken action to regulate products such as cellphone billing, for-profit career colleges, and even loans made by auto dealers (despite express jurisdictional limits in Dodd–Frank regarding the latter).

The consequences of this unchecked authority have been disastrous for consumers and the economy. Complicated rules with high compliance costs have choked off access to mortgages, credit cards, and other financial products. Overwhelmed by the costs and uncertainty of regulatory compliance, small banks have exited traditional lines of business, such as home mortgages, and feared entering new lines, such as small-dollar loans. Consistent with the general effects of Dodd–Frank, the CFPB has contributed to the consolidation of the American financial sector, making big banks bigger, and forcing consolidation of small banks. By imposing one-size-fits-all bureaucratic underwriting standards on community banks and credit unions, the CFPB has deprived these actors of their traditional model of relationship lending and intimate knowledge of their customers—their lone competitive advantage over megabanks.

Perhaps the most tragic element of the CFPB train wreck is the missed opportunity for reform that it represents. At the time of Dodd–Frank, the system of consumer financial protection was badly in need of modernization: The existing system was cumbersome, incoherent, and ineffective. Fragmented among multiple federal agencies with authority over different providers of financial services, the federal system lacked the ability to lay down a coherent regulatory regime that would promote competition, consumer choice, and consumer protection consistent with the realities of a 21st-century economy and technology. While there is little evidence that the financial crisis resulted from a breakdown of consumer financial protection (as opposed to safety and soundness issues), reform was timely. But Dodd–Frank squandered a once-in-a-generation opportunity to bring about real reform.

In this chapter, we briefly make the case that some degree of reform of the consumer financial protection system was appropriate, in particular, the consolidation of consumer financial protection in one federal agency. However, we challenge the apparatus constructed by Dodd–Frank that created a new unaccountable super-regulator with a tunnel vision focus on a narrow definition of “consumer protection.” Instead, we argue that existing substantive powers were largely sufficient to the task of consumer protection, and that Congress could have achieved better results by acting within the existing institutional framework by simply consolidating authority in the FTC. By working within the existing framework of long-standing substantive authorities and institutional arrangements, Congress could have provided the needed modernization of the federal consumer financial protection system without the unintended consequences that have resulted from the creation of the CFPB. . . .

Consolidating the powers granted to the CFPB in the FTC, which still retains certain regulatory responsibilities with respect to consumer finance, would have a number of advantages over the course chosen in Dodd–Frank.

First, the FTC is a multimember, bipartisan commission. This is an important improvement over the structure of the CFPB, which [is led by a single unaccountable director and] is neither an independent commission nor an executive agency. . . . 

[Second,] [t]he FTC [,unlike the CFPB,] is . . . subject to Congress’s appropriations process, an important check on the agency’s actions. . . .

Finally, the FTC has a large Bureau of Economics, staffed with academically trained economists who would be ideally suited to take into account the regulatory economic policy issues, discussed herein, to which the CFPB has paid no heed. This would make it far more likely that agency regulatory decisions affecting consumer credit markets would be taken in light of the effects of agency actions on consumer welfare and the broader economy. . . .

[In conclusion,] [e]liminating the CFPB’s authority over consumer protection in financial services, and transferring such authority to the FTC, would greatly improve the current sorry state of affairs. Admittedly, the FTC is a less-than-perfect agency, and even a multimember-commission structure does not prevent institutional mistakes from being made and repeated by the majority. All in all, however, as an accountable institution, the FTC is far superior to the CFPB. Consolidating this authority with the FTC—where it should have been in the first place—will better allow free markets to promote innovation and overall economic welfare. Strengthening this legal framework to provide a single, clearly defined, properly limited set of rules will facilitate competition among financial firms, thus protecting consumers and providing them with better choices.

In federal trade commission, financial regulation , , ,
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The American Antitrust Institute Fruitlessly Searches for the Key to American Competitive Conditions under the Antitrust Lamppost

Alden Abbott —  5 October 2016

On September 28, the American Antitrust Institute released a report (“AAI Report”) on the state of U.S. antitrust policy, provocatively entitled “A National Competition Policy:  Unpacking the Problem of Declining Competition and Setting Priorities for Moving Forward.”  Although the AAI Report contains some valuable suggestions, in important ways it reminds one of the drunkard who seeks his (or her) lost key under the nearest lamppost.  What it requires is greater sobriety and a broader vision of the problems that beset the American economy.

