First, we're proposing new rules to protect consumers and a new Consumer Financial Protection Agency to enforce those rules. This crisis was not just the result of decisions made by the mightiest of financial firms. It was also the result of decisions made by ordinary Americans to open credit cards and take on mortgages. And while there were many who took out loans they knew they couldn't afford, there were also millions of Americans who signed contracts they didn't fully understand offered by lenders who didn't always tell the truth.
This is in part because there is no single agency charged with making sure it doesn't happen. That is what we'll change. The Consumer Financial Protection Agency will have the power to ensure that consumers get information that is clear and concise, and to prevent the worst kinds of abuses. Consumers shouldn't have to worry about loan contracts designed to be unintelligible, hidden fees attached to their mortgages, and financial penalties - whether through a credit card or debit card - that appear without warning on their statements. And responsible lenders, including community banks, doing the right thing shouldn't have to worry about ruinous competition from unregulated competitors.
Now there are those who are suggesting that somehow this will restrict the choices available to consumers. Nothing could be further from the truth. The lack of clear rules in the past meant we had innovation of the wrong kind: the firm that could make its products look best by doing the best job of hiding the real costs won. For example, we had "teaser" rates on credit cards and mortgages that lured people in and then surprised them with big rate increases. By setting ground rules, we'll increase the kind of competition that actually provides people better and greater choices, as companies compete to offer the best product, not the one that's most complex or confusing.
Second, we've got to close the loopholes that were at the heart of the crisis. Where there were gaps in the rules, regulators lacked the authority to take action. Where there were overlaps, regulators often lacked accountability for inaction. These weaknesses in oversight engendered systematic, and systemic, abuse.
Under existing rules, some companies can actually shop for the regulator of their choice - and others, like hedge funds, can operate outside of the regulatory system altogether. We've seen the development of financial instruments, like derivatives and credit default swaps, without anyone examining the risks or regulating all of the players. And we've seen lenders profit by providing loans to borrowers who they knew would never repay, because the lender offloaded the loan and the consequences to someone else. Those who refuse to game the system are at a disadvantage.
Now, one of the main reasons this crisis could take place is that many agencies and regulators were responsible for oversight of individual financial firms and their subsidiaries, but no one was responsible for protecting the whole system. In other words, regulators were charged with seeing the trees, but not the forest. And even then, some firms that posed a "systemic risk" were not regulated as strongly as others, exploiting loopholes in the system to take on greater risk with less scrutiny. As a result, the failure of one firm threatened the viability of many others. We were facing one of the largest financial crises in history and those responsible for oversight were caught off guard and without the authority to act.
That's why we'll create clear accountability and responsibility for regulating large financial firms that pose a systemic risk. While holding the Federal Reserve fully accountable for regulation of the largest, most interconnected firms, we'll create an oversight council to bring together regulators from across markets to share information, to identify gaps in regulation, and to tackle issues that don't fit neatly into an organizational chart. We'll also require these financial firms to meet stronger capital and liquidity requirements and observe greater constraints on their risky behavior. That's one of the lessons of the past year. The only way to avoid a crisis of this magnitude is to ensure that large firms can't take risks that threaten our entire financial system, and to make sure they have the resources to weather even the worst of economic storms.
Even as we've proposed safeguards to make the failure of large and interconnected firms less likely, we've also proposed creating what's called "resolution authority" in the event that such a failure happens and poses a threat to the stability of the financial system. This is intended to put an end to the idea that some firms are "too big to fail." For a market to function, those who invest and lend in that market must believe that their money is actually at risk. And the system as a whole isn't safe until it is safe from the failure of any individual institution.
If a bank approaches insolvency, we have a process through the FDIC that protects depositors and maintains confidence in the banking system. This process was created during the Great Depression when the failure of one bank led to runs on other banks, which in turn threatened the banking system. And it works. Yet we don't have any kind of process in place to contain the failure of a Lehman Brothers or AIG or any of the largest and most interconnected financial firms in our country.
