American Enterprise Institute

November 28, 2006

[Edited transcript from audio tapes]

2:00 p.m.	Panelists:	Brian P. Brooks, O’Melveny & Myers LLP
		Thomas W. Merrill, Columbia University Law School
		Amy Quester, Center for Responsible Lending
		Todd Zywicki, George Mason University Law School
	Moderator:	Ted Frank, AEI
4:00	Adjournment

Proceedings:

TED FRANK:  Welcome to AEI.  We have a great panel here today.  Watters v. Wachovia itself is a fascinating Supreme Court case that will be argued tomorrow.  It arose because of a change of regulations in the National Bank Act, at which point a subsidiary of Wachovia bank told the State of Michigan that it no longer felt that it needed to be regulated by Michigan, that the decisions of the Office of the Comptroller of the Currency (the OCC) preempted state regulation of their mortgage practices in the state of Michigan.  Michigan protested, so Wachovia sued in Federal Court [to try to get] a decision [saying] that it did not have to be regulated by the State of Michigan. 

The district court, and then, on appeal, the Sixth Circuit Court of Appeals, held that indeed the federal decision did preempt the state regulation.  It granted something called Chevron deference to the agencies’ interpretation of the National Bank Act.  We will be getting into what Chevron deference is here on the panel.  And as a result, the commissioner of the Michigan Office of Insurance and Financial Services went to Watters to appeal to the Supreme Court.  I will not embarrass her by pointing her out in the audience.

The Supreme Court did take the case, and a lot of people have filed briefs seeking a hearing on these issues.  It raises a lot of important issues, not just on the National Bank Act and deregulation of banks in the federal economy and the public policy questions that that raises, but also the relationship between the federal ¬government and the states, and even under the 10th Amendment and just in general, the public policy questions that raises.  And for those of you who are psychologically troubled like me, [it] also [raises] interesting questions of administrative law and the deference that courts give to administrative agency decisions on the question of preemption, which has interesting public policy implications once again because of recent news by administrative agencies such as the FDA, the Food and Drug Administration, and the National Highway Traffic Safety Administration (NHTSA) to preempt state law through federal regulations. 

I’ll start with our first speaker.  Brian P. Brooks is a partner in the Washington, D.C., Office of O’Melveny & Myers.  He represents financial services organizations across the country in a variety of class actions.  He is a member of the American Law Institute and its consultative group on the principles of aggregate litigation.  He serves as the Chair of the Federal Society’s Class Action Committee and editor of its Bulletin Class Action Watch.  He is also a faculty of the Practicing Law Institute’s Consumer Financial Services Litigation Institute and frequently speaks on topics like today’s.  Mr. Brooks.

BRIAN P. BROOKS:  Thank you very much for that gracious introduction. 

You know you have to ask yourselves, why would 60 people come into a room on a work day to talk about operating subsidiary preemption.  There has to be something else going on.  And it occurred to me as I reflected on today’s topic that what is going on must be something more than a nuanced interpretation of whether preemption applies to operating subsidiaries under a new OCC regulation, and what could that be? 

Here is what I concluded.  What I concluded is that this Watters v. Wachovia case is round two, or maybe it is round 20, depending on your point of view, of a debate that goes all the way back to Alexander Hamilton vs. Thomas Jefferson having to do with the first bank of the United States in 1791.  There is an inherent, long-standing, and, I might say, populist suspicion, of federally created corporations that have the power to ignore state law.  One reason for that is that it calls into question our assumptions and beliefs about our federalist structure in America, and certainly people of my political point of view have very serious questions about how and when state law ought to be preempted.  But the bottom line is that something more, I think, is going on here in Watters v. Wachovia than just a question about operating subsidiaries. 

What I also think is that this debate is part of a larger populist strategy on the part of state politicians to attack the broader idea of national banking more generally.  I say that not to be provocative, although someone once taught me that when you are on television you should always be provocative.  I say that because there are other simultaneously filed actions out there by other state regulators in the country that do not involve operating subsidiaries. 

The most famous was the lawsuit brought by New York Attorney General Eliot Spitzer - I should not say lawsuit: the series of subpoenas that were served by Spitzer commencing investigations against the variety of large national banks - not operating subsidiaries, but national banks - over their compliance with their lending laws back in 2005.  This represented a fundamental breach of faith in the banking community.  The OCC filed its own affirmative lawsuit in the Southern District of New York to enjoin that investigation, which was not focused on the technical issue of operating subsidiaries, but said that the federally chartered banks themselves had to submit to the state oversight in connection with their fair lending compliance.  So, I think something more is going on here, ladies and gentlemen, and just the issue that is technically represented in Watters. 

But all that said, let me take a few moments to talk a little bit about what we in the financial services community see in terms of the actual legal issues presented.  And then let me conclude by talking just for a moment about what I think the underlying consumer protection themes are that really are the reason for the populist and political outcry over issues of banking preemption. 

Let me start with the legal question.  I’m just going to venture a guess about the outcome of the cases being argued tomorrow.  My guess is going to be the OCC and Wachovia are going to prevail, and they are going to prevail nine-zero, and it is not even going to be a debate.  Okay, that will be my provocative prediction, and here is why I say that.  There are really two issues going on legally in the case.  One has to do with preemption and the other has to do with deference.

Let me unpack those concepts a little bit.  The concept of preemption, as all the lawyers in the room know and most of the non-lawyers will know as well, says that where federal law takes a position on an issue, state law has to give way under the supremacy clause of the constitution.  After all, federal law is the supreme law of the land under our constitution.  Now when you look at the Supreme Court’s history of looking at banking preemption, you will have a very hard time finding the case where the Supreme Court has declined to find that federal banking law preempts contrary state law. 

Let me just tick off a handful of cases.  In 2003, for example, the last time the Supreme Court really looked at the specific question of National Bank Act preemption, the court held that the National Bank Act preempts state usury laws in the Beneficial v. Anderson case.  In 1996, the Supreme Court looked at National Bank Act preemption.  It found that the federal law preempts the state laws that limit the amount of late fees that can be charged on credit card balances.  In 1982, the Supreme Court held that regulations under the Homeowners Loan Act, which was a statute patterned after the National Bank Act and designed to govern thrifts instead of banks, the Supreme Court held that that statute preempts state laws that limit the enforceability of due-on-sale clauses in mortgages.  In 1978, the Supreme Court had another decision, finding that the National Bank Act prohibited certain state usury laws, and I could go on but the bottom line is you can trace this pattern all the way back to 1819 when the great Chief Justice Marshall wrote McCulloch v. Maryland.  The Supreme Court has routinely and almost universally, whenever it was put forth, whatever the context, recognized the preemptive power of federal banking law over state law to the contrary. 

The reason for that, as I said at the beginning, flows from the outcome of the Hamilton–Jefferson debate, which Hamilton won, for good or ill, and that was that we would have a national economy and that the federal government would be empowered to charter financial institutions without regard to entry barriers and other regulations put forth at the state level.  That is the preemption issue. 

Now I said there was a second issue having to do with deference, and here is the way that issue comes into play; more about this in a moment.  The issue here is not whether the National Bank Act preempts.  As I say, I think even the state government community would concede that where it specifically speaks, the National Bank Act does have preemptive power.  But here, there is nothing in the National Bank Act itself that specifically results in preemption of a state licensing and registration requirements, such as that at issue in Michigan.  So here the issue has to do with a regulation promulgated by the OCC which charters and regulates national banks, which itself purports to have preemptive effect, and the question is should we defer to the OCC or was the OCC off on a frolic and detour when they promulgated these regulations several years ago.

Well, on this again, there is a very, very long history of Supreme Court precedent asking the question what deference is accorded to OCC interpretations.  I’m not saying these cases are all the same.  I’m not saying there is no distinction.  I’m just going to go out on a limb and make a prediction that because the Supreme Court has deferred to the OCC every time the question has been asked, it is probably going to do so tomorrow. 

Again, here is just a list of examples.  In 2004, the Supreme Court deferred to the Federal Reserve Board’s interpretation -- and the Federal Reserve is one of the four federal banking agencies -- of Federal Truth in Lending Laws to put down a consumer class action that challenged over-limit fees charged by credit card companies.  The industry won that case. 

In 1996, the Supreme Court deferred to an OCC interpretation, stating that late fees constitute interest for purposes of National Bank Act preemption.  In 1987, the Supreme Court deferred to the OCC interpretation of the National Bank Act in terms of permitting national banks to engage in discount brokerage operations.  In 1995, the OCC interpreted the statute as permitting banks to engage in the annuities brokerage business, and again the list goes on and on. 

I could go back virtually to the beginning of the comptroller’s office, but there is really no need.  The point is, case after case after case comes to the same conclusion.  The OCC gets deference.  The OCC is, in the Supreme Court’s eyes, one of the most well-respected regulatory agencies in the federal government.  And so, without even getting into a serious analysis I can predict with a fair amount of confidence who is going to win the case tomorrow. 