The AAI Report begins by asserting that “[n]ot since the first federal antitrust law was enacted over 120 years ago has there been the level of public concern over the concentration of economic and political power that we see today.”  Well, maybe, although I for one am not convinced.  The paper then states that “competition is now on the front pages, as concerns over rising concentration, extraordinary profits accruing to the top slice of corporations, slowing innovation, and widening income and wealth inequality have galvanized attention.”  It then goes on to call for a more aggressive federal antitrust enforcement policy, with particular attention paid to concentrated markets.  The implicit message is that dedicated antitrust enforcers during the Obama Administration, led by Federal Trade Commission Chairs Jonathan Leibowitz and Edith Ramirez, and Antitrust Division chiefs Christine Varney, Bill Baer, and Renata Hesse (Acting) have been laggard or asleep at the switch.  But where is the evidence for this?  I am unaware of any and the AAI doesn’t say.  Indeed, federal antitrust officials in the Obama Administration consistently have called for tough enforcement, and they have actively pursued vertical as well as horizontal conduct cases and novel theories of IP-antitrust liability.  Thus, the AAI Report’s contention that antitrust needs to be “reinvigorated” is unconvincing.

The AAI Report highlights three “symptoms” of declining competition:  (1) rising concentration, (2) higher profits to the few and slowing rates of start-up activity, and (3) widening income and wealth inequality.  But these concerns are not something that antitrust policy is designed to address.  Mergers that threaten to harm competition are within the purview of antitrust, but modern antitrust rightly focuses on the likely effects of such mergers, not on the mere fact that they may increase concentration.  Furthermore, antitrust assesses the effects of business agreements on the competitive process.  Antitrust does not ask whether business arrangements yield “unacceptably” high profits, or “overly low” rates of business formation, or “unacceptable” wealth and income inequality.  Indeed, antitrust is not well equipped to address such questions, nor does it possess the tools to “solve” them (even assuming they need to be solved).

In short, if American competition is indeed declining based on the symptoms flagged by the AAI Report, the key to the solution will not be found by searching under the antitrust policy lamppost for illumination.  Rather, a more thorough search, with the help of “common sense” flashlights, is warranted.

The search outside the antitrust spotlight is not, however, a difficult one.  Finding the explanation for lagging competitive conditions in the United States requires no great policy legerdemain, because sound published research already provides the answer.  And that answer centers on government failures, not private sector abuses.

Consider overregulation.  In its annual Red Tape Rising reports (see here for the latest one), the Heritage Foundation has documented the growing burden of federal regulation on the American economy.  Overregulation acts like an implicit tax on businesses and disincentivizes business start-ups.  Moreover, as regulatory requirements grow in complexity and burdensomeness, they increasingly place a premium on large size – only relatively larger businesses can better afford the fixed costs needed to establish regulatory compliance department than their smaller rivals.  Heritage Foundation Scholar Norbert Michel summarizes this phenomenon in his article Dodd-Frank and Glass-Steagall – ‘Consumer Protection for Billionaires’:

Even when it’s not by nefarious design, we end up with rules that favor the largest/best-funded firms over their smaller/less-well-funded competitors. Put differently, our massive regulatory state ends up keeping large firms’ competitors at bay.  The more detailed regulators try to be, the more complex the rules become. And the more complex the rules become, the smaller the number of people who really care. Hence, more complicated rules and regulations serve to protect existing firms from competition more than simple ones. All of this means consumers lose. They pay higher prices, they have fewer choices of financial products and services, and they pretty much end up with the same level of protection they’d have with a smaller regulatory state.

What’s worse, some of the most onerous regulatory schemes are explicitly designed to favor large competitors over small ones.  A prime example is financial services regulation, and, in particular, the rules adopted pursuant to the 2010 Dodd-Frank Act (other examples could readily be provided).  As a Heritage Foundation report explains (footnote citations omitted):

The [Dodd-Frank] act was largely intended to reduce the risk of a major bank failure, but the regulatory burden is crippling community banks (which played little role in the financial crisis). According to Harvard University researchers Marshall Lux and Robert Greene, small banks’ share of U.S. commercial banking assets declined nearly twice as much since the second quarter of 2010—around the time of Dodd–Frank’s passage—as occurred between 2006 and 2010. Their share currently stands at just 22 percent, down from 41 percent in 1994.