That's why, when this crisis began, crucial decisions about what would happen to some of the world's biggest companies - companies employing tens of thousands of people and holding trillions of dollars in assets - took place in hurried discussions in the middle of the night. And that's why we've had to rely on taxpayer dollars. The only resolution authority we currently have that would prevent a financial meltdown involved tapping the Federal Reserve or the federal treasury. With so much at stake, we should not be forced to choose between allowing a company to fall into a rapid and chaotic dissolution that threatens the economy and innocent people, or forcing taxpayers to foot the bill. Our plan would put the cost of a firm's failure on those who own its stock and loaned it money. And if taxpayers ever have to step in again to prevent a second Great Depression, the financial industry will have to pay the taxpayer back - every cent.
The Consumer Financial Protection Agency, as I've written before, would seem more compelling if there were any substantial evidence that people have gone wrong for reasons that were less easily discernible than "I am using credit to buy consumption goods that are far, far outside of what people in my income group can usually afford". Even basically sympathetic accounts of the housing bubble always arrive at a moment where they ask someone how they thought they could afford to buy a house that cost six or eight times their annual income, or cash hundreds of thousands in equity out of a fairly modest home, and the people kind of shrug and blame it on the bank. Yes, the banks were stupid, but this required quite a bit of willful ignorance of reality on the part of the borrowers, too.
As for the notion that we will finally put together a system that will make the whole industry pay if its members require a bailout . . . that sounds hopeful, but there's a catch. The problem is, the time at which you realize that you need the money to pay for the massive bailout is the time at which you have a lot of weak companies that could be tipped over the edge by the additional levy, which is why the PBGC has been underfunded for as long as I've been writing about it. The problem is even more acute in the financial system.
Your best shot is at trying to structure firms that can withstand a crisis, and quickly shutter those that can't. The problem with that is that this was the mandate we gave our regulators before September 2008.
And we've seen lenders profit by providing loans to borrowers who they knew would never repay, because the lender offloaded the loan and the consequences to someone else. Those who refuse to game the system are at a disadvantage.
Barack fails to mention this was partly because the government was allowing subprime risks to be hidden in order to increase access to such loans in the name of social justice.
And even then, some firms that posed a "systemic risk" were not regulated as strongly as others, exploiting loopholes in the system to take on greater risk with less scrutiny.
This is why the political class doesn't want to break up these behemoths into pieces that are too small for future taxpayer bailouts: large firms make it easier to control the industry as a whole, and can provide mountains of campaign cash in exchange for these loopholes.
Canada escaped most of this crisis because they had simple, easily enforceable regulations.
Heh, so Canada is the model now? Remember, Canada also has that simple, easy to use universal health insurance model-single payer. So let's imitate our great northern sister.
Healthcare =/= financial regulation.
Every country has some things they do well and some things they do badly. Imitating Canada's banking stability would be good for most countries. Imitating our habit of picking the person who nominally runs the country from the ranks of no-name newsreaders off the government network, not so much. And ripping off our healthcare system is in that second category. If you have to steal a public healthcare system, some European countries do a far better job of it than we do, so steal from them.
McArdle's warnings are right on, but still there is a great deal of improvement possible in financial regulation, and it would be good if this bill provides it. Up to now, it's been a responsibility shared by the States and several Federal agencies, and the system is baroque and, by the way, broke.
But to prevent abuses like regulatory capture and the sort of loophole-mania that characterizes the tax code, this bill will require a tight focus and a bright light from the media. And it's not going to get it. The media are focused on health care, the financial crisis, foreign wars, the virus of the year, and the scandal of the day.
"I am using credit to buy consumption goods that are far, far outside of what people in my income group can usually afford".
I'm wondering how much the easy availability of credit impacted the income inequality issue.
