The Revenge of Richard Nixon: The Consumer Financial Protection Bureau Spreads Its Tentacles

Last month marked the one-year anniversary of the Consumer Financial Protection Bureau (CFPB).  At the time the Bureau was created I predicted that it would be a bureaucratic train wreck: an institution that is almost perfectly designed to manifest all of the worst pathologies that scholars of regulation have identified over the past several decades.  Unfortunately, its operations to date have confirmed those fears.

The institutional structure of the CFPB is novel in American history—not merely an independent agency, it is an independent agency tucked inside another independent agency (the Federal Reserve).  Its decision-making is not only independent of any review by the President or Congress, but also from the Federal Reserve itself.  Its budget is independent from the congressional appropriations process and is instead drawn directly from the operating revenues of the Federal Reserve, a sum that will rise to 12% of the Federal Reserve’s operating expenses by 2013 (an estimated budget of $448 million).  The only check on CFPB’s power is the power of the Financial Stability Oversight Council (FSOC) to veto actions by the CFPB but even then the veto can be exercised only by a 2/3 vote of the Council and only if the proposed action would seriously threaten the safety and soundness of the American financial services system.

Unlike most independent agencies the CFPB is not headed by a multi-member commission: even the Federal Reserve has a multi-member commission structure.  Instead, it is headed by a single director appointed for a fixed term of 5 years and removable only for cause, such as corruption or complete dereliction of duty.  Its powers are vast and vaguely defined: the power to regulate or even ban any product or loan term that it considers to be “unfair, deceptive, or abusive,” to engage in rule-making, or to bring litigation, including seeking penalties of up to $1 million per day for violations.

As currently structured, CFPB had only one meaningful democratic control—the power of the Senate to confirm the Bureau Director.  Yet even this tiny shred of democratic control was thrown out the window by President Obama’s decision to end-run this check and illegally appoint Richard Cordray as the acting director, even though Congress was not in recess.

What may be most striking about the CFPB is not just its extraordinary combination of power and unaccountability—although it may be the single most extreme combination of power and unaccountability in American history (except for those that have been struck down as unconstitutional).  It is the way in which CFPB ignores virtually all of the lessons of sound regulatory design that has been learned over the past century.  In fact, the CFPB resembles some sort of creature from Jurassic Park frozen in amber during the Nixon Administration and thawed out by President Obama to run the American economy.

Beginning during the Progressive Era and accelerating during the New Deal it was believed that all that was necessary was to cede power to independent “experts” who would bring technical expertise to bear on regulatory problems.  During the 1970s, however, America learned the damage that insulated, uncontrolled regulatory agencies can inflict on the economy—a period of economic stagnation, declining international competitiveness, and rising inflation, caused in large part by unresponsive regulation.  Beginning with Jimmy Carter and accelerating under Ronald Reagan, a bipartisan consensus came to recognize that unaccountable regulatory dinosaurs were strangling the American economy.  This bipartisan awareness prompted a wave of reform and, in some cases, even abolition of numerous dysfunctional and counterproductive regulatory agencies.

An agency headed by one person, completely insulated from democratic control and budgetary oversight, guarantees an agency that is vulnerable to all of the excesses that strangled the American economy in the 1970s—regulation that chokes innovation and cripples economic growth.  And, indeed, even in its short time in existence the CFPB is already manifesting the problems of cost externalization, undue risk aversion, and other regulatory costs.

To date, the CFPB has issued one final rule, governing cash remittances.  The CFPB’s own estimate is that compliance with the rule will impose 7,684,000 hours of compliance time for providers of cash remittance services.  The rule turned out to be so onerous for smaller banks that the CFPB eventually raised the threshold for requiring compliance with the rule from 25 transfers annually to 100.

And its long-awaited rule to simplify mortgage disclosures landed with a 1,099 pages thud last month—a rule so convoluted and confused that Jonathan Macey noted that it even drew criticism from Habitat for Humanity, which expressed concern that it would impede its “ability to enable low-income families to become homeowners” because of the barriers it erects to extending home-ownership to low income households.  Rather than merely simplifying disclosures, the proposed rule would impose a multiplicity of new substantive limits on high-cost loans—all of which will continue to strangle mortgage markets, constrict access to credit, and result in forcing lower-risk borrowers to subsidize higher risk.  For example, in the name of consumer protection the payments in exchange for a large payment at the end of the loan—even though recent research shows that these sorts of “complex” mortgages were used by the most sophisticated, high-income borrowers during the housing boom, and who have acted rationally and strategically in defaulting on them, not victims of predatory lending.  Similarly, the proposed rules cap late payment fees, forcing good risks to subsidize bad by making all consumers pay the additional costs that late payments create.