Having said all that, let me speak for a moment to the underlying substantive debate because it is complicated.  It is technical and it raises some important issues of public policy.  To me, the real question on the Watters case, the real nub of the debate turns on a statement that I think was best put in Professor Merrill’s brief as a friend of the court in the case.  Here is the statement.  The statement is, “The role of administrative agencies in resolving preemption questions has been a matter of considerable uncertainty, both for this court and the lower federal courts.”  That is the debate.  But with respect, I think that that statement is just not accurate.  I really do not think that there is considerable uncertainty about the role administrative agencies play in the world of preemption and here is why. 

First of all, the Supreme Court has specifically spoken to the question of whether agencies have the power to go beyond the Congress’ expressed delegation in an act and preemption regulations.  And what the court said in the famous case called New York v. FCC is this:  “A federal agency acting within the scope of its congressionally delegated authority may preempt state regulation and hence render unenforceable state or local laws” - here is the key – “that are otherwise not inconsistent with federal law.”  That are otherwise not inconsistent with federal law.  So the question of whether an agency has the power to go beyond to the question addressed by Congress and itself render a preemptive opinion is, I think, established in a case of at least 20 years provenance, New York v. FCC.  Now in the specific context of banking, even farther back in that position the Supreme Court decided in the Fidelity Federal Savings v. de la Cuesta case that the preemptive effect of an agency rule is the same as the preemptive effect of an act of Congress, even where Congress has said nothing about the preemptive effect of the underlying statute. 

And finally, every single lower court that has looked at the issue presented in Watters, and this issue has been looked at by at least four courts:  The Second Circuit, the Sixth Circuit, the Ninth Circuit, and the District of Maryland.  Every single court that looked at this issue has come to the same result, that the [agency] interpretation is entitled to deference and that [state law] is preempted.  And so in that light, it does not sound to me like there is a lot of considerable uncertainty on the question at all.

But despite all this, the basic legal argument that is going on here seems to be that the OCC was in some way acting outside of its authority when it promulgated its preemption regulation - these are the operating subsidiaries - and I think the argument goes on the plaintiff side here, on the state regulatory side, that the OCC was acting outside of its authority in two different ways. 

First, the argument is put forth that the OCC is clearly authorized to make substantive interpretations of banking laws.  But that is different from saying that it is authorized to make interpretations about the preemptive effect of either the banking laws or its own regulations.  This is the distinction that is made in Professor Merrill’s brief, which is very intriguing, and which I think will probably turn up to be the focal point of the debate in the court tomorrow. 

So the question is, is there a difference between an agency’s authority to interpret substantive law on the one hand and its authority to interpret the preemptive effect of that law on the other hand?  Again, a very interesting question but I think not subject to very much debate when one looks at the actual statutory enactments of Congress. 

In 1994, Congress passed the Riegle-Neal Act.  And in that Act, Congress enacted a statutory provision which is not discussed very much, but which I think answers this question about whether the OCC has authority to interpret not only the substance but also the preemptive effect of banking law.  The relevant provision of the Act says this: Before issuing any opinion letter or interpretative rule that concludes the federal law preempts the application to a national bank of any state law regarding consumer protection, fair lending, and some other things, the agency must comply with the notice and comment procedures of the administrative procedure act.  That statutory provision is meaningless if the OCC does not, in fact, have the power to render opinions and interpretations about the preemptive effect of laws that it is charged with carrying out.  I think that Riegle-Neal Act provision really may turn out to be the issue that is definitive tomorrow.  It is a geeky banking lawyer’s point, but it turns out to answer the argument. 

Now, the second way in which the proponents of state regulation contend that the OCC is off the reservation and outside of its jurisdictional authority is they say that the OCC may be authorized to preempt state law as applied to national banks but not to operating subsidiaries of those banks.  But again, that does not conform very well with the legislative record in Congress.  Here, Congress spoke to this issue in 1999 in the Gramm-Leach-Bliley Act, where Congress specifically recognized the OCC’s authority over something called financial subsidiaries.  And it also recognizes the substantive financial subsidiaries whose activities are limited to activities permissible to national banks, in other words, operating subsidiaries.  And Congress provided in Gramm-Leach-Bliley that those operating subsidiaries are “subject to the same terms and conditions that government conduct of the activities by a national bank.” 

So in short, while there are politically sensitive issues here and populist issues here, in the end I do not think the Supreme Court is going to find it particularly difficult or controversial.  My guess is that the reason the court took the case was not to resolve the split in authority, obviously, because there is no split.  It was not because there was uncertainty about the outcome, but it is instead because there is a major political human cry over the issue to wit, 30 state attorneys general filing support, filing briefs in support of the Michigan Department.  The issue has to be decided. 

Let me conclude, though, by making an observation on one related point.  Okay, that is the legal landscape.  Let me talk for a moment about the policy landscape, which I know my colleagues on the panel will talk more about.  The other strand of debate going on here on the Watters case is not really legal at all.  It is about this very simple policy question: is preemption the equivalent of no liability?  Does preemption equate to a get-out-of-jail free card for financial institutions?  And here, the consumer advocates clearly believe that state regulators are on the side of the angels and that federal regulators are in the pocket of the industry. 

The way that the Center for Responsible Lending’s brief puts the point is this:  “In the area of abusive mortgage lending practices alone, state banks supervisory agencies initiated 20,332 investigations in 2003 in response to consumer complaints, which resulted in 4,035 enforcement actions.”  By contrast, the same brief notes, “the OCC launched only eight losses,” and even I cannot deny that 4,035 is a lot bigger than eight.  But equating consumer protection with the number of lawsuits filed, I think, improperly conflates the concepts of enforcement -  which is what state attorneys general do very well - and supervision, which is really what the banking agencies do and do better. 

Enforcement is what we litigators are used to in the unregulated world here.  You have a client who does a lot of bad things for a lot of years, and then retrospectively somebody catches them in the act, and they haul them into court and they sue them for damages and they punish them with punitive damages and injunctions.  That is what enforcement does. 

The world of banks is very, very different from that.  Banks are subject to examinations; the large banks are subject to ongoing examinations with examiners onsite on the premises.  What happens in the bank examination world is that everyday there are operational personnel onsite at the bank who are reviewing the banks’ operating procedures, marketing practices and compliance with laws, including consumer protection laws.  Now in those cases, what typically happens, if my clients are any indication, is that on the day the bank is about to do something wrong, the examiner typically sees it and the examiner tells the bank that is not going to fly and the bank changes its process prophylactically. 

Now it is true that that turns out to be an ounce of prevention rather than a pound of cure.  It is true you do not get any headlines out of the examination process, but I think we can all agree that consumer protection is not accomplished by headlines; it is accomplished by ensuring reasonable practices on the part of the company.  And so it may well be that the OCC has only filed eight lawsuits.  That very well might be possible.  It may well be that state AGs have filed 4,000 lawsuits, but the number of lawsuits is not the measure of consumer protection.  The measure of consumer protection is the underlying processes which the OCC and other bank regulators look at everyday in real time, and I submit that is a better concept of consumer protection. 

MR. FRANK:  We turn now to Professor Tom Merrill, the Charles Keller Beekman Professor of Law at Columbia Law School.  He is a former Deputy Solicitor General in the Department of Justice and he has written numerous articles in journals and books.  With relevance to this case, he filed a brief on behalf of the Center for State Enforcement of Antitrust and Consumer Protection Laws.  Professor Merrill.

THOMAS MERRILL:  Thanks very much, Ted.  Unlike Brian, I’m not going to predict the outcome of the case tomorrow.  This case, like most cases that are argued in the Supreme Court, features learned briefs on both sides, which quite confidently state that the issues are absolutely clear.  There is no doubt about the outcome whatsoever.  But I think my position is that what makes this case particularly interesting and intriguing is precisely because it involves an issue as to which there is a great deal of un-clarity, and as to which the law is at a critical turning point right now.  This is really the front lines of the ongoing evolutionary struggle over the balance of power between the federal government and the states, and between the federal courts and the federal agencies, and the two of them meld together in this case to produce a particularly intriguing set of jurisprudential issues. 

What exactly is preemption?  Let us start with that that proposition.  Preemption is a rather extraordinary power that the federal government wields to essentially pull out a big gum eraser and wipe out state law in a particular area in which it would otherwise apply.  It is essentially the nullification or displacement of state law, but pursuant to federal authority.  The nullification takes place because of a judgment that is made that the application of state law would interfere with federal law or the policies that underlie federal law. 

Now it is often said, and the briefs in this case repeat this, that preemption is just really a matter of interpreting congressional intent.  It is just like ordinary statutory interpretation.  We are trying to figure out what Congress would really want with respect to the application of state law.  I do not think that is quite accurate. 

I think if you unpack what goes on in a preemption controversy, you will see that there are really three steps to the process.  First is you have to figure out what the federal law in question means.  There is often a dispute about exactly what federal law requires and does not require, and that federal law has to be interpreted.  Then there is a question about what state law means.  We have to figure out what the state law requires and whether that is different or in some tension with what the federal law requires.  And lastly, if there is some tension, we have to just make a sort of policy judgment about whether the degree of tension between state law and federal law is sufficiently great, so that it really is necessary to get out the gum eraser and wipe out state law in this particular instance. 

