Protecting Consumers in the Financial Marketplace
Thinking Outside the Boxes

When I considered the Consumer Financial Protection Agency last spring, I gave some testimony entitled "One Good Idea and a Number of Bad Ones," and that is still my summary of this proposal--except I would add now "and One Possible Compromise."

Starting with the bad ideas, it seems to me that anybody looking at the proposal in its various forms would agree that you would objectively expect a large, very expensive, highly intrusive bureaucracy with rather undefined and probably arbitrarily exercised powers, which would impose heavy costs and requirements likely to conflict with other regulatory agencies.

Where the parties in the debate differ on this proposal is that some people like such bureaucracy and some people don't, like me.

When it comes to fraud, as Todd said, there was of course some fraud against consumers and some fraud by consumers; fraud is known to attend every financial bubble in history. The idea that you can make a lot of money basically for free always gives rise to fraud. But that isn't the main point.

When it comes to this proposed consumer protection function, James mentioned location. Its organizational location is very important, in my view, as Todd also suggested. If this were a stand-alone agency, its inevitable dynamic would be a vast expansion of its regulatory activity: basically, telling people what they can and can't do when it comes to financing.

As context, I'd like to suggest what our fundamental philosophy toward risk in financial activity should be. Needless to say, America is a nation of risk-takers. The risks those of us who have the great advantage of living in this wealthy society take today are nothing compared to those that our ancestors took while they were conquering the frontier, but they're interesting nonetheless.

Should Americans be able to take risk in their financial decisions and, in particular, in financing the buying of a house if they want to? My answer is, of course they should. Should Americans be able to decide, if they want to, that they're going to have to eat oatmeal and hot dogs every day for five years to buy the house of their dreams? Absolutely, but they ought to know what they're doing. Should lenders be able to decide to make risky loans which are likely to have high charge-off rates and heavy losses in bad scenarios? Sure they should, if they know what they're doing.

It occurs to me that the opposite of consumer protection is making people loans that they can't afford. That's the worst thing you can do, both to yourself as a lender and also to the borrowers.

Both sides of a credit transaction ought to know and understand what it's about and what its risks are. That brings me to the one good idea--and it really is a significant idea--that's embedded in all this discussion, and it's also a nonpartisan idea: clear, simple, straightforward, honest information, generally called "disclosure."

Just as we ought to get rid of the term "entitlements" when it comes to budgeting because there is no spending of other people's money which you are entitled to, we ought to get rid of the term "disclosure" because disclosure implies that there's a scheme somebody has that you're trying to discover. They may have such schemes, and you ought to discover them, but what we really should be concerned with is key, essential information about the credit commitments that you as a borrower are making and making sure that you understand them.

So what we're really talking about is understanding by the borrower which allows the borrower to exercise personal responsibility in making financial commitments. That, it seems to me, is the fundamental, really good idea which is entangled in all of this debate and which we ought to make progress on.

As James was kind enough to mention, I proposed--it's now almost three years ago--a mortgage key information form. I did it because, as I said to a congressional committee, "You should get everything that a borrower really needs to know onto one page." Having said that, I needed to create such a form. It's available on the AEI Web site if you want to take a look at it.

I don't insist on that particular form, but on presenting in straightforward language the key information elements so that people can understand in a clear way exactly the commitments they're making and can therefore decide for themselves how much risk in their financial lives they wish to take. Then we can enable greater personal responsibility in the way the financial system functions. That, it seems to me, is a fundamental and extremely important thing to advance.

We talked about organizational location, and I mentioned a possible compromise. I do think that a stand-alone Consumer Financial Protection Agency, for the reasons discussed a minute ago, is a really bad idea. But, as we all know, the Members of Congress are busy discussing whether you might locate a consolidated consumer financial rules function inside some existing regulatory body--perhaps the Federal Reserve. I think that this location question is very important because if you're going to do this, it is essential to maintain, as many others have said, a balance between the consumer protection functions and the safety and soundness functions.

This is especially important if the bureaucratic behavior of consumer protection evolves as it is almost certain to do. In a stand-alone agency, it is absolutely, with 100 percent probability, going to grow into a credit-promotion as opposed to an information-assuring function. In the original Administration proposal, it was very clear they wanted this organization to promote, as they say, "access" to credit; that is to say, to promote the taking of greater risk by lenders and investors.

If you're going to promote that--I say if--you have to have it balanced inside a safety-and-soundness, prudential risk-managing organization, and that organization should be in charge. We have to reject a false compromise which would put such an agency theoretically inside a safety-and-soundness organization but really make it into an independent fiefdom. That is not a compromise and, in my view, is not acceptable.

I do think there is some argument for centralizing the already existing consumer regulation under already existing laws. For example, we have RESPA (the Real Estate Settlement Procedures Act), administered by the Department of Housing and Urban Development. I imagine that in the mid-1970s they had higher hopes for the Department of Housing than one might have today. We have TILA (the Truth in Lending Act), administered by the Fed. Anybody who follows this knows what a mess of consumer information--so-called disclosures--is made by having these two competing bureaucracies trying to create rules over the same mortgage transaction.

It seems to me there is an argument for consolidating these functions under existing statutes like Truth in Lending and RESPA but making sure that they're inside and subordinate to a financially prudent function. If that happened, by far the most important project that this organization should take on is clear, straightforward, key information--and, of course, honest information--to borrowers about exactly what commitments they're making so they can decide for themselves how much risk they want in their financial lives.

Alex J. Pollock is a resident fellow at AEI.

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