The increased consolidation rate is driven by regulatory economies of scale—larger banks are better suited to handle increased regulatory burdens than are smaller banks, causing the average costs of community banks to rise. The decline in small bank assets spells trouble for their primary customer base—small business loans and those seeking residential mortgages.

Ironically, Dodd–Frank proponents pushed for the law as necessary to rein in the big banks and Wall Street. In fact, the regulations are giving the largest companies a competitive advantage over smaller enterprises—the opposite outcome sought by Senator Christopher Dodd (D–CT), Representative Barney Frank (D–MA), and their allies. As Goldman Sachs CEO Lloyd Blankfein recently explained: “More intense regulatory and technology requirements have raised the barriers to entry higher than at any other time in modern history. This is an expensive business to be in, if you don’t have the market share in scale.”

In sum, as Dodd-Frank and other regulatory programs illustrate, large government rulemaking schemes often are designed to favor large and wealthy well-connected rent-seekers at the expense of smaller and more dynamic competitors.

More generally, as Heritage Foundation President Jim DeMint and Heritage Action for America CEO Mike Needham have emphasized, well-connected businesses use lobbying and inside influence to benefit themselves by having government enact special subsidies, bailouts and complex regulations, including special tax preferences. Those special preferences undermine competition on the merits by firms that lack insider status, to the public detriment.  Relatedly, the hideously complex system of American business taxation, which features the highest corporate tax rates in the developed world (which can better be manipulated by very large corporate players), depresses wages and is a serious drag on the American economy, as shown by Heritage Foundation scholars Curtis Dubay and David Burton.  In a similar vein, David Burton testified before Congress in 2015 on how the various excesses of the American regulatory state (including bad tax, health care, immigration, and other regulatory policies, combined with an overly costly legal system) undermine U.S. entrepreneurship (see here).

In other words, special subsidies, regulations, and tax and regulatory programs for the well-connected are part and parcel of crony capitalism, which (1) favors large businesses, tending to raise concentration; (2) confers higher profits on the well-connected while discouraging small business entrepreneurship; and (3) promotes income and wealth inequality, with the greatest returns going to the wealthiest government cronies who know best how to play the Washington “rent seeking game.”  Unfortunately, crony capitalism has grown like topsy during the Obama Administration.

Accordingly, I would counsel AAI to turn its scholarly gaze away from antitrust and toward the true source of the American competitive ailments it spotlights:  crony capitalism enabled by the growth of big government special interest programs and increasingly costly regulatory schemes.  Let’s see if AAI takes my advice.

In antitrust, economics, regulation , , ,
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The Constitutionally-Challenged Consumer Financial Protection Bureau (CFPB) Now Directly Challenges the Lawful and Welfare-Enhancing Pay-Day Lending Industry

Alden Abbott —  6 June 2016

The Consumer Financial Protection Bureau (CFPB) is, to say the least, a controversial agency.  As documented by such experts as Scalia Law School Professor Todd Zywicki, the CFPB imposes enormous costs on consumers and financial service providers through costly and unwarranted command-and-control regulation.  Furthermore, as I explained in a February 2016 Heritage Foundation legal memorandum, the CFPB’s exemption from the oversight constraints that apply to other federal agencies offends the separation of powers and thus raises serious constitutional problems.  (Indeed, a federal district court in the District of Columbia is currently entertaining a challenge to the Bureau’s constitutionality.)

Given its freedom from normal constitutionally-mandated supervision, the CFPB’s willingness to take sweeping and arguably arbitrary actions is perhaps not surprising.  Nevertheless, even by its own standards, the Bureau’s latest initiative is particularly egregious.  Specifically, on June 2, 2016, the CFPB issued a “Notice of Proposed Rulemaking on Payday, Vehicle Title, and Certain High-Cost Installment Loans” (CFPB NPRM) setting forth a set of requirements that would effectively put “payday loan” companies out of business.  (The U.S. Government has already unjustifiably harmed payday lenders through “Operation Choke Point,” pursuant to which federal bank regulators, in particular the Federal Deposit Insurance Corporation (FDIC), have sought to deny those lenders access to banking services.  A Heritage Foundation overview of Operation Choke Point and a call for its elimination may be found here; the harm the FDIC has imposed on payday lenders is detailed here.)