Now sometimes Congress actually resolves this question for us.  Those are the relatively few and happy cases where Congress steps up to the plate and says, “You know what, we think that state law really cannot apply in this area because that would be inconsistent with federal policy.”  But unfortunately, that does not happen all that often.  Even when Congress adopts expressed preemption clauses, frequently there are serious disputes about the scope of those clauses and what they mean, and I think it is inherent in the nature of the situation that Congress cannot resolve these questions itself.  After all, we have 50 different states and we have tens of thousands of municipal governments in this country and there is no way that Congress can anticipate in advance all the conflicts that are going to exist, or all the tensions that are going to exist between some enactment that is made.  It has not been implemented yet and the various varieties of state law that exists or that may come into existence in the future, so Congress is institutionally incapable of resolving preemption issues itself.  Somebody else has to resolve them ex post as they arise. 

And so that raises the question of which institution in society ought to be making these determinations of displacement of state law.  The two main candidates are either the federal judiciary or the federal agencies that have specialized expertise in particular areas.  Now in reality, I think that authority is shared.  I would agree with Brian that there are cases that uphold the agency’s power to preempt state law.  Those cases are not really at issue in the Watters decision, but the exact balance of authority between agencies and the federal courts is very much not resolved. 

Two points of reference I do think are relatively clear here and demarcate the terrain so that we can pinpoint where the controversy actually arises.  One point that I think is well established is that Congress can assign authority explicitly to some institution to decide when to displace state law.  It can tell the federal courts you have to decide this, or you can tell a federal agency you have to decide this.  There are some examples of federal statutes that explicitly delegate authority to agencies to make preemption decisions.  The Supreme Court seems to have indicated that that is permissible, although never quite directly so. 

The closest case is one that Brian referred to, called New York v. FCC, where the Supreme Court seemed to say that an agency had exercised authority to preempt state law in the past and Congress had reenacted the statute in the way that ratified that practice, and so therefore the court was willing to assume that the agency had what amounted to explicit authority to preempt state law.  Now if Congress does explicitly give an agency such authority, then I think the agency is entitled to the strongest degree of deference, the so-called Chevron deference which would uphold its determinations of preemption as long as there are ones that a reasonable person might adopt.  Not necessarily one the court would agree with, but one that a reasonable interpreter might adopt.  But this is not an issue in the Watters case.  No one claims that there is expressed authority to preempt in Watters. 

The other point of reference that I think is established, although some people would debate me on this, is that a statement of opinion by an agency about the need or desirability for preemption, which does not itself have the force of law, is not entitled to strong Chevron-type deference.  In such statements of agency opinion, which are increasingly common, particularly in preambles to regulations, agencies are increasingly saying, “You know what, we think that state law is preempted or state tort law is preempted if states tried to predicate liability on principles that are different from those articulated in our regulations.”  Those sorts of opinions are entitled to respectful consideration by a court, so-called Skidmore deference, to see whether or not they are persuasive but they are not entitled to the strong Chevron deference which is an issue in the Watters case.

So, those are the two points of reference that I think are clear.  Why do agencies not get Chevron deference if they just make an opinion about preemption?  Well, the answer comes because of some recent Supreme Court cases about the predicates for Chevron deference, namely that there has to be a delegation of authority to the agency, the act of the force of law, an agency has to be acting pursuant to that delegation of authority before it gets Chevron deference.  When an agency just says in the preamble or in some kind of interpretative ruling, “We think state law is preempted,” that is not entitled to Chevron deference under the Mead case and the Gonzalez v. Oregon case, which limit Chevron deference in that fashion. 

So what exactly is the ground of dispute in the Watters case?  The issue that Watters raises is whether an agency that has not been given specific authority to preempt state law, but which has been given general rule-making authority, exercises general rule-making authority to issue what purports to be a legislative rule that declares state law is preempted, is such a regulation entitled to Chevron deference the same way an agency ruling would be given if it had the explicit authority to preempt, or it is just entitled the Skidmore deference, the type of deference the agency would give if it is just offering its opinion about preemption but not acting with the force of law? 

This issue, I think, is an open question.  Brian says, and various briefs supporting the banks say, “Oh no, it is well established that agencies are going to issue these declarations of preemption.”  But I think if you look at the cases closely, they do not resolve this issue.  The case is they do give agencies deference on the meaning of the statutes they interpret, but when the crunch time comes, when the issue is whether there is enough tension between the law as interpreted by the agency and state law to warrant displacement of state law, the court has generally decided that issue on its own. 

New York v. FCC is the one outlier case that Brian quoted to you.  I would point out, however, that that case, although decided shortly after Chevron, does not even cite the Chevron decision, and that a number of years later in a case, that interestingly enough involves the banking laws, the Smiley decision, the Supreme Court expressly drew the distinction between the substantive meaning of the statute, as to which it applied Chevron, and the question whether a statute is preempted, where the court explicitly declined to apply Chevron.  In fact, the court said, “We may assume without deciding that the latter preemption question would always be decided de novo by the courts. 

So after the Smiley case was decided, in 1996, if you look at the Supreme Court’s decisions after Smiley in particular, you will see that that court is very wary about this issue of how much deference agencies get on preemption questions.  The court has surely given consideration to agency views and they have been discussing at some length and some of the opinions, but in no case has the court come out and said the agency is entitled to Chevron deference on the issue of whether or not the agency can issue a preemptive regulation, as opposed to just a substantive interpretation of federal law, which is one of the elements that goes into deciding the preemption question. 

I think the court is aware of the significance of this issue and has been reluctant to come down in support of Chevron because it intuits that that is probably not the right answer.  So what is the right answer?  I think it is a tough question and I think you can argue a number of points on both sides of the issue. 

There are a number of things to be said in favor of giving agencies significant weights in the preemption controversy.  Agencies typically have a very sophisticated understanding of the laws that they administer, much more sophisticated often than what the federal courts have.  And so the agency’s views about the meaning of federal statutes and their readings about the way state law interacts with federal statutes are surely entitled to significant consideration. 

Agencies have a lot of factual expertise.  Certainly they know what is going on out there in the real world and how applying two sets of law versus only one federal set of laws would impact the real world when the courts do not have the foggiest idea about what is going on. 

As I mentioned earlier, the preemption decision, I think properly considered, is basically a policy judgment.  It is not answered by Congress, for the most part.  It is a policy judgment about how much tension there is between federal and state law and whether that tension warrants displacement of the state law and we tend to think of agencies as being better suited to make policy judgments in courts most of the time, although cf. constitutional law.

And finally, it is conceivable in many cases that the states’ interest will be represented before agencies as much, or maybe more than they will be represented before Congress.  After all, if the agency uses notice-and-comment rule making to make a preemption determination, the agencies can participate in the notice-and-comment rule making and they can get to have their say, and the agency would have to respond to any objections that they raise to preemption. 

Those are strong arguments in favor of having the courts pay some attention to agency views, but there are some significant and I think even more significant arguments on the other side.  First of all, preemption, as it applies these days, is judge-made law.  We have a doctrine of preemption, it is a rather elaborate one.  I would not bother to recite it for you.  This was entirely the creation of the federal judiciary, particularly the US Supreme Court.  It is rather odd to have courts giving strong Chevron deference to agencies’ interpretations of a judge-made body of law.  If the law has been created by the federal judiciary, presumably, they are the ones that ought to interpret and elaborate that body of law, not turn it over to a federal agency to elaborate. 

Secondly, the states’ rights people have made this point and I think it can be lost in the debate: preemption implicates in a systemic fashion the balance of power between the federal governments and the state.  It is probably the most important issue that determines the balance of power between the federal government and the states.  Because it is this gum eraser that wipes out state law, it negates state authority whenever it applies and substitutes exclusive federal authority for the state’s authority.  That is a big deal.  Because the systemic federalism issue was presented, it seems that you need an institution that has a sort of systemic jurisdiction of being the institution that ultimately decides the contours of preemption doctrine. 

I think that institution has to be the federal courts, as I said earlier.  Congress really cannot do this because it cannot decide these cases like ex ante.  The agencies do not have the same breadth of view that the courts have.  Each agency has its own little backyard that it tends to, where it is very knowledgeable and has distinctive views about policy, but the agencies do not have any wide-angle perspective on what the overall balances between the federal governments and the states, and if any institution does, it is the federal judiciary that has that, so I think they need to have a strong role in the preemption issue. 

And lastly, I think preemption decisions, decisions to displace state law, profoundly implicate the scope of authority of federal agencies.  I’m guessing about this - it is probably not universally true - but probably most agencies are somewhat sympathetically inclined to the view that they - federal agencies - would have exclusive authority over a particular subject matter, and that they do not have to deal in competition with some state regulators.  That being the case, there is a built in tendency, I think, for federal agencies to be pro-preemption in their own little area, and hence, to try to expand their authority [into] the states’ own little area.  One of the reasons why we had judicial review of agency action is to try to keep agencies in their place, to keep them from having this sort of aggrandizing effect.  That counsels, I think, in favor of having federal courts decide preemption issues to a greater degree than deferring to agencies on these issues. 

So when I put all these factors together in my own line, the question is on the frontiers of dispute over these issues, and the correct analysis really is that the so-called Skidmore standard, the one that would give a respectful consideration to agency views but not compulsory deference, the way Chevron dictates, is the right standard review to apply here.  What does that mean for the Watters case?  Well, if the court agrees with me, maybe they would not even reach this issue, but if they were to agree with me, then they have to reverse because the Sixth Circuit relied four-square on Chevron and upheld the OCC interpretation of Federal Banking Law.  [So they] did not apply what I think is the correct standard of a review, and that means the case has to be reversed and sent back for reconsideration.  Thanks.

