Senate Banking Committee Chairman Chris Dodd’s effort to house a new Consumer Financial Protection Agency under the Federal Reserve is fatally flawed. For the past two decades, the Fed has aligned itself with any policy that boosts short-term profits for America’s largest banks, regardless of the consequences for consumers or the broader economy. But even worse is Dodd’s effort to block the new agency from enforcing the rules it writes, leaving enforcement up to the same regulators who ignored rampant predation and outright fraud throughout the housing bubble.
The bank lobby and its boosters in the Republican Party have been targeting the CFPA since President Barack Obama proposed creating it in July. It’s easy to see why: for the first time, a regulatory agency would be concerned with protecting the public, rather than bank balance sheets. That’s good news for the economy, but bad news for quarterly earnings at major US banks. Republicans are doing anything they can to gut the proposal, and several back-lobby-backed Democrats are reluctant to push for a strong agency. But instead of forcing lawmakers to cast vote siding with the bankers, Dodd appears ready to let the agency die without even extracting a political pound of flesh.
If the new CFPA cannot enforce its own rules, it is effectively powerless. All the good rules in the world don’t amount to anything without strong enforcement, and the existing federal bank regulators–the Federal Reserve, the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OCC)–have proven time and again that they simply are not interested in enforcing consumer protection laws.
All of the major federal banking regulators were fully aware of the dangers of predatory mortgage lending well before the mortgage meltdown destroyed the financial system in 2008. In 1994, Congress gave the Fed power to police the entire mortgage market, from small specialty subprime shops to banking behemoths. As early as 2001, the Fed and other bank regulators issued a guidance warning about subprime loans. That guidance included simple, common-sense standards: make sure you can afford to make these loans, and watch out for predatory lending. The trouble is, as soon as these rules were issued, the Fed and fellow regulators developed a policy of actively looking the other way on abusive subprime lending. The rules were good. They simply decided not to enforce them.
The Fed identified three key aspects of predatory lending that it was would crack down on with its 2001 rules, including:
"Making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation;
Inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (‘loan flipping’); or
Engaging in fraud or deception to conceal the true nature of the loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower."
All three of these practices were rampant from at least 2004 through 2007, but the Fed, the OCC and the OTS ignored all of them. Everyone in the mortgage business began issuing loans based on the assumption that home prices would increase forever, ignoring pesky details like whether or not a borrower could afford the loan. Industry lobbyists don’t even dispute the point. Denise Leonard of the National Association of Mortgage Brokers admitted to Congress in April 2009 that, "Underwriting standards for mortgage loans were significantly relaxed and greater emphasis was placed on home valuation as opposed to other factors traditionally used to determine a borrower’s likelihood of repaying a loan."