The CFPB defines a “payday loan” as “a short-term loan, generally for $500 or less, that is typically due on your next payday. . . .  [The borrower] must give lenders access to . . . [his or her] checking account or write a check for the full balance in advance that the lender has an option of depositing when the loan comes due.”  Moreover, payday loans are often structured to be paid off in one lump-sum payment, but interest-only payments – “renewals” or “rollovers” – are not unusual. In some cases, payday loans may be structured so that they are repayable in installments over a longer period of time.”

Despite their unusual character, economic analysis reveals that payday loans efficiently serve the needs of a certain class of borrower and that welfare is reduced if government seeks to sharply limit them.  In a 2009 study, Professor Zywicki summarized key research findings:

Economic research strongly supports two basic conclusions about payday lending:  First, those who use payday lending do so because they have to, not because they want to.  They use payday lending to deal with short-term exigencies and a lack of access to payday loans would likely cause them substantial cost and personal difficulty, such as bounced checks, disconnected utilities, or lack of funds for emergencies such as medical expenses or car repairs. Those who use payday loans have limited alternative sources of credit, such as pawn shops, bank overdraft protection, credit card cash advances (where available), and informal lenders. Although expensive, payday loans are less expensive than available alternatives. Misguided paternalistic regulation that deprives consumers of access to payday loans would likely force many of them to turn to even more expensive lenders or to do without emergency funds. Although payday loans may lead some consumers to be trapped in a “debt trap” of repeated revolving debt, this concern is not unique to payday lending. Moreover, evidence indicates that those who are led into a debt trap by payday lending are far fewer in number than those who are benefited by access to payday loans.

Second, efforts by legislators to regulate the terms of small consumer loans (such as by imposing price caps on fees or limitations on repeated use “rollovers”) almost invariably produce negative unintended consequences that vastly exceed any social benefits gained from the legislation. Moreover, prior studies of price caps on lending have found that low-income and minority borrowers are most negatively affected by the regulations and the adjustments that they produce. Volumes of economic theory and empirical analysis indicate that further restrictions on payday lending likely would prove counterproductive and harmful to the very people such restrictions would be intended to help.

Unfortunately, the CFPB seems to be oblivious to these findings on payday lending, as demonstrated by key language of the CFPB NPRM:

[T]he [CFPB’s] proposal would identify it as an abusive and unfair practice for a lender to make a covered loan without reasonably determining that the consumer has the ability to repay the loan.  The proposal generally would require that, before making a covered loan, a lender must reasonably determine that the consumer has the ability to repay the loan.  The proposal also would impose certain restrictions on making covered loans when a consumer has or recently had certain outstanding loans. . . .  The proposal also would identify it as an unfair and abusive practice to attempt to withdraw payment from a consumer’s account for a covered loan after two consecutive payment attempts have failed, unless the lender obtains the consumer’s new and specific authorization to make further withdrawals from the account. The proposal would require lenders to provide certain notices to the consumer before attempting to withdraw payment for a covered loan from the consumer’s account. The proposal would also prescribe processes and criteria for registration of information systems, and requirements for furnishing loan information to and obtaining consumer reports from those registered information systems. The Bureau is proposing to adopt official interpretations to the proposed regulation.

In short, the CFPB NPRM, if implemented, would impose new and onerous costs on payday lenders with respect to each loan, arising out of:  (1) determination of the borrower’s ability to pay; (2) identification of the borrower’s other outstanding loans; (3) the practical inability to recover required payments from a defaulting consumer’s account (due to required consumer authorization and notice obligations); and (4) the registration of information systems and requirements for obtaining various sorts of consumer information from those systems.  In the aggregate, these costs would likely make a large number of payday loan programs unprofitable – thereby (1) driving those loans out of the market and harming legitimate lenders while also (2) denying credit to, and thereby reducing the welfare of, the consumers who would be denied their best feasible source of credit.

As Heritage Foundation scholar Norbert Michel put it in a June 2, 2016 Daily Signal article:

The CFPB’s [NPRM] regulatory solution . . . centers on an absurd concept: ability to repay. Basically, the new rules force lenders to certify that consumers have the ability to repay their loan, turning the idea of voluntary exchange on its head.

Here, too, the new rules are based on the flawed idea that firms typically seek out consumers who can’t possibly pay what they owe. It doesn’t take a graduate degree to figure out that’s not a viable long-term business strategy.

None of this matters to the CFPB. Shockingly, neither does the CFPB’s own evidence.

In sum, the CFPB NPRM provides yet one more good reason for Congress to seriously consider abolishing the CFPB (legislation introduced by the House and Senate in 2015 would do this), with consumer protection authority authorities currently exercised by the Bureau returned to the seven agencies that originally administered them.   While we are awaiting congressional action, however, the CFPB would be well-advised (assuming it truly desires to promote economic welfare) to reconsider its latest ill-considered initiative and withdraw the NPRM as soon as possible.

In consumer financial protection bureau, financial regulation, truth on the market ,
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Politically-Mandated Credit Card Interchange Fees Won’t Create Jobs (But They Will Hurt Consumers and the Economy)

Geoffrey Manne —  20 March 2010

by Geoffrey A. Manne, Joshua D. Wright and Todd J. Zywicki

Cross-posted at Business in the Beltway (at Forbes.com) and The Volokh Conspiracy.

In a recent commentary at Forbes.com, former Clinton administration economist Robert Shapiro argues that some 250,000 jobs would be created, and consumers would save $27 billion annually, by reducing the interchange fee charged to merchants for transactions made by consumers using credit and debit cards.  If true, these are some incredible numbers.

But incredible is indeed the correct characterization for his calculations.  Shapiro’s claims, based on a recent study he co-authored, rest on tendentious accounting, questionable assumptions, and—most crucially—a misunderstanding of the economics of interchange fees.  Political price caps on interchange fees won’t help the economy or create jobs—but they will make consumers poorer.

First, Shapiro estimates the employment impact of a redistribution of fees using the same stimulus multiplier that the Obama administration uses to tout the effect of its stimulus package.  But it is completely inappropriate to simply “plug in” the multiplier for government stimulus to calculate the effect of a reduction of interchange fees —unless the interchange fees currently paid to banks somehow simply disappear from the economy, contributing nothing to job creation, lowering the cost of capital, or increasing access to credit.  Even assuming that some portion of the fees are pure profit for card issuers, those profits must be paid out to shareholders or employees, invested, or used to bolster bank balance sheets (which provides capital for lending).  So, unlike the stimulus, this is at best merely a politically-mandated wealth (and employment) redistribution from card issuers to merchants, and any calculation of apparent economic gain must be offset by a similar calculation of loss on the other side.  Having ignored this offset, Shapiro’s conclusions are completely untenable.

But Shapiro also misunderstands the economics of payment card networks and the role of the interchange fee within them.  For example, Shapiro estimates that 70% of merchant savings from reduced interchange fees would be passed on to consumers in the form of lower retail prices.  But that is pure speculation.  In Australia, where regulators imposed price controls on interchange in 2003, fees paid by merchants have fallen but consumers have seen no reduction in the prices that they pay.  And where merchants have been permitted to impose surcharges on credit users, the surcharge can, and often does, substantially exceed the interchange fee cost.  It is not for nothing that merchants have spent millions trying to push interchange fee regulation through Congress.

In addition, Shapiro suggests that interchange fees are excessive in light of the “transaction and processing costs of using credit and debit cards.”  But his estimation of these costs is dramatically off-base.  Not only does he appear to exclude the cost of the delay between the time merchants receive payment (almost immediately) and when consumers pay their bills (at the end of a billing cycle), he ignores what may be the most significant single cost of consumer credit operations (and corresponding benefit to merchants): the cost of credit loss. Continue Reading…

In business, credit cards, economics, financial regulation, law and economics, markets, personal finance, politics , , , , , ,
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