MR. FRANK:  Thank you, Professor.  Our next speaker, going down the panel: Amy Quester filed a brief [in this case] and is senior policy and litigation counselor at the Center for Responsible Lending, and I guess I should say that her brief was also on behalf of another dozen or so [organizations].  She is also an adjunct professor of law at Washington and Lee University School of Law.  Previously she was with the Federal Trade Commission, and the civil division of the United States Department of Justice.  She clerked for the Southern District of New York in the Second Circuit.  Ms. Quester.

AMY QUESTER:  Thanks, Ted.  My organization got involved in this case because we recognize the critical role that states play in protecting consumers.  The OCC rules that are at issue in the case before the court tomorrow present a huge threat to this historic state role.  The main rule that is at issue is the 2001 operating subsidiary preemption rule which states that unless otherwise provided by Federal law or by OCC regulation, state laws apply to national bank operating subsidiaries to the same extent that those laws apply to the parent national bank. 

Now in 2004, the OCC issued additional rules which expanded the scope of the OCC’s own authority over national banks and by extension over operating subsidiaries because of the 2001 rule.  The OCC also issued a series of preemption rules in 2004 in which it said that the National Bank Act preempted state laws that merely placed the condition or have more than an incidental effect on any National Bank Act powers.  So my view of the history of why we have all these cases, including the Spitzer case pending now, is a little bit different than Brian’s view, because I see this as an issue that the OCC brought to the table rather than the States. 

But the main point for today’s case or tomorrow case is that together the OCC’s 2001 and 2004 rules insulate national bank operating subsidiaries from the states in two important ways.  First of all, they immunize state-chartered operating subsidiaries from the reach of numerous state laws.  And secondly, they prevent state officials from enforcing even those state laws that the OCC concedes apply.  These rules would concentrate a huge amount of power in one federal agency and would prevent states from playing any meaningful role in overseeing operating subsidiaries that operate under their charters. 

Now this is a mistake in my view because states are generally more familiar, more accessible, more accountable to their constituencies, and more able to respond quickly to consumer issues as they emerge.  Like many consumer protection issues, mortgage lending, which is what is the issue in this case, has an obvious local dimension since real estate is inherently local and economic conditions can also, of course, be very localized.  States have a particular interest in responding to mortgage abuses because they can lead to neighborhood decline, lower property values, and higher rates of violent crime. 

States can also act as laboratories of experimentation in responding to consumer abuses, especially in the predatory lending context.  Last year Professor Baher Azmy published an article called “Squaring the Predatory Lending Circle” in which he laid out the argument for states operating as laboratories of experimentation, particularly in the predatory lending context.  Congress has repeatedly recognized the important role that States play here.  In enacting federal consumer protection and civil rights laws, Congress typically provides a floor, not a ceiling, and allows states to innovate above the floor that it has provided. 

States have done so in a number of ways, enacting for instance a number of laws that buttress, bolster, and shore up the weaknesses in the 1994 Homeownership and Equity Protection Act.  States have also been, as we pointed in our brief and as Brian mentioned, very active in enforcing and bringing law enforcement actions on behalf of consumers against financial institutions.  And to offer just one example, there was a recent settlement with Household International, which included $484 million in relief for consumers. 

Now the fifty states are able to bring formidable resources to bear when they tackle consumer protection issues, and they also bring considerable expertise.  Their broad expertise is particularly important in the context of operating subsidiaries because these operating subsidiaries, like the national banks that are their parents, have been authorized by the OCC to engage in a wide range of activities that range far afield from what we think of as traditional banking activities.  To give just one example, the OCC has approved operating subsidiaries acting as finders for used car sales.  Now this is not an area that one would expect the OCC to have particular expertise, but often, the states do have expertise in this type of activity.  In 2001, the State of Minnesota brought an action against the national bank operating subsidiary based on allegations of deceptive telemarketing practices.  In contrast to the state’s record, the OCC record on consumer protection, as we point out in our brief, is very weak.  This is not really surprising because the agency’s focus is really on safety and soundness, which is different in consumer protection. 

Now I appreciate Brian’s point that formal enforcement actions are not the whole story but they are very telling and they are the only information, unfortunately, that is publicly available and the only information that can serve as a deterrent to other banks and other operating subsidiaries.  For what it is worth, the OCC obviously thinks that formal enforcement actions are important, too, because it issues literally hundreds of them each year.  They are just generally not about consumer protection.  Even under the federal statutes that the OCC is charged with enforcing, the OCC has brought very, very few formal enforcement actions. 

For example, it took the agency more than a quarter century to bring its first action alleging unfair or deceptive practices by a national bank under its authority under the Federal Deposit Insurance Act and the FTC Act.  And in the 19-year period from 1987 to 2005, the OCC brought only four formal enforcement actions under the Equal Credit Opportunity Act.  Given its poor track record in enforcing federal statutes, it is very strange that the OCC now wants authority, exclusive authority, to enforce even non-preempted state laws.  And so that is the backdrop for the case in my view, and why I hope that Brian’s prediction about what is going to happen tomorrow is wrong. 

But as a legal matter, I think there are many reasons why the court should rule in Michigan’s favor, so let me just spell those out.  First of all, the statutory language that is at issue here is very clear.  The statutory provision that generally prevents state officials from exercising visitorial powers by its terms only applies to national banks.  That provision is 12 USC section 484A.  Now of course, Wachovia Mortgage, as an operating subsidiary, does not meet the definition for a national bank under the National Bank Act, and so it is not covered by Section 484A.  In adopting its 2001 operating subsidiary preemption rule, the OCC justified the rule by saying that operating subsidiaries have often been called the equivalent of a department or division of the parent bank, of their parent.  But that is totally inconsistent with basic notions of corporate law, which say an operating subsidiary is legally separate from its parent. 

Now although Section 484 A has been amended as recently as the 1980s, Congress has never seen fit to change the wording and add in operating subsidiaries.  By contrast, Section 481 of the National Bank Act broadly applies to affiliates and would, of course, cover an operating subsidiary.  The Supreme Court in Board of Governors v. Dimension Financial held that the Federal Reserve Board did not have power to extend its authority over banks to include certain non-banks that the board thought were the equivalent of banks. 

The same logic applies here to Section 484A.  Now the OCC and Wachovia have also pointed to the incidental powers provision in 12 USC Section 24-7, but that provision is not a license to rewrite Section 484A.  There is no dispute in this case that Wachovia Bank has the right to have operating subsidiaries.  But Michigan’s laws do not prohibit that.  The state laws that Wachovia is challenging are actually quite minimal.  Wachovia Mortgage is required to register, to pay fees, to submit financial statements and to retain certain documents for examination. 

The laws are set up to minimize the burden on the operating subsidiary.  For example, they permit Michigan to investigate a complaint only if the OCC is inadequately pursuing it.  And as Michigan notes in its reply brief, Wachovia Mortgage operated under these very same laws that it is now challenging for six years and has been unable to identify any significant way in which they impeded its functions.  Given this, the incidental power provision cannot bear the weight that Wachovia and its amici have placed upon it. 

Although Wachovia relies on a provision of the Gramm-Leach-Bliley Act as well, that provision was not an authorization of exclusive OCC control over state-chartered operating subsidiaries.  Rather, the provision was actually intended to curb the OCC because the OCC had adopted a rule in 1996 that permitted operating subsidiaries to engage in activities the national banks were not allowed to engage in.  The Gramm-Leach-Bliley Act forced the OCC to roll back that authorization while creating a new category of subsidiaries called financial subsidiaries.  So that language was clearly not intended to dramatically expand the OCC power, as Wachovia now claims. 

And finally just to note the Riegle-Neal provision that Brian mentioned cannot also be viewed as authorizing.  It was intended to restrict the OCC’s ability to take action in any preemptive action that the OCC would be taking [so that it] would have to be based on some authority that preceded Riegle-Neal.  It is also worth noting that the Riegle-Neal Act only refers to opinion letters and interpretive rules, which are not binding.  It does not refer to legislative rules. 

So in short, the plain statutory language shows that Congress intended to authorize exclusive visitorial powers over national banks, but not over their operating subs.  Now as Michigan explains in its brief, that conclusion is reinforced by the presumption against preemption and several other interpretive rules, like the clear statement rule and the constitutional doubt doctrine.  Wachovia claims that the presumption against preemption is not applicable because there has been a history here of a significant federal presence.  And in his remarks, Brian emphasized the federal role in banking regulation, but I think that Brian’s comments overlooked the fact that states have played a historic role in protecting consumers from national banks. 

As early as 1870, in National Bank v. Commonwealth, the Supreme Court held that national banks are subject to the laws of the state and are governed in our daily course of business far more by the laws of the state than that of the nation.  In 1996, the court, in its Barnett bank decision, reaffirmed that states have the power to regulate national banks, where doing so does not prevent or significantly interfere with the national bank’s exercise of its power.  And I would also note that here, we are not talking about national banks.  We are talking about operating subsidiaries.  Wachovia Mortgage is not even a bank, and it is certainly not a federal instrumentality.  States clearly have an interest in regulating the corporations that they charter and foreign corporations that do business within their boundaries.  And so Michigan, I think, has made a strong argument that there should be a presumption against preemption in this case. 

