Consumer Protection as Systemic Safety

The Senate is in the midst of a fierce battle over the future of the consumer-credit market. If you aren't watching, you should be.

While President Barack Obama and reform advocates are pushing for the sort of meaningful rules that would fix a badly broken credit market, Wall Street is pouring millions of dollars into blocking any changes that could force the industry to change how it does business. At the center of this fight is a proposal for a new consumer agency with the authority to write meaningful rules and with the teeth to enforce those rules.

Senate Banking Committee Chair Chris Dodd's latest proposal, which the committee recently reported to the full Senate, would house the watchdog in the Federal Reserve System. Although the agency would not be stand-alone, as it was in the version Barney Frank led the House to approve, the Senate bill still gives it substantial authority. Sen. Jack Reed of Rhode Island is pushing for a truly independent agency, as the president proposed, while Sen. Richard Shelby of Alabama is leading the charge to put the agency more directly under the thumb of the regulators who have routinely favored banking interests. Whether the consumer agency can survive in meaningful form will be up to the Senate in the days ahead and then the House-Senate conference.


Today, nearly every product sold in America has passed basic safety standards well in advance of being put on store shelves. A focused and adaptable regulatory structure for drugs, food, cars, appliances, and other physical products has created a vibrant market in which cutting-edge innovations are aimed at attracting new consumers. Businesses can't boost profits by substituting baking soda for antibiotics or weaker plastics in infant car seats. To grow, they need to make safe and effective products that satisfy consumers.

By contrast, credit products are regulated by a bloated, ineffective concoction of federal and state laws that have failed to adapt to changing markets. Costs have risen, and innovation has produced incomprehensible terms and sharp practices that have left families at the mercy of those who write the contracts. Profits come from tricks and traps, surprise fees, hidden risks, and sudden increases in interest rates.

While manufacturers have developed iPods and flat-screen televisions, the financial industry has perfected the art of offering mortgages, credit cards, and check overdrafts laden with hidden terms that obscure price and risk. Good products are mixed with dangerous products, and consumers are left on their own to sort out which is which. The consequences can be disastrous. More than half of the families that ended up with high-priced, high-risk sub-prime mortgages would have qualified for safer, cheaper prime loans. A recent Federal Trade Commission survey found that many consumers cannot understand, or even identify, key mortgage terms.

This information gap between lender and borrower exists throughout the consumer-credit market. So-called innovations in credit charges -- including teaser rates, negative amortization, increased use of fees, universal default clauses, and penalty interest rates -- have turned ordinary credit transactions into devilishly complex undertakings. Study after study shows that credit products are deliberately designed to obscure costs and to trick consumers. The average credit-card contract is dizzying. Credit-card contracts that were a little over a page long in 1980 have ballooned to an unreadable 30 pages today. Lenders advertise a single interest rate on the front of their direct-mail envelopes while burying costly details and hidden fees deep in the contract.

Faced with impenetrable legalese and deliberate obfuscation, consumers can't compare offers or make clear-eyed choices about borrowing. Creditors can hire an army of lawyers and MBAs to design their programs, but families' time and expertise have not expanded to meet the demands of a changing credit marketplace. As a result, consumers sign on to credit products focused on only one or two features -- nominal interest rates or free gifts -- in the hope that the fine print will not bite them. Real competition, the head-to-head comparison of total costs that results in the best products rising to the top, has disappeared.

What's worse, the proliferation of toxic products fed enormous and unsustainable risk into the financial system. The lack of meaningful consumer-protection rules triggered an economic crisis that truly began one household at a time, eventually rocking the most storied institutions on Wall Street and wrecking the larger economy. While the explosive growth of risk and deceptive consumer products should have served as an early warning system, Washington plainly wasn't paying attention.

The lack of meaningful oversight in Washington is the direct result of the immense political power of the financial industry and its success at heading off robust rules. The industry's onslaught over time has left us with a sluggish, bureaucratic regulatory system that is designed to be ineffective. Today, consumer-protection authority is scattered among seven federal agencies. But not one of those agencies has real accountability for making consumer protection work, and, as a result, not one has been successful at doing so.

The seven agencies with a piece of consumer protection have failed to create effective rules for two structural reasons. The first is that financial institutions can currently shop around for the regulator that provides the least oversight. Bank-holding companies can shift their business from their regulated subsidiaries to those with no regulation- -- and no single regulator can stop them. The problem is exacerbated by the funding structure: Regulators' budgets come in large part from the institutions they regulate. To maintain their size, these regulators compete to attract financial institutions, with each agency offering more bank-friendly regulations than the next. The result has been a race to the bottom in consumer protection.

The second structural flaw is cultural: Consumer-protection staffs at existing agencies are small, are low priorities for funding, and invariably play second fiddle to the primary mission of the agencies. At the Federal Reserve, senior officers and staff focus on monetary policy, not protecting consumers. At the Office of the Comptroller of the Currency and the Office of Thrift Supervision, agency heads worry about bank profitability and capital adequacy requirements. As the current crisis demonstrates, even when they have had the legal tools to protect families, existing agencies have shown little interest in meaningful consumer protection.

The new consumer agency is designed to fix these structural problems by consolidating the scattered authorities, reducing bureaucracy, and ensuring an agency in Washington is on the side of families to counterbalance the industry's enormous political power. By giving this agency a clear mission and making it answerable directly to Congress and the American people, we can begin to reverse decades of regulatory capture. By staffing it with people who believe in the importance of family economic security -- not just banking profits -- we can allow the agency to develop the expertise to fix the broken consumer-credit market and give families a fighting chance against the resources of Wall Street banks.

The consumer agency would be able to revolutionize consumer credit by promoting simple, straightforward contracts that allow consumers to make better-informed choices. For decades, policy-makers mistakenly followed the principle that more disclosure promotes product competition. What they missed is that more disclosure is not necessarily better disclosure. The extra fine print has given creditors pages of opportunity to trick unsuspecting customers. Comparison shopping has become impossible.

The new agency would cut through the fragmented, cumbersome, and complex consumer-protection laws, replacing them with a coherent set of smarter rules that will bring more competition into the market. These rules will drive toward shorter, easier to understand agreements, like the one-page mortgage agreement promoted by the American Enterprise Institute. Shorter, clearer contracts will allow consumers to begin making real comparisons among products and to protect themselves. Better transparency will mean a better--functioning market, more competition, more efficiencies, and, ultimately, lower prices for the families that use them.

A century ago, anyone with a bathtub and some chemicals could mix and sell drugs -- and claim fantastic cures. These "innovators" raked in profits by skillfully marketing lousy products because customers weren't equipped to analyze and compare treatments. In the decades following, the Food and Drug Administration developed a few basic rules about safety and disclosure, and everything changed. Companies had greater incentives to invest in research and to develop safer, more effective drugs. Eliminating bad remedies made room for creating good ones.

The FDA cannot prevent drug over-doses, and the new consumer agency cannot stop overspending. Nothing will ever replace the role of personal responsibility. A credit-card holder who goes on an unaffordable shopping spree should bear the consequences, as should someone who buys an oversize house or a budget--busting new car. Instead, creating safer marketplaces is about making certain that the products themselves don't become the source of trouble.

Most consumers -- those willing to act responsibly -- would thrive in a credit marketplace that makes costs clear up front. And for the vast majority of financial institutions that would rather win business by offering better service or prices than by hiding "revenue enhancers" in fine print, the consumer agency would point the way to a more efficient and competitive financial system.

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