For example - If your a nurse and you want a house nicer than you can afford you can either A. Pick up an extra shift. B. Get your masters and become a Nurse Practioner. or C. Get a zero down, interest only mortgage. Without access to cheap credit, people would have only been able to make due or make more money - but when the credit option is available, that's the choice people are going to gravitate to.
Another example would be someone who had a lucrative out of state job offer. Without the availability of easy credit the lifestyle bump of the new position might be very tempting. But, with credit available, one can potentially enjoy a similar lifestyle without all the stess and disruption of a move.
Or, a kid who's parents were able to finance his education with a home equity loan might choose a less lucrative field as he wasn't concerned about paying off a lot of student loan debt.
I'm certainly not saying this is always the case, but I'd have to think it impacts the income inequality equation.
For example - If your a nurse and you want a house nicer than you can afford you can either A. Pick up an extra shift. B. Get your masters and become a Nurse Practioner. or C. Get a zero down, interest only mortgage.
My wife is an RN; we used to live in Southern California. What her coworkers appeared to do was A and C. That is, they were paying for option C by *relying* on option A (which isn't always possible -- extra shifts are only available when patient count is up.)
This, of course, while adding on little sleep (because shifts are 12 hours minimum) and long commutes (because no one in SoCal lives in a half-hour drive of their workplace.)
They say you know you're in a real estate bubble when the price/rent ratio gets too far out of wack. I admit most people don't know what that is - but they should have had a huge clue.
If you were in So Cal, living in a nice 1500/month apartment and you went to buy a home (at the peak of the market) and all you could find was some 1100 ft/2 $549,000 ranch - you should have noticed that your housing expense was going to go from $1500 to $4000+.
I would have thought that more people would have said an extra $2500 a month? Hell no. I'd rather save $1000, but a fancy car, and go on a nice vacation every 3 months - then spend 4k a month on a run down shack.
That's really funny -- that's only 5 dollars off of our rent ($1505) for a nice, one bedroom apartment in a half-decent apartment complex close to her hospital.
Next to our complex were houses going for (and selling for!) 800K (4 bed, ~2000 sq. ft.) We always wondered who those people were making it. Now that we've moved away, Google tells us that 3 or 4 of those houses in that small subdivision are in foreclosure proceedings.
a moment where they ask someone how they thought they could afford to buy a house that cost six or eight times their annual income, or cash hundreds of thousands in equity out of a fairly modest home, and the people kind of shrug and blame it on the bank.
I know some people who got bit this way. Their real response is that the loan officer assured them that they could, in fact, afford it. And since he was, after all, the professional, they trusted him to know what he was doing. They didn't realize that he wasn't really loaning them his (or his employer's) money. That the loan would be sliced and diced into tranches and sold off to various other people who also trusted the professionals.
These aren't people who've been to college, taken courses in financial management, or even algebra. These are high school graduates who simply didn't know better, and the people who did said "Sure you can afford it."
Which they could have, if the value of the houses went up forever. But they didn't.
As you know, due to their risk an complexity only those with incomes above $200k and investible net worths in excess of $5 million are allowed to invest in hedge funds.
Would you support similar income and education restrictions on complex financial products? For example - everyone would be able to get a 20% down 30 year fixed mortgage, 25% 36 month car loan, and a charge card that would need to be paid in full at the end of the month.
Anyone wishing to utilize anything more risky would have to provide evidence of adaquate financial resources or pass a series of financial competency exams.
Which they could have, if the value of the houses went up forever.
This is the core problem. Lenders were making loans based not on increased income generation or borrowers ability to repay but on appreciating asset values. This is the root cause of the financial crisis and financial bubbles in general.
Unifying regulatory activity is a fairly standard proposal for looking like doing something without actually doing anything. It's what you use when "form a blue-ribbon commission" just doesn't cut it. In practice, there are enough legacy regulatory players unwilling to cede turf, and too little public or media interest to force them to, to derail any such unification. Instead, you get just another regulator with overlapping turf and their own capture issues.