And even if the statutory language were not clear, I think there are a lot of reasons why this would not be an appropriate case for deference.  This is, first of all, not a circumstance where Congress has delegated authority to the agency to make the kind of preemptive determinations at issue here.  As Professor Merrill has pointed out, the authority that was granted in section 93a to the OCC is just to carry out the responsibilities of the office and that is akin to the authority that was at issue in the Gonzalez v. Oregon case that the Supreme Court decided earlier this year.  Moreover, as Professor Merrill makes clear, there are a lot of reasons why courts are better equipped to make preemption determinations than agencies.  One, of course, is that courts are better suited to interpret preemption case law than an agency is. 

The irony here is that in promulgating section 7.4006, which is the 2001 preemption rule, the OCC said that the rule reflects the conclusion we believe a federal court would reach even in the absence of the regulation pursuant to the supremacy clause and applicable judicial precedent.  So, what the OCC is now arguing is that the court should defer to its guess about what the court would do.

Another reason why courts are better equipped to make preemption determinations than agency is that these determinations, as Professor Merrill said, implicate the scope of an agency’s own power, so the agency may be self-interested in a way that a court would not be.  This is particularly a concern in this case because depository financial institutions in the United States have their choice of charter, and therefore their choice of regulator.  Due to this unusual financial system, financial institutions have the ability to select who is going to be regulating them and we believe that the OCC’s funding mechanism really compounds this problem because the OCC is funded by assessments from the banks it regulates.

I would finally note that even if the court finds ambiguity in the statute and rejects all of Michigan’s other arguments, deference would not make sense here because of the magnitude of the underlying issue.  Chevron was premised on the idea that Congress may have implicitly delegated authority to an agency when a statute is ambiguous.  But the courts in the past have recognized that notion may not be apt when the underlying issue is one of significant magnitude.  In our amicus, we alerted the court to the sweeping ramifications of the OCC’s rules have for consumers.  Not because we think that the court will be deciding what laws are best for consumers.  Instead, we wanted to make it clear to the court that Congress would not have implicitly delegated authority on a question of this significance to a self-interested agency. 

Thanks.

MR. FRANK:  Thank you, Amy.  Our next panelist, in addition to having a last name worth 78 scrabble points, has also filed a brief, but as an amicus rather than as a lawyer.  He is a professor of law at George Mason University School of Law, and a senior fellow at the James Buchanan Center’s Program on Politics, Philosophy, and Economics.  He is the former director of the Office of Policy Planning at the Federal Trade Commission.  He has written more than 50 articles in leading law reviews and peer-reviewed economics journals.  He is a contributor to the popular legal weblog, The Volokh Conspiracy, and is currently the chair of the Academic Advisory Council for the Bill of Rights Insitute.  Todd?

TODD ZYWICKI:  Thanks, Ted.  I want to thank the Competitive Enterprise Institute.  The brief that I filed with several other law professors and economists was written up by the Competitive Enterprise Institute, and I would like to recognize Sam Kazman from CEI who is here today. 

I'm going to talk about more of the policy questions here, starting with the policy of federalism and then talking about the policy of why preemption makes sense in cases like this, predicated on fundamental principles of federalism. 

Federalism is a philosophy of individual liberty, not a philosophy of state power.  Somewhere along the road of American constitution and history, it got converted into a theory of state power, but it is quite clear that federalism is a theory of individual liberty.  Along with separation of powers and many other sorts of things are referred to in the federalist papers as the auxiliary precautions in the constitution, it is a mechanism for individual liberty free markets and the like. 

And with respect to the kind of questions that are on the table here, especially banking, it is clear that these are the kind of questions that the framers had [showing] concerns about state governments run amuck.  We can look throughout the federalist papers, throughout the structure of the constitution; what we see is that more than anything else, the construction of the federal government was a mechanism to override and put the states back in their place for ill-advised and populist legislation that prospered under the Articles of Confederation. 

The constitution itself refers to, in many ways, issues that it cedes to the federal government that relate to these questions, whether it is questions of prohibiting paper money, which, of course, was a mechanism for undermining banks under the Articles of Confederation, the full faith and credit clause, the bankruptcy clause, which was primarily a creditor protection device, or the federal courts themselves, which were in mechanism to allow our creditors to get out of the home cooking of local state courts.  We see a profound concern about ill-advised populist legislation, as Brian refers to it. 

And more generally, there is nothing in the theory of federalism that suggests that it is efficient or rational for these kind of questions to be regulated by two layers of government, much less one.  The claim here is that there is room here for both layers of government, so Professor Merrill refers to this as a competition between the state and federal government, but it is anything but.  What it is as a piling on by the states of a federal regulatory scheme, and so instead of a competition, what you get is the worst of both worlds, which is a piling on of two layers of regulation instead of one. 

Keep in mind again that under the original constitution, there was really only one layer of regulation applied on these sorts of situations, which is either goods were in interstate commerce or not, and they were regulated by the states or by the federal government, but not both.  We did not have this concern of duplicative layers of regulation.  And as Brian noted, in McCulloch v. Maryland we see a pretty firm swatting back of the efforts of states to infringe upon federal prerogatives there, a case in many ways very similar to this one, which was an effort to tax the branches of the bank of the United States, and the Supreme Court said no.  This notion of dual banking system animated by these principles of federalism, I think, is well ensconced in the Supreme Court’s jurisprudence. 

I think the Fidelity Federal Savings Loan v. de la Cuesta case, which was previously mentioned, is a good example.  That case, too, dealt with the power of the Federal Home Loan Bank Board to preempt state prohibitions on due-on-sale clauses and mortgages of federally chartered savings and loan associations.  Again, here the backdrop is typical, which is as interest rates started rising in the late 70s and early 80s, populist state legislatures tried to nullify mortgage contracts that permitted due-on-sale clauses and the Federal Home Loan Bank Board intervened and said they should not be allowed to do that.  Congress had not given the board the power to preempt the state laws expressly, and so the question is whether or not it was a valid exercise of the board’s powers. 

The board there offered three reasons why preemption was necessary.  First, for the protection of financial security and the stability of federal savings and loans by making sure that the underlying loans were not unduly risky in light of the applicable loan terms that could be charged.  Secondly, that elimination of these important contract clauses would likely reduce the supply of capital available for mortgage lending and lead to an increase in interest rates and increased prices on other loan terms.  And third, a lack of consistency in state rules would clog the secondary market for loans by creating loans with heterogeneous loan terms, thereby interfering with interstate commerce in the efficiency of lending markets. 

The Supreme Court held there was a valid exercise of the board’s power and that the court would not second-guess the reasonable policy judgments of the board, that these ill-advised state regulations should be preempted.  Moreover, the majority in that case specifically rejected the protest and the dissent by Justices Rehnquist and Stevens who insisted that the board did not have the power to preempt state regulations that it thought were economically unsound; that was soundly rejected by the majority.  The majority noted in that case that rejecting the policy judgment of the states was precisely the reason why the Federal Home Loan Bank Board was set up in the first place. 

The Homeowner’s Loan Act was enacted in 1933 to address the situation of massive defaults and foreclosures on home loans occasioned by the Great Depression.  In that situation, the Great Depression, the state’s policy judgment had been to enable lenders to exercise their state contractual and foreclosure rights, which led to widespread foreclosures on home mortgages.  Congress set up the board to create an alternative set of rules, preempting state foreclosure rules and other regulations as they apply to federal savings and loans.  So the entire point was to override state laws and policy judgments in that situation, and so it followed directly that the board was empowered to preempt state laws, barring due-on-sales clauses because of the harm that they do would bring about for the lenders, consumers, the banking system, and the interstate commerce system.  The dual banking system in general operates on that premise. 

Chevron, as it has been applied, is of a piece.  As noted in the brief filed by Professors Cross, Pierce, and Seidenfeld in the Watters case, it is this basic logic that underlies Chevron as it applies in this context.  If the choice of preemption represents a reasonable accommodation of conflicting policies, which are committed to agencies carried by the statute, then the court will not disturb it unless the policy judgment was clearly contrary to what Congress intended. 

The question of preemption is therefore a policy judgment who delegated to the administrative agency not a legal question, which is whether or not the basic area is delegated to the agency’s judgment.  Thus, as in de la Cuesta, it seems here the agency can preempt ostensibly pro-creditor or pro-debtor state laws so long as they are within the agency’s scope of delegated power and represent a reasonable policy accommodation. 

What about here?  Is this a reasonable policy judgment?  The states and some amici have argued that in this case, that the major effect of preemption will be to gut these enforcement actions of consumer protection laws that are designed to protect consumers from the rapacious federal lenders.  Applying basic economics, however, it seems quite clear the OCC’s resolution and competing policy goals are more than reasonable as they weigh against the state’s claims. 

Restrictive regulations like consumer lending terms have several predictable results.  The first is, of course, you will get less use of the particular terms that are in question, but that is the easy part.  There are several other circumstances that flow from heavy regulation of lending terms.  First, what you get is term re-pricing.  For instance, when usury regulations were widespread in the states, you saw a massive term re-pricing.  They put caps on what you could charge for interest rates, but that led to a whole series of predictable economic adjustments.  For instance, they require higher down payments of loans, they require higher collateral repayments on loans. 