The proposed rule also prohibits prepayment penalties in high-cost mortgages, which reduce the interest rate that borrowers would otherwise have to pay—and even though there is no evidence that prepayment penalties increase foreclosure risk (in part because loans with prepayment penalties have lower interest rates and thus are more affordable than those without).  But even more important is that the CFPB’s proposal fails to appreciate the reality that consumers respond to incentives and well-intentioned paternalistic rules can be exploited by rational consumers.  Thus, while there is no evidence that the presence of prepayment penalties increase foreclosures, their absence can: by permitting borrowers to prepay and refinance their mortgages many borrowers were able to strip out their equity at the top of the market, increasing the number of underwater homeowners when housing prices later fell, and thus contributing to the foreclosure crisis.

In addition, the CFPB recently released a study on student loans that illustrates the politically-motivated nature of the CFPB’s decision-making and its failure to appreciate the problem of moral hazard by consumers.  It compares student loans made during the past decade to subprime mortgage lending in terms of its excess.  Moreover, it goes on to recommend easier dischargeability of student loans in bankruptcy—a proposal that would have disastrous consequences for the operation of the student loan market.  By their very nature student loans present a uniquely powerful problem of moral hazard and opportunism with respect to bankruptcy.  The standard bankruptcy proceeding enables a borrower to discharge all of her debt and shield her future income from creditors while surrendering her non-exempt assets to pay creditors.  But a college graduate, and especially a graduate of graduate school, will often have a large amount of debt but few assets—and the promise of high future income.  And while recent reforms to the bankruptcy code have reduced the incentives for high-income individuals to file bankruptcy, the problem still remains.  Yet the CFPB seems oblivious to the real problems of moral hazard implicit in their proposal.

But this political motivation behind the student loan study hardly is unique.  As House Government Reform and Oversight Committee Chairman Patrick McHenry has recently observed, there appears to be a remarkably high degree of political coordination between the White House and the ostensibly-independent CFPB.  Although the agency was touted as a non-political expertise-based agency, the CFPB, of course, was politicized from the beginning.  Rather than nominating an independent director in a timely manner, the White House instead decided to name the highly-partisan and ideological Elizabeth Warren to found the agency and oversee its initial actions.  Warren, of course, later used this position as a springboard to run as the Democratic nominee for the United States Senate from Massachusetts.

A final likely consequence of CFPB’s operations will be to promote consolidation of the banking industry.  Much of CFPB’s regulatory burden is compliance-related, such as paperwork obligations and the like.  Economists have long-noted that these burdens generally do not scale with output as other burdens do: Citibank’s forms may be longer than First Bank of Smallsville but the number of forms and the like are comparable.  This means that larger banks can swallow regulatory costs more easily as a percentage of their business than can smaller banks.  Moreover, larger institutions can better-afford the lobbyists and lawyers to find and exploit loopholes in CFPB’s operations than smaller banks.  Thus while regulatory capture is often a problem with Washington, the threat from CFPB is more dangerous: the imposition of new seemingly neutral regulations will give a comparative advantage to large banks over smaller banks.  Community banks and credit unions, for example, have expressed concern over the groaning cost of CFPB regulation already.  As Michael Martin, CEO of Lordsburg’s Western Bank put it, “We’re small business people.  We have to understand and comply with the regulations just like Wells Fargo.  We don’t have 70 attorneys on staff to figure it out.”

CFPB’s behavior to date unfortunately has vindicated the worst fears of its critics.  It has imposed rules with massive regulatory compliance burdens (such as its remittance rules) with minimal benefits.  Its study on student loans is a virtual invitation to moral hazard for borrowers by recommending expanded discharge in bankruptcy.  And its proposed rules on mortgages are hugely complicated and impose new substantive limits on high-cost mortgages that are going to increase costs and reduce choice to consumers.  Regrettably this sort of decision-making was entirely predictable for this agency with inadequate checks and balances.  And the lessons of regulatory design will have to be re-learned yet again.

Todd Zywicki

Todd J. Zywicki is George Mason University Foundation Professor of Law at George Mason University School of Law and Senior Fellow of the Mercatus Center. He is the co-author of “Consumer Credit and the American Economy” with Thomas A. Durkin, Gregory Elliehausen, and Michael E. Staten (Oxford University Press, 2014).

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  1. willis says

    For the next commissioner of the CFPB, I suggest President Romney appoint Mr. Jerry Sandusky. Not only does he bring talents uniquely suitable for the position, but he also comes with the advantage of being located precisely where the commissioner should be housed.

  2. says

    And according to Ms. Warren,Obama and all of their ilk ,all these consequences are a “Feature”,not a bug. And yet they continue to wonder why the economy is still stuck in a rut.Yep, that’s a real mystery.

  3. FSTate says

    Was there any mention that the law that created the CFPB required that the CFPB director be confirmed by the US Senate and that did not happen? Rather, Obama declared the US Congress to be in recess (when it was not) and made an imperial decree appointing the director (an extra legal act – aka illegal).

    The lack of legal standing of the CFPB and its director will lead to its shut down soon after 20 January 2013.

  4. Chris Low says

    The CFPB is a train wreck. Thankfully, because Cordray was a recess appointment, he is limited to a two-year term. But he can do, and is doing, a whole lot of damage in the interim.

