A wise man -- I believe it was Spanish-American philosopher George Santayana, or possibly Marty McFly, from the Back to the Future movies -- once sagely observed:  “Those who cannot remember the past are condemned to repeat it.”1

With that in mind, I think it worthwhile to examine an important, current public policy debate through the lens of recent history.  The question, currently posed in the debate over the Administration’s proposed Consumer Financial Protection Agency (“CFPA”), is simple:  should consumer financial protection responsibilities be undertaken by the same regulator responsible for overseeing a bank’s safety and soundness?

The Administration clearly believes that the answer is no -- that consumer protection should be separated, and reside in the CFPA. 

Double-Talk from the Bank Lobby

The opposite argument, perhaps not surprisingly, is made by the bank lobby.  As the powerful American Bankers Association (the “ABA”) argued before the House Financial Services Committee last month:

Consumer regulation and safety and soundness regulation are two sides of the same coin. Neither one can be separated from the other without negative consequences; nor should they be separated. An integrated and comprehensive regulatory approach is the best method to protect consumers and protect the safety and soundness of the financial institution.2

For anyone who was around consumer finance during the bubble years, this was a striking argument from the ABA.  Because during the lengthy, tortured debate between 2004 and 2006 on whether and how federal bank regulators should attend to the explosion in (later, the explosion of) non-traditional mortgages, the ABA -- the very same association, with the very same clients -- made almost precisely the opposite argument:

The [Nontraditional Mortgage] Guidance combines safety and soundness guidance with consumer protection guidance, creating confusion that is best addressed by separating the them [sic].3

Fortunately, the final regulatory guidance essentially ignored this argument, but the lengthy delays attendant to the bank lobby’s fierce opposition meant that effective regulation of bubble-inducing mortgage products arrived almost precisely too late.

Back then, the array of federal bank regulators