The classic example is that the inability to charge market rates of interest on credit cards, which simply led to an innovation known as the annual fee, which many of you will not remember anymore because the effect of deregulation of interest rates brought about eliminations of annual fees, which were simply an end-run around usury interest rates.  Retail goods have brought about a bundling of credit with retail sales, so empirical evidence suggested that appliances in states like a refrigerator, which is usually bought in credit, a refrigerator in a state with restrictive usury regulations costs 10 percent more than a refrigerator on the state without restrictive usury regulations.  Banks had shorter hours in states with a stricter usury regulations.  Department stores did not give complementary gift-wrapping in states with stricter usury regulation. 

Essentially, what you saw were a whole series of adjustment that were just termed re-pricing efforts to evade and get around the regulated terms.  Secondly, what you have is a predictable credit rationing.  It makes it more difficult for people to give credit, especially marginal high-risk borrowers.  Empirical evidence is pretty clear on this that there is a significant drop in the states that have these so-called anti-predatory lending rules and similar types of regulations with respect to the truly crazy states like Georgia.  We saw lenders actually pulling out of the states because of their inability to be able to price their loans effectively.  Any impact on higher risk borrowers can really be quite severe. 

The claim here is that there is a consumer protection.  Let’s think about how consumers stand.  Today, we stand at the highest homeownership rate in American history of 69 percent, five percentage points just from a decade ago.  Of those several million new homeowners who did not own their own homes a few years ago, most are higher risk marginal borrowers who have been brought into the market by the ability to innovate in credit markets and the growth of the sub-prime lending market.  Today, it appears the greatest wealth accumulation gap is not between rich and poor, but rather it is between homeowners and non-homeowners because of the tremendous power of homeownership as a vehicle for wealth accumulation in the American economy, so that foreclosing these people from markets could have a substantial social cost, especially among those who are supposedly protected from these practices. 

So who are protected?  While empirical evidence of usury regulation suggests that those who benefited the most were middle class and upper middle class people who enacted laws in the name of the downtrodden, but what essentially happened was that usury regulations drove credit away from loans to lower-risk borrowers, increasing the supply of capital to prime lending markets, thereby benefiting upper-class and upper-middle-class lawyers, and the like. 

Finally, a third effect is the substitutional alternative forms of credit.  If you cannot get a certain type of credit, that does not mean you do without credit.  Empirical evidence suggests that in the heyday of usury regulations, states with the strictest usury regulations also became the pawnshop capitals of America, that basically, if you could not get unsecured credit, you would go to a pawnshop, you would go to a payday lender, you do something like that.  It is not clear whether or not borrowers are better off by having to haul their TV down to the all-American pawnshop then they would be if they could get a loan on competitive terms. 

Additional wrinkles are added in this particular case.  As noted in de la Cuesta, there was the impact on interstate credit markets.  If anything today, credit markets have become even more interstate in notion, which suggests that irregular, inconsistent, overreaching state laws would be even more prone to clogging interstate markets than in the past.  And in fact, one of the reasons why state or by lenders have pulled out of states with particularly troublesome laws is the inability to resell their mortgages on the secondary market because of the peculiar terms that would be enforced on them. 

What the dual banking system offers is a consumer choice.  You could have a state-chartered lender with these heavy-duty enforcement regulations, these heavy-duty enforcement actions, they would likely have higher interest rates, less access to credit, higher costs, and that sort of thing.  Or you could have federally-charted lenders with OCC regulation and ongoing examination, as Brian described it, where credit terms will be set much more by the market, leading to lower interest rates, more access to credit, and the like. 

If federalism is a theory of individual freedom, I cannot see what would be wrong with giving consumers this choice between a heavy regulated state credit option with enforcement versus an OCC examination market which would likely be less expensive in terms of a consumer protection.  And in fact, if consumer protection laws are so great, we can predict how this would turn out.  If consumer protection laws are really helping consumers so much, consumers will flock to the state banks willing to pay higher interest rates and higher cost for the added protection of these thousands of enforcement actions. 

If, however, consumers prefer lower credit terms, then the OCC banks will have an advantage.  And in fact, we have seen this competition in action before.  In 1978, in the Marquette National Bank case, the Supreme Court essentially held that interest rates could be exported on credit cards, which basically meant that you could apply the rules of the bank-issuing state rather than the consumer’s home state. 

This spurred very widespread competition and in fact, we can think of the two forms of credit cards that were offered at that time.  One was what we called the Arkansas Credit Card.  Arkansas had the strictest usury regulations in the country.  The Arkansas Credit Card gave you a very low rate of interest because of heavy usury regulations, and also had a very high annual fee, and about twenty percent of people who applied were able to get the Arkansas Credit Card.  It had credit limits of about $700 because they could not price the credit terms accurately enough to deal with the risk of lending at such a low interest rate.  The alternative could be the North Dakota or the Delaware Credit Card, such as Citibank or MBNA.  This was a credit card that essentially offered no usury regulations, market rates of interest, market rates of annual fees and other credit terms. 

[When] we saw this competition come about, that is why we are all carrying Arkansas Credit Cards today because VISA and MBNA just disappeared off the face of the earth because of their inability to compete with these strict rules in Arkansas.  Of course, the exact opposite occurred, which is because consumers prefer to have their lending term set by the market rather than by the wise men of the Arkansas state legislature and as a result what we saw was a great, essentially, deregulation of American credit markets involving credit cards, and perhaps the most amazing spread of a financial instrument to consumers in American history.  So it seems to me that the notion of preemption in this case is well grounded in notions of federalism as the Supreme Court has recognized it especially as it applies in the context of the dual-banking system.

MR. FRANK:  Thank you, Todd.  I would like to give the panelists a chance to respond to what they just heard and we will just work our way back.

MS. QUESTER:  Great.  Yes.  May I have a couple of thoughts?  One is, Todd characterizes the dual regulation as piling on, but I think that one of the things I would like to emphasize is the point that I made earlier which is this is exactly what Congress had in mind.  When Congress enacted HOEPA, which is the Homeownership and Equity Act, the conferees indicated in the legislative history that they intended to allow states to enact more protective provisions than those in the federal statute. 

And I would also just note that there are so many inefficiencies in the market, and particularly in the sub-prime mortgage market.  There are tremendous asymmetries of information in this context and deceptive practices that are both bad for consumers and also anticompetitive.  I think when there is deception in the marketplace, and there is, Todd’s idea to just let consumers choose does not work because responsible lenders cannot compete with deceptive lenders.  And I think Todd’s arguments about how lenders adjust their practices and response to regulation is really an argument for why we need the level of government that is able to respond quickly to be involved in addressing mortgage-lending issues because the federal government does not lift, it does not move fast. 

I think all of that speaks to why we want states involved.  I would also just note that there is a lot of empirical research, some of which has been done by my own organization, about the effects that state lending laws have, and what they have indicated is that these mortgage laws in particular are working very effectively.  We put out a study earlier this year which shows that state laws intended to prevent predatory mortgage lending allow for the free flow of responsible credit with lower cost and fewer abusive terms.  There are also a number of other studies, including one by UNC, University of North Carolina, talking about the North Carolina law in particular.

MR. MERRILL:  I'm sympathetic to a lot of Todd’s arguments, certainly as a matter of economic theory, but I think this is an area like many others where, really, we should not try to resolve these issues based truly on economic theory, but we should sort of try to engage in some empiricism, as Amy just suggested.  And so I do not really know a priori what the answer is.  I mean Todd’s theory, essentially, is a version of the standard economic argument that any type of legally mandated quality term is going to reduce consumer welfare because consumers are going to have to pay higher prices for those mandatory quality terms and some consumers would elect to go without the quality term in preference to a lower price, and so all these state regulations of predatory lending and so forth are lumped together as mandatory quality terms.  And there is a theoretical case for that, but it would be nice to know empirically whether in fact that the world works that way or not. 

The other thing I'm sympathetic to is this idea that we do have this dual-banking system so we have a sort of natural experiment here.  We have state-chartered banks, which are really subject to state regulation, and we have this federally chartered national banks which are clearly not subject to state regulation.  And so let’s let the experiment proceed and see empirically which serves the people better. 

Now, I do not see, however, how that has any bearing on the preemption case issue in the Watters case.  The Watters case is really about where we draw the line between the national sphere and the state sphere and it is sort of seems like the OCC has reached out and grabbed the chunk of state-regulated banks.  These are state-chartered banking corporations that are now being subject to exclusive federal regulation under this preemptive regulation, and so the OCC has essentially said, “Oh okay, we are going to have this experiment, but let's take this big chunk of banks or bank-like entities that have been operating into the state system and move them over to federal system, and then let’s run the experiment that way.”  I do not really see how that move really helps or does not help run this experiment as to whether we prefer more or less consumer protection regulation.  In banking, I think we have to sort of resolve the issue about the OCC’s power to reshuffle the deck using other legal principles besides these economic ones.

