In most respects, we live much safer lives today than we did a generation or
two ago. Our cars, our homes, our food, our toasters – all of them are
free now from many dangers that existed in decades past. The world of financial
products, by contrast, has moved in the opposite direction. Millions of Americans
suffer severe financial harm, up to and including foreclosure and bankruptcy,
because of financial products they bought in an age of ever-increasing financial-product
innovation. That innovation brought risk to the masses – something which
can carry no little upside, but which also has a very real cost in terms of
ruined lives.
Harvard’s Elizabeth Warren is at the forefront of efforts to implement a federal
regulatory agency which would be charged not with the protection of the financial
industry itself, so much as with the protection of the consumers it serves.
She has a manifesto
of sorts in the latest issue of Democracy: A Journal of Ideas, which I linked
to a couple of weeks ago, and which is well worth reading. I spoke to her
this afternoon, to ask her more about her ideas – ideas which seem to
be popular with John
Edwards:
Edwards’ plan includes a Borrower’s Security Act, new rules for the credit
card industry to help give consumers debt relief. He also would limit payday
loans, which frequently are used by low-income earners.
He said he would create a Family Savings and Credit Commission to help protect
consumers from abusive financial practices. He also said he would eliminate
the Office of Thrift Supervision, a financial regulatory division under the
Treasury Department that he called an “excess regulatory bureaucracy.”
When she spoke to me, Warren said that "credit products aimed at both
middle class and poor families are designed to trick them, trap them, and otherwise
pick their pockets," and that a principles-based federal regulator was
needed to address the problem.
That regulator would regulate more than just credit products such as credit
cards, payday loans, and mortgages. It would also, in Warren’s vision, regulate
a host of other financial products as well, including checking accounts, with
their sometimes-enormous fees, and money remittances, which can also be very
expensive, especially if they’re sent from a local corner shop rather than from
a bank.
"It’s not that you want to ban Western Union," explained Warren.
"It may be appropriate to ban certain hidden fees and high costs. Safety
regulations can promote consumer-friendly competition and also can be good for
business."
What Warren wants to do is prevent the race to the bottom that is reasonably
common at the moment. She’s currently in the middle of a field project, where
she’s examining a representative cross-section of indivduals who declared bankruptcy
in March. One of those individuals is a 78-year-old widow, whose husband died
18 years ago and who bought a small house where she could look after her elderly
sisters. Her social security check covered the mortgage payments.
Three years ago, a "nice lady" at a bank phoned her up and persuaded
her to take out a variable-rate mortgage, on the understanding, or so she thought,
that she could switch back to her fixed-rate mortgage if rates went up. Of course,
she couldn’t, and now this 78-year-old widow is in foreclosure and is going
to have to live in her car.
"There’s nothing on the face of the story that makes this unlawful,"
says Warren. "If she had understood the deal the bank was offering, her
answer would have been no, no, and a thousand times no. But it’s the deal she
took, not the deal she understood."
Warren sees a bigger picture, too:
Not only did that mortgage company steal from her, they also stole business
from the mortgage company where she had been paying. They also stole from
every competitor in the marketplace who doesn’t want to engage in that kind
of predatory behavior.
If creditors are banned from using certain very profitable but deceptive practices,
then their competitors in that marketplace can build a business around a cheaper
product.
Warren is not trying to protect people from bad decisions. "People will
still be able to get in trouble with credit," she says. "This idea
is designed to stop the tricks and traps."
It might well be an idea whose time has come. It’s quite astonishing that a
large range of sophisticated financial products, from mortgages to insurance
contracts, are sold by entities who are either completely unregulated or who
are regulated at such arm’s length and with such little regard for consumers
that they might as well be unregulated. A mortgage broker, for instance, is
quite within her rights to sell a prime credit a subprime mortgage – and
as a result, a very large proportion of subprime mortgages, perhaps as many
as half, have been issued to people who could have borrowed much more cheaply.
"None of the regulatory agencies has the consumer as its primary focus,"
says Warren. "The obligation of the Fed, the OCC, the OTS and the other
federal agencies is to protect the profitability of the financial institutions
and the stability of the financial markets."
Warren contrasts the situation on the mortgage front with the situation in
the securities industry. Securities brokers, unlike mortgage brokers, do have
a fiduciary duty, and are reasonably heavily regulated. Anybody can still buy
a high-risk security if they really want, but they’re unlikely to be pushed
that security by a broker. And that makes a world of difference, in practice.
Says Warren:
If we look at the SEC and the broker-dealer rules, much of this protection
is already in place for people who hold stocks. The phone call to the elderly
widow could not have been made from a brokerage. Why is your stock portfolio
better protected than your home?
It’s easy for people living in the world of finance to lose sight of how mortgages
and other consumer products work in practice: "Americans don’t see mortgages
as risk products," she says, despite the fact that in recent years they
have been used that way, to make highly-levered bets on the housing market.
If someone wants to make a speculative housing bet, Warren is happy to let
them do so. If they tick a box saying that they’re financing their house as
a speculative investment, and they’re clearly cognisant of the fact that if
they can’t refinance or sell in two years then they might not be able to make
the mortgage payments when their ARM adjusts, then they should be free to take
out that kind of mortgage. Warren just wants to make sure that products which
make sense for housing speculators aren’t being sold to normal families who
have every intention of staying in their home for decades.
Neither Warren nor I has any desire to ban subprime mortgages, and it’s worth
emphasizing that neither of us is particularly unhappy with the interest rates
that many borrowers pay. In extreme circumstances, they can certainly be excessive,
as in the payday lending industry or on certain credit cards. But what Warren
is proposing is not – or not only – some kind of anti-usury device
which would stop lenders from charging market rates for money. Rather, it’s
an attempt to inject some transparency and accountability and responsibility
into a system which at present verges on anarchy and thrives on obfuscation.
I’m sympathetic. In an era of disintermediation, consumer-finance companies
are making bigger profits than ever, which is weird. They’re also generally
extremely unpopular. Any well-meaning company finds it hard to compete against
sleazier companies with hidden fees: as a board member of my local credit union,
I’ve noticed this myself. Debt is a good and necessary thing, and no one is
advocating that it be abolished. But there’s no good reason to hide from borrowers
the true costs of their debt.