Previous results of this dynamic include the Securities and Exchange Commission, the Federal Trade Commission, the Department of Homeland Security.
Yes, the banks were stupid, but this required quite a bit of willful ignorance of reality on the part of the borrowers, too.
So? Borrowers have been willfully ignorant since time began. In fact, the lender's primary job is sorting out those that can/will repay the loan from those who can't/won't.
...or so one would hope.
is there any legitimate reason that hedge funds seem to be the eternal whipping boy? i could be mistaken, but from my understanding hedge funds made no real contribution to the financial meltdown and actually helped the situation by providing much needed liquidity once credit markets dried up. if that is the case, we will see how new and improved regulation will benefit them when the next bubble bursts.
This sounds like the reasons for creating DHS - urgently addressing a problem that is sort of related to the crisis by expanding the government to provide more oversight and intra-agency communication. And DHS turned out pretty well, right? http://www.centerforinvestigativereporting.org/blogpost/20080924thecostofhasteandwasteatdhs
"Barack fails to mention this was partly because the government was allowing subprime risks to be hidden in order to increase access to such loans in the name of social justice."
I assume that you're talking about the CRA, which was passed in 1977. Only 25% of lending institutions were subject to CRA requirements, and it's not clear it had much of an effect, vis a vis all the other factors in this mess. To quote a Federal Reserve study: "Since 1995, there has been essentially no change in basic CRA rules or the enforcement process that can be reasonably linked to subprime lending activity. This fact weakens the link between CRA and the current crisis . . .".
As we speak, the majority of foreclosures is changing to more conventional loans with presumably family incomes and down payments that were reasonable.
The government was allowing subprime risks because new financial products coupled with looser regulation created the perception that the "ownership society" was expanding and the American Dream was easier to reach than had been previously understood. If you're bouncing back from a horrible attack on the country and an economy that dug itself out after 9/11, who wants to get in front of that narrative?
The problem is that no matter what you do, no political or regulatory regime is ever going to want to be the bad guys that take away the punch bowl. So sooner or later, we're going to hear, yet again, that this time is really different. And then in a couple years we'll be right back where we are now. What's needed is a little of TR's trustbusting and a concerted effort to reduce government impacts on the economy so that you've got less of the too-big-to-fail and it's cousin, government-backed. In other words, it's too much to hope we won't have bubbles, but maybe we can have the government and regulators on the sidelines until they need to step in instead of them being active cheerleaders. (I know, that's asking way too much.)
The CRA was just one piece.
There were hearing from 2002-2006 on FNMA. Some observers argued that these loans were getting too risky and they needed tighter standards. Others claimed they weren't that risky and tighter regulation would hurt those who needed loans most.
The question you have to ask is, how did all these financial companies end up with massive amounts of securities that were actually worth far less than how they were being valued? The answer is the individual risks were hidden when they were packaged and resold.
Look, we can make this really, really easy. Just make it illegal to loan money to people where the payments equal x% of their free income in the year they borrow, and they have to provide the previous years tax return with all W2s and 1099s as proof- no exceptions.
Now, of course, this is politically impossible. Indeed, any significant restrictions on people's ability to borrow (or lend, for that matter) are going to be political death, so what we will end up with is another game of Charades so that politicians can pretend that they are actually doing something meaningful while selling more favors to the connected.
People were given the freedom to borrow - they abused that freedom and now it needs to be taken away.
Good luck with that taking away.
Re: Now, of course, this is politically impossible.
Why? While I don't think it was a public law, lenders most definitely did require income and asset verification in times past, and I believe this has become the practice again now. I know I had to hand over recent bank statements, my previous years' federal tax return, and my most recent pay stubs when I bought a house in 1995.
Problem with that is that financial capability isn't necessarily related to income in a single year. For example, you just banned all student loans - while students may not be the best credit risks in the world, there's certainly a net profit to be made lending to people who are going to be lawyers and engineers in a couple of years, and it's not the sort of activity we need to ban.
Megan seems to overlook the credit card industry and their predatory terms of use-hidden away in indecipherable fine print gobbledygook. Here is a limited list of the bank's outrageous-indeed fraudulent- practices:
There's plenty to reform. During the housing bubble, credit-card vendors inflated interest rates – even as the Fed slashed them – and found increasingly sneaky ways to usher their customers into perpetually indebted servitude. Such as:
•Raising rates as high as 32 percent on existing balances, with no notice, even when they've always been paid on time.
•Compressing the time between statement mailings and due dates.
•Charging interest on debt already repaid.
•Posting on-time payments after their due date – and then charging late fees.
•Neglecting to disclose how much interest and time it will take to pay off a balance with minimum payments (if ever).
Banks in the card game are raising rates and fees to limit their losses on mortgage loans they made. This is doubly ironic, since their delusional lending and exotic mortgage cocktails gave the housing bubble its irrational effervescence to begin with. So now millions of American households are being dragged under even further.
This year, card companies will break all records for late fees, over-limit charges, and other penalties, pulling in more than $19 billion. Not to mention extra charges for paying by mail or by phone (try $14.99). Credit card is the only industry where customers pay extra to be allowed to pay. Where agreements can be changed without notice. Where nearly half of industry revenues come from penalty fees.
You can't just dismiss these predatory practices as a tax on stupidity. Borrower beware? A quaint notion, when bankers play misleading and retroactively abusive games with other people's lives.
Competition? Five card vendors control nearly 80 percent of the market. State regulation? Enforcement has been rendered toothless. Recourse to the courts? This industry, given mandatory binding arbitration, is shielded from any class action. Meanwhile, the average mailbox is stuffed with 24 credit card offers each year. I'm looking at one from First Premier Bank, at an attractive 9.9 percent rate, whose fine print cost in first year fees and interest is $256. For a $250 credit line. Provided I pay on time
http://www.oneradionetwork.com/money%10finance_-_articles/the_economy_-_articles/the_outrage_in_your_credit_card%27s_fine_print_20080814388/
Faced with such blatant abuse, the call for a consumer finance agency is long overdue. I just home it has some teeth.
Again, we can make this much easier- just ban credit cards. Debit cards are what people should be using anyway. If that seems too extreme, then ban the use of credit cards for people that carry balances some set percent of their income- you have to pay off the balance before you get to use them again.
I'm almost in favor of that, actually. But in fact we can have credit cards.-just ban the predatory , usurious practices listed above. Allow "tort reform", such as allowing class action suits against the banks. And you know, actually REGULATE the banks.
Again, the people who get into trouble with credit cards are not the people who get snookered by some obscure term. They're people who lived well beyond their income for a very long period of time.
Banning credit cards would make some transactions much more difficult. Renting a car for example. (Yes, they will sometimes take debit cards, but the terms are much more onerous). Also, buying by credit card provides superior consummer protection. If I may buck the general trend of bank bashing here, I've twice had my credit card issuer assist in resolving a dispute (in my favor) with items purchased on the card. Too many customer (dis)service departments will blow off the random complainer; when Visa is threatening to reverse a 800$ charge they are forced to pay attention.
What we shouldn't allow however is people to have credit limits beyond a certain responsible fraction of their income and assets. I'd go with a ten percent rule: ten percent of your after tax income that is not dedicated to other debt service (car loans, mortgage, etc.), adjusted for whatever liquid or quasi-liquid (=non retirement accounts) assets you hold.
Debit cards are what people should be using anyway. If that seems too extreme
Uh, yes...yes it does.
A credit card is an on-demand loan with greater convenience and security features than cash or debit, and a designated interest-due period. As such, in spite of the potential for abuse, it can be used to make purchases over risky mediums (e.g. the Internet), generate interest-free loans to yourself across the middle of the payment-due period, or generate high-interest loans to cover emergencies across the payment-due period. While it is advisable to avoid the latter two wherever possible, I have used the second option to cover unexpected car repairs on one ocassion, and I can conceive of personal circumstances where I might even use the third (although I hope it never comes to that).
The modern economy was built on consumer credit. Just because it has gotten out of hand in some quarters is not a call to roll the clock all the way back, nor is it even feasible to do so.
Ah, but how do you make an economy grow faster than wages if you limit credit and require that people can only purchase goods and services commensurate with the goods and services they're producing? And, more to the point, if you're part of the political class, how do you stay in the people's good graces if the government's allowed to borrow with abandon to fuel the perception of doing great things but the people aren't allowed to borrow with abandon to convince themselves their standard of living is at least inching up?
Letting the people borrow to buy things they didn't need with money they didn't have on the assumption that their house, their stocks or whatever would just keep appreciating if they ever had to pay it back wasn't a bug, it was a feature. It allowed people to feel more prosperous than they were and therefore to have good feelings toward the financial services industry and the government as they democratized finance.
It's especially crucial that we not get too worked up about this stuff at this juncture. After all, if people get the impression that sooner or later they have to pay for stuff, they'll start wondering if universal healthcare, however structured, will prove not to be free either.
Some of what you're saying is reasonable, which is why I'm not a huge fan of credit cards in a lot of cases. But some is just silly.
Charging interest on debt already repaid.
Are we talking cash advances here? Maybe interest that accrued after one statement was printed and was put onto the next?
Posting on-time payments after their due date – and then charging late fees.
Or maybe that's actually when they got the payment. I wouldn't be surprised if the origins of stories liek this often boiled down to "I put the cheque in the mailbox on the due date, that means I paid on time!". I had this problem myself a couple times with scheduled cash transfers from my bank to the credit card, until I noticed the bit where it said the payment could take a day or two to process. This sounds more like borrower stupidity than lender malfeasance.
This year, card companies will break all records for late fees, over-limit charges, and other penalties, pulling in more than $19 billion.
Yes, records denominated in nominal dollars go up, pretty much every year. Inflation does that.
Credit card is the only industry where customers pay extra to be allowed to pay.
Not true. I can think of many occasions where choosing an alternate payment method costs you extra - COD charges, to name the most obvious.
Where agreements can be changed without notice.
Have you ever read any software EULAs? If what you say is legal and practiced, the sort of people who write EULAs have certainly used it.
And most importantly:
and found increasingly sneaky ways to usher their customers into perpetually indebted servitude
...you really can't be put into indentured servitude if you don't run up a balance. Pay off your credit card, in full, on time, and there's really no problem. The problems only come when you're dumb, or when you're in a desperate enough position that the credit card is actually quite a good thing to have around.
Regardless of the President's good intentions, this appears to be nothing more than the creation of another permanent Washington bureaucracy that will spend more of the taxpayers' money to little effect. I expect the Washington political class, of both parties, to favor the idea -- a new agency means more opportunities for patronage, graft, influence peddling and expansion of political fiefdoms.
If Obama were to announce that he would he would be closing down some other agency now that the CFPA exists I could perhaps get behind it. I'm not going to hold my breath.
Exactly correct.
Look, I was being provocative, but due to my cynicism. The problem is that our culture has equated credit with income, and this has two profound effects- the poorer half of the population and their political benefactors think that access to credit should be much more egalitarian than actual prudence recommends, and the higher income segment and their political benefactors then expect even looser credit for themselves because, afterall, they are better credit risks. Rinse and repeat several times, and you get a country borrowing itself into oblivion- top to bottom.
At least one bank my mom deals with either has the slowest mail delivery in the country or is doing something hinky. She mails multiple bills at a time and all of the others clear before the one bank posts theirs. It consistently takes up to 10 days for them to get her payment while it takes only a couple of days for everyone else. Maybe their post office is really, really slow... or maybe they're sitting on mail for seven or eight days before opening it.