MR. BROOKS:  Well, let me see if I can address a couple of legal points that have been made, and then also a couple of the policy points.  I want to start with Tom’s point about the distinction between agencies getting deference when they are interpreting their substantive law issues and not getting deference or getting a lesser degree of deference when they are interpreting the preemptive effect of those laws. 

What makes, I think, the banking situations somewhat different from other preemption questions where I think that distinction might well make sense is that the nature of banking preemption that we are talking about in Watters, and that it is litigated most frequently into these kinds of regulations is a powers preemption question. 

Let me see if I can make clear what I mean by that.  Usually when a corporate defendant invokes preemption as a defense, what it is saying is there are some standards of conduct out there that federal law has established compliance with, which insulates the complier from liability under some state law.  A classic example, I think, would be the cell phone brain cancer class actions that were filed a few years ago in various courts around the country, where the allegation was you have these cell phones which were constructed pursuant to FCC safety standards.  They admitted power to certain level.  But still, it turned out that some of these plaintiffs alleged that they had gotten brain cancer because emitting power at that level is dangerous and so the question was, gee, just because the federal government has set that standard of conduct does not necessarily mean that a state negligence or a state strict liability regime couldn’t nonetheless render you liable if you did not comply with a higher standard of product. 

In that world, I think Tom’s point makes a lot of sense.  It may be that the FCC’s use ought to be taken into consideration, but perhaps because all it is doing is establishing a standard of conduct.  Maybe that does not end with the debate from a deference standpoint.  What is going on with the OCC is very different, however, and it requires that we go back and reexamine what Chief Justice Marshall said in McCulloch. 

What the OCC is doing with the entities that it charters and regulates is it is affirmatively authorizing them to exercise certain powers.  And to me, doing that by its nature is preemptive.  Think of it this way.  When the OCC says to Citibank, “You are henceforth licensed to conduct the business of banking pursuant to your federal charter,” and then Michigan says, “Well, we have a law of general applicability which says that no person may engage in the business of banking without first registering with our office and paying a tax,” well, that is McCulloch v. Maryland.  In McCulloch v. Maryland, the states said I think precisely what Amy said here, [which is that] Wachovia has the right to have operating subsidiaries and the Michigan law does not prohibit that.  All they have to do is register and pay a tax. 

Well, that is exactly what happened with the first Bank of the United States, or I guess in McCulloch it was the second Bank of the United States.  Nobody in Maryland said they could not operate.  They just had to register and bow down to and render unto Caesar.  And what the Supreme Court said is that the power to tax is the power to destroy in the powers context.  And so the distinction I’m trying to make here is that here the agency regulation issue is not a standard setting regulation, it is a licensing or power-granting regulation. 

I think the distinction collapses because by dint of having said, this bank, or in this case, this operating subsidiary may go to marketing and conduct to the business of banking.  The OCC has authorized and empowered something which cannot, under McCulloch, then be subject to state-entry barriers.  Let me make this distinction, which I think it is very important in the Watters case.  The Watters case is not about all bank subsidiaries.  It is about something called operating subsidiaries, and they are not the same thing, okay?  Operating subsidiaries for bank regulatory purposes are those subsidiaries that engage only in activities that are permissible to national banks.  They are not the same things as subsidiaries that do other things, which may also be financial subsidiaries under applicable law, and to me that is a critical distinction.  Because given that distinction, Amy’s point may make a lot of sense when you are not talking about operating subsidiaries; in other words, when you are talking about activities that are being conducted not pursuant to authority created by the National Bank Act and OCC regulations.  But instead, general corporate activities that are permissible, if at all, is a matter of state corporate law.  So do not forget that distinction when we are talking about the nature of the entities that are at issue here. 

Two other points I want to make.  First, there is this question about whether the federal government is nimble enough in identifying, particularly consumer protection violations, and addressing them quickly.  To me, that gets back to what I said before and I'll tell you a story about that, but it is the distinction between supervision and enforcement, which it is so hard to get people who are outside the industry to understand. 

If you assume that the definition of nimble is quickly filing lawsuits, then you are right, and if you equate consumer protection and consumer welfare with high levels of litigation, there is no question but that the federal banking regulators are far inferior to their state counterparts.  But on the other hand, if you are anything like the clients that I deal with everyday who call me up and say, “Oh my God, we implemented this new deposit transfer system last week and Ginnie Mae [Government National Mortgage Association] was just in for their weekly audit, and they discovered it and they are telling us we have to stop.”  These things happen on a dime, and the reason they happen on a dime is because they are not retrospective liability imposition devices.  They are actually devices that are intended to induce compliance on a real-time basis, which is radically different from what the plaintiffs’ lawyers and state attorneys general of the world are all about.  You have to ask yourself what it means to be nimble.  If you talk to an actual bank who actually deals with an on-site examiner, they will tell you what nimble means, and it is very different from the litigation definition that I think you have heard here.

But the last thing I want to talk about is this notion of a presumption against preemption.  I'm probably closing on a low note here, but this is a great bugaboo of defense lawyers who deal in preemption issues as I do.  The presumption against preemption is Roman numeral I of every brief that I have ever debated.  Indeed, I have some colleagues here who I think just finished writing the seventh presumption against preemption response this week, and it is only Tuesday.  Everybody says that, and I think it is true in a sense.  It is implicit in our federalist structure that there are issues of state and federal power delineation that require federal courts to be chary of the proposition that we should, as Tom says, take out our gum erasers and write out the state law of the books.  But in the banking context, there really is not much of a question. 

The case on the point is Barnett Bank, the case that Amy mentions, and what Barnett Bank said, and this is pretty close to a quote, is that in the area of banking, federally chartered banks are not usually subject to, but federal law is ordinarily preempting of the contrary state laws.  I mean, that is the Supreme Court’s recently designated balance of powers between state and federal law when it comes to the business of banking, and the reason again is going all the way back to McCulloch and all the way back to the Bank of the United States v. Osborne.  This has been understood since the earliest days of the republic.

MR. FRANK:  Questions?

JAMES ROSEN:  James Rosen, McClatchy Newspapers.  Mr. Brooks identified the reason why 50 people might be here today as tied into this historic struggle between state and federal banking power.  It goes back to Jefferson-Hamilton in the state- and federal-controlled economy more broadly, but also I think the second reason that you all have talked sort of around but you have not addressed directly that I like to hear you address is tort reform and how this case ties into tort reform efforts and why the Supreme Court decision, how it might influence that.

MR. BROOKS:  Well, I'm happy to think to swing it that one.  A number of us here in the room have been very active in tort reform efforts, but I will say I think maybe the phrase “tort reform” is a little bit of a misnomer.  I know Ted and I worked on class action fairness act issues together.  There have been some other punitive damages, medical malpractice liability issues that Michael Greve and others in the room have been leaders on.  The reason I say tort reform may be a misnomer is it really is about liability reform generally, and the reason I say that is there is unanimity, I think, on the question of whether it would be a good thing to induce better corporate behavior.  Nobody would disagree with that proposition.  That is sort of an easy proposition. 

The question is, is the right and most efficient and most innovation-producing way of doing that to increase the amount of liability in the system, or is there some alternative to that.  This gets to the point I was making a moment ago where I would consider myself a tort reformer in this debate because I do not think that increasing the number of civil lawsuits filed is the same thing as increase in compliance.  I think that there are other less onerous, less costly ways of increasing consumer welfare along the lines that Todd talked about.  And in the banking area I think that is accomplished not through “gotcha litigation” where you wait for someone to commit a wrongdoing until they have done it long enough that there is a big pot money to sue over on the one hand, and on the other hand having a system that monitors day-to-day compliance so as to catch errors and even catch intentional schemes that would be a bad thing and stop them before they actually injure anybody. 

What the tort reformers of the world say is that liability qua liability is not a good thing.  Liability is only wealth-producing to the extent that it incentivizes good behavior on the part of companies, and in the banking area I think there are a lot of ways to do that other than filing lawsuits.

MR. MERRILL:  Let me try to answer your question rather than answer another question about tort reform.  Your question is what impact might Watters have on this whole struggle?  Well, my own view is this – I think I mentioned briefly in my remarks – that if an agency just offers its opinion about the preemptive effect of some action that it has taken or the statutes that it implements to have required.  For a question like tort reform, that is not entitled to Chevron deference.  It is, at best, Skidmore deference.  And this is going on all over the place, agencies like NHTSA, the National Highway Traffic Safety Administration, the Consumer Protection Administration, and the FDA are issuing these opinions about the preemptive effect of their regulations on product’s liability and other tort actions. 

Analytically speaking, I think those statements are only entitled the Skidmore deference, and I think if Watters is decided under the principles that the court has previously laid down, that will not change.  Now, what might happen here if, let's say, the court renders a broad ruling in Watters that agency preemption decisions are no different from any other type of agency actions and they are entitled to Chevron deference in the same terms as other agency action are entitled to, that could unsettle what I think is the correct analysis of these tort reform perambulatory preemption statements and might give them further tailwind. 

On the other hand, if the court comes out the way I think they should here and says that agency determinations of preemption as opposed to substantive interpretations of law are not entitled to Chevron deference but again, at best, Skidmore deference, I think that sort of nails the lid on the coffin in terms of whether or not agencies are going to engage in stealth tort reform through perambulatory opinions about the effect of their actions on tort suits.

MS. QUESTER:  I would just add that there was a great article by Allison Zieve and Brian Wolfman of Public Citizen published by VNA earlier this year which is titled, “The FDA’s Argument for Eradicating State Tort Law: Why It Is Wrong and Warrants No Deference.”  I think you can guess its thesis…

[Laughter]

MR. JENNINGS:  Tom Jennings with the Federal Housing Finance Board.  This is a question primarily for Professor Merrill.  Dealing with the separation of powers rather than federalism and delegation of powers and in particular Chevron, you mentioned, is there to show how the legislative branch can delegate power down to the administrative agency and what the parameters of what the administrative agency can do with those with legislative powers.  On the other hand, you said that preemption is primarily judicially developed doctrine and the question has to do with the fact that agencies have both legislative and judicial powers.  Most agencies do. 

The reason there is delegation on the legislative side is because the agencies know the operations of what they are regulating better than what Congress does, for instance.  And in connection with the judicial side and preemption, the courts may be thinking that the agencies also know better than the courts do how the regulated entities ought to be doing things.  So could not the Supreme Court be using this case as a vehicle for deciding how agencies are to go about handling the preemption powers, with the limits of those are similar to the body of laws that has been developed of appeals and whether or not you hear an appeal just determining whether or not the lower court was wrong in the way they decided?

MR. MERRILL:  Yes, I'm not sure I completely followed your question, but I do think that the distinction between adjudication and rule-making has complicated the picture quite a bit as to the delegation of powers to agencies and what kind of deference they be given, and I think the larger long-term picture here is that we have seen a sort of sea change gradually taking place, with agencies increasingly engaged in rule-making-like exercises and putting decreasing emphasis on adjudication relative to what happened, say, before World War II. 

And yes, it seems to me that there ought to be greater attention given to the desirability of agencies acting through legislative rule-making when they are making highly important decisions, such as the one in the Watters case to displace state regulation over a huge category of entities operating subsidiaries and national banks.  And so at the very least, I think it would be desirable for the court to underscore the importance that those are the decisions to the extent there to be done by agencies and given deference by a court. 

It is really ought to be done through legislative rule-making with notice-and-comment, where states are fully allowed to participate and have their views heard rather than through opinion letters or interpretative rulings or little adjudications involving Bank A rather than the rest of banking, where those sorts of participation rights and that sort of broad, highly transparent form of decision-making is not present to the same degree.  So I'm not sure that is responsive to your question, but I do think that that is the one of the subtexts here and maybe the court will provides some guidance along those lines.

MICHAEL GREVE:  Mike Greve, AEI.  Just of two quick questions.  One is about the practical effects.  Suppose against all odds, as Brian would say, that Michigan wins here, I would assume that Wachovia and other institutions will just change the corporate form; that is to say do not have them as operating subsidiaries.  Just make them parts of the national bank that may be limited a number of transactions with that, or if the transaction costs are just too high for other reasons, you spin them off.  But the last thing they are going to do is operate these places under Michigan law under their own umbrella.  I just wondered whether that is not right. 

And the second question is simply this, and it is mainly to Tom and maybe also to others.  Tom, I am as nervous about Chevron deference in this context as you are, or be it perhaps for somewhat different reasons and the reason is this.  I'm quite confident or comfortable with Chevron deference so long as the agency preamble statements and notices of intent are written by Mr. Troy, by Mr. Hawk, or others like them.  Two years form now under the Clinton administration, those same statements may be written by former state AGs will never have encountered a federal law that actually preempts someone, right? 

And under those circumstances, I'll entrust the DC circuit with Skidmore deference any day of the week, but not with Chevron deference.  Does that make your newfound friends on the political left nervous?

MR. BROOKS:  The quick answer, Michael, I think, to the practical question is that the operating subsidiaries will roll up into the bank which will have all kinds of unfortunate consequences, but that is what they will do.  When the first of these cases was filed, it was the Wells Fargo v. Boutris case in California.  Wells Fargo temporarily suspended the operations of Wells Fargo Home Mortgage, rolled up the operation into Wells Fargo NA and now is doing business is normal, except that it was slightly less efficient to do so because of capital structure issues, management issues, and other things.  I mean the reason banks do this is because it is more efficient.

MR. GREVE:  Can I just follow up real quickly?  Does Wachovia operate in Michigan other than through operating subsidiary?

MR. BROOKS:  I'll tell you what I think the real answer is, as I think it is more nuanced, and I'm pretty sure that Wachovia Bank N.A. makes second mortgages, home equity loans, and things like that through the bank in Michigan, but the bank, I think, does not have any branches in Michigan.  One thing to know about Wachovia Mortgage, by the way, is - this is the dirty little secret nobody has talked about – Wachovia Mortgage is not a Michigan company.  It is a North Carolina company.  So if there were an issue about state corporate form or state corporate law, why is it Michigan corporate law?  But that is another story.

MR. MERRILL:  So anyway, we could talk more about this practical issue, I suppose.  But on your question, I mean I think one interesting thing about Chevron – there are many interesting things about Chevron - is it was very much an endorsement of the idea of the permissibility of radical change by agencies in response to elections.  If you recall, it was 1984, the court had just slapped down NHTSA, the National Highway Traffic Safety Administration, for its airbags case, which was made in response to the Reagan revolution, and maybe it was feeling a little bit badly about that. 

And so Chevron comes along and they say, well, of course, it is entirely legitimate for an agency to change its interpretation of the law in response to changing political perspectives that are brought by, among other things, elections, because the agency is accountable to the present, the present is accountable to the people.  Elections are what determine who is the president, what the president’s policies are, and that is all part of the American way of life.  It is good for courts to stand aside and let agencies change their interpretations in response to these events. 

The older tradition, which goes back to Skidmore, was much more focused on things like the desirability of continuity and stability in the law that we want to protect the reliance interest that people have based on longstanding interpretations of law.  And so that older doctrine very much focuses on those sorts of reliance-based variables rather than this political accountability theory, and so you are right to identify a big tension between those two perspectives about deference, and my only thought here would be that maybe with respect to something like the balance of power between the states and the federal government, which is a major structural issue about the way our government functions. 

Maybe we do not want to have big zigzags back and forth with these changes in administration, the balance of powers changing radically back and forth on an issue like tort liability.  Maybe they want a little more stability about that issue and that might be another reason why the Skidmore framework, which is kind of reliance-based stability promoting as opposed to Chevron, which is accountability-based, changed favoring and makes sense in this context.

MS. QUESTER:  I might just add just in response to Brian’s point about Wachovia Mortgage being a North Carolina corporation, this is a case where all 50 states are on the same side.  I mean 49 states in the District of Columbia and Puerto Rico all signed on to an amicus brief supporting Michigan.  So I think I'm not sure how relevant it is, what state it is incorporated in.  And I think the other point to make which Michigan has made in its brief is that it has a recognized interest, not only in the corporations that it charters, but also in foreign corporations that do business within its boundaries.

THOMAS EMERY:  My name is Tom Emery.  I'm a retired attorney and I have been retired from the Michigan Attorney General’s Office for about nine-and-a-half years now.  And I must say when Mr. Brooks made his presentation it got my state regulatory juices flowing, but this is on a perhaps more narrow point because I have been away long enough not to want to engage you on that. 

Mr. Brooks, your suggestion that you concede that while the examiners for the federal agency maybe come up with eight matters as opposed to the approximately 4,200 that the state attorney general had.  I will say from my experience with the attorney general’s office, because of limitations on our manpower so to speak, the number of attorneys, we only dealt with the most egregious cases that actually went to litigation.  So I find it quite compelling that your suggestion that the cozy examiner system is dealing with all these issues that despite that and I'm assuming that they are operating over a period of time, that this assistant, well, they would be generally assistant attorneys general managed to find is many cases that they are capable to bring to litigation in spite of your system, but I find that compelling on the other side.

MR. BROOKS:  Sure.  Well, yes.  Let me make a couple of points in response to that because I think that is a perfectly legitimate thing to say.  One point is, of course, the state agency in question here is not the Michigan Attorney General, though I have talked a lot about attorneys general.  It is really the Michigan – I forgot the name – but it is the Office of Financial Regulation or its equivalent in the State of Michigan. 

And so, if the concern was about agency capture, which I think is a significant issue in the world of regulated industries, you might well think that the attorney general is insulated from that because he is really a law enforcement officer.  But the division of banking or the office of financial regulation of state is not, and at least it is not obvious to me why that would be any more independent of the entities that regulates them with something like the OCC and seems to me that you would think the contrary because the OCC sits in Washington sort of far away from all of these banks, whereas if you are the New York Division of Banking, for example, that is where Chase Manhattan is, that is where Citigroup is.  You might assume there is more agency capture there instead of the other way around.

The other thing I would say about that is if you read the Center for Responsible Lending’s brief here, they make the following comparison:  They say that these various state banking departments and other enforcement agencies across the 50 states have somewhere north of 700 examiners – that is what their brief said – this colossal number, as compared… and they say in the brief that 17 times the number of OCC employees were focused on consumer protection enforcement, but if you compare apples to apples, their number of 700 in the brief is the number of examiners. 

The OCC employs more than 1,800 full-time examiners, almost three times as many as the 50 states combined.&nb