    • says

      Todd, you are basically canllig the head of Bush’s OLC from 2005-2009 (and his deputy) incompetent. They both have publicly stated that pro forma sessions are shams that do not prevent recess appointments (see Bradbury and Elwood’s 2010 piece in the Washington Post about the subject), and we now find out from today’s OLC memo that they put their conclusions in writing to Bush at the time. As for the argument that the President can read “no business” as actually meaning “no business,” I don’t think that is particularly controversial. Sure, the Senate reversed its previous order and passed legislation on December 23rd. But so what? The ability of a Senate to reverse it’s previous order does not make the order meaningless; it just means that order was superseded by another order for that day. The Senate conducted no business since, under the order specifically forbidding business, and that duration is sufficient for an intra-session recess appointment according to decades of precedent (including 11th circuit judicial precedent). You are basically arguing that in 1800, the Senate could have taken a 9-month recess, with pro forma sessions forbidding any business for 9 months. These would supposedly block recess appointments for all 9 months, solely because the Senators could travel by Horseback back to Washington and reverse their previous order preventing business for 9 months. That sounds highly implausible as a matter of Constitutional interpretation.

      • says

        Let’s see where this leads. If unconstitutional, then so be it. Appointed reevpsentatires go. Maybe the President too.If this proves to be constitutional, which it probably isn’t, then the Republicans must apologize formally to the President.Also, isn’t Lamar Smith the same guy who proposed PIPA and SOPA? And he wants to talk Constitutionality with the President? Irony.

      • says

        Ok They made the government with a chckes and balances system for a reason. To ensure things are being done right and that no one branch or person gets to much power. If he is allowed to do this then others will do the same to bypass the system and chckes and balance will be a thing of the past and soon the US will be facing communism.

  5. John David Galt says

    The Federal Reserve Bank is not a federal agency at all, but a chain of privately owned banks to which Congress has granted special privileges. Thus, creating within the Fed an agency that can regulate all other banks is of questionable legality because of the conflict of interest it creates, and I’m surprised that no such case has yet been brought.

    And yet, the banking industry as it now exists is loaded with fraudulent practices that cry out to be regulated. For one thing, no bank’s main source of income should be overdraft fees, even when not accompanied (as it usually is) by dishonest manipulations such as not acknowledging deposits on the date received or holding deposited funds long after the deposited check has been redeemed by its issuer.

    I suggest that bank regulation be done by the states, and that the federal government not be involved in chartering any bank other than the Fed.

    • says

      “But even if some such acts are inconsistent with the Senate being in rpateeed and continuous session, then that is a problem senators can raise with their leadership. It is not a valid excuse for someone outside that branch to ignore the House s power under the Constitution and imagine the Senate sessions to be constitutionally meaningless. Who is the President to judge whether the Senate is doing enough for its proceedings to qualify as a recess?” Can the Senate adopt a resolution, just before taking a six-week vacation, saying they are NEVER in recess, and that no matter what we might see with our lying eyes, they are in perpetual session and ready to do business? Presumably not, because doing so would entirely negate the recess appointment power as well as be facially preposterous. Your earlier arguments maintain that the Senate IS in recess by some discernible objective standard. Let’s debate that. Suggesting that Congress has a unilateral authority, beyond all challenge, to negate the recess power, certainly proves too much.

      • says

        But it is the President’s job is to uphold the Constitution. From the Washington Post: Article I, Section 5, of the Constitution satets that neither house of Congress may adjourn for more than three days without the consent of the other house. The House of Representatives did not consent to a Senate recess of more than three days at the end of last year, and so the Senate, consistent with the requirements of the Constitution, must have some sort of session every few days.The president and anyone else may object that the Senate is conducting e2809cpro formae2809d sessions, but that does not render them constitutionally meaningless, as some have argued. In fact, the Senate did pass a bill during a supposedly e2809cpro formae2809d session on Dec. 23, a matter the White House took notice of since the president signed the bill into law. The president cannot pick and choose when he deems a Senate session to be e2809creal.e2809d

    • says

      But it is the President’s job is to uphold the Constitution. From the Washington Post: Article I, Section 5, of the Constitution sttaes that neither house of Congress may adjourn for more than three days without the consent of the other house. The House of Representatives did not consent to a Senate recess of more than three days at the end of last year, and so the Senate, consistent with the requirements of the Constitution, must have some sort of session every few days.The president and anyone else may object that the Senate is conducting “pro forma” sessions, but that does not render them constitutionally meaningless, as some have argued. In fact, the Senate did pass a bill during a supposedly “pro forma” session on Dec. 23, a matter the White House took notice of since the president signed the bill into law. The president cannot pick and choose when he deems a Senate session to be “real.”

      • says

        The obstructionist right wing of the Republican party left President Obama no other chioce. They have only one mission. Is it to protect consumers from the fine print in a mortgage agreement? NO! Is it to help middle class home owners take advantage of low mortgage rates and get there homes above water? NO!The only job the right wing politicians have is to make President Obama a one term president.The good of the country be dammed!


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