July/August 2012 Too Important to Fail

Predatory lending still poses a systemic risk to the economy. Will Obama's new Consumer Financial Protection Bureau succeed in taming it, or will the agency be strangled in its crib?

By John Gravois

Date’s route to the CFPB began one day in the summer of 2006, when, in the course of researching some financial institutions that Capital One had recently acquired, he gave himself a crash course on the basics of the mortgage market of the time. And the basics were horrifying. “I flipped out. I completely flipped out,” he recalls. “The entire market was making fanciful credit decisions.” Date became so convinced that American finance was on the verge of collapse that he quit his job and sold his house. But rather than run for the hills, he went to work for Deutsche Bank on Wall Street—expressly to help banks raise capital as a buffer against the coming calamity. Then, after being paid well to raise those alarms, he left finance and turned full time to advocating for reform.

When I first met Date, he was sitting in his office at the bureau—a bare room little bigger than a supply closet, with a single small window looking out on the brick wall of an adjacent building. With a sheepish grin, he handed me a piece of gum, apologizing that he had nothing else to offer. He had taken a 95 percent pay cut from his last paying job, but he brimmed with the pride of an institution builder. “I’ve got little toddlers, so I’m very attentive to the fact that toddlers learn bad habits very quickly, and they learn good habits very quickly. The same thing is true with institutions,” he said. “We have tried to be intentional about baking in good habits.” (One policy Date carried over from Capital One is a rule that all executives must spend some time every month manning the consumer help lines.)

But, of course, the start-up phase of any institution’s life cycle—when major decisions are made in hallways, aspirations are grand and abstract, and the boss sits in a glorified closet—is an ephemeral thing. Already, the consumer bureau has had to choose its battles, raising the ire of consumer advocates recently, for example, by allowing credit card companies to exploit a loophole in the CARD Act by charging large signup fees. And it remains to be seen how the bureau will strike what is likely to be a tricky balance between its two most important mandates—to protect consumers and, at the same time, foster access to financial services. If the bureau focuses exclusively on protecting consumers by cracking down on abusive products, it could limit access to credit; if it focuses too much on expanding access, it could just give cover for driving more Americans into debt and the arms of a powerful financial sector. And it will doubtless be lobbied heavily in both directions.

So the question is: Over the long run (assuming the CFPB has a long run), why should we believe that the bureau will succeed in protecting consumers where other regulators have failed? Why, in other words, is it any less likely to become captive to the interests of the complex, powerful, and deep-pocketed industry it regulates?

This spring, the CFPB began moving out of its rented start-up digs and into its permanent headquarters—an address whose pedigree is enough to cause a shudder among those who know the recent history of financial regulation. The bureau’s employees now come to work at a high-Brutalist concrete and glass structure just a block from the White House, at the intersection of 17th and G streets, a building that, before the crash, served as the headquarters of the now-defunct Office of Thrift Supervision—former regulator to the subprime giants Washington Mutual and Countrywide.

The OTS, in its day, had jurisdiction over federally chartered savings-and-loan associations, or thrifts, and derived its funding from a system of fees: basically, any institution that was regulated by the agency paid dues to the agency. After a period of aggressive oversight in the early 1990s, bureaucrats at the OTS began to realize that they were eating away at their own revenue by closing runaway thrifts. And so, over time, the agency came to rely on a rather different strategy: hustling for new business. The OTS sent its agents out to the highways, byways, and boardrooms of America, trying to convince banks and other financial entities to change their charters and become thrifts, on the promise that the OTS would regulate them with a lighter hand than other federal agencies. This practice, and the consequent ability of firms to shop for the most congenial overseer, is known as “regulatory arbitrage.”

Experts often describe the run-up to the financial crisis as a “race to the bottom.” In reality it was a veritable track-and-field meet of such contests: some of them played out in the marketplace, others inside the government. Out in the financial marketplace, in the 2000s, opaquely marketed subprime products pioneered by unregulated, fly-by-night, nonbank mortgage lenders began to take off in the mainstream. Much as in the credit card business—where the boldly marketed 4.9 percent teaser rate masks the 18.9 percent rate that will eventually kick in—these were often mortgages that masked exploding costs down the line. Banks and thrifts, in order to hold their own, had to jump in with similar products, lest their plain-Jane fixed-rate mortgages look expensive by comparison. In market after market, hiding the true costs and risks of a product became a requirement for survival. And as lenders began to compete with each other on lack of transparency, regulators competed on laxity of oversight. The rest, as they say, is history.

Years later, when it was announced that the CFPB would take over the retired OTS building, some bureau staffers joked about holding an exorcism. In a sense, that’s just what the architects of the CFPB set out to do in designing the bureau’s institutional structure. “The bureau,” says the Harvard political scientist Daniel Carpenter, “is probably the first modern agency designed from the ground up with an eye to preventing regulatory capture and preserving autonomy.”

For example, the bureau’s jurisdiction covers the entire waterfront of consumer financial products and transactions—whether they involve banks, thrifts, payday loan shops, nonbank mortgage lenders, credit unions, debt collectors, student lenders, credit reporting services like Equifax, or something else. By regulating a sweeping array of institutions that have divergent, even fiercely competing interests, the bureau ensures that its interests are less likely to line up with any one segment of the industry. “They’d have to be captured by the entire financial system,” says Ed Mierzwinski, the consumer program director at the Public Interest Research Group. “Those guys will play against each other.” This commanding view of the market should also allow the bureau to level the playing field, taking away the advantages that once flowed to unregulated institutions—the nonbank players that served as nurseries for the predatory practices that eventually swept the market.

John Gravois is an editor of the Washington Monthly.


  • paul on July 09, 2012 1:30 PM:

    The other week I was reading some century-old novel from Gutenberg, in which the hero, a munitions manufacturer (!) decides that he's not going to gouge the government for a huge set of emergency war orders. Instead, he's going to take "only a banker's profit."

    That's what commodity businesses where customers know exactly what they're buying ultimately come down to: small, consistent profits. Exactly the opposite of the financial industry today.

  • kay sieverding on July 14, 2012 11:29 AM:

    I don't understand why no one is talking about modifying the 1948 McCarran Ferguson Act. It prohibits federal regulation of insurance.

    Even if the McCarran Ferguson is allowed to stand, the feds should step in when the states fail to regulate insurance.

    Look at this insurance company. It claims to be a Bermuda company and claims to sell insurance across the U.S. It's not listed on the website of the National Association of Insurance Commissioners


    Look at Colorado Intergovernmental Risksharing Agency. Here's a blog I wrote about CIRSA


    Now the State of Colorado links to the NAIC. Previously they listed TIG as active and selling health insurance. The phone number listed was a residential cell phone and the address listed was a private home.

    There are other examples. If you look at state insurance websites you will see that they list out of state insurers. But the states where they are listed as being based in won't have records of them. Often the names are changed slightly too indicating that legally they aren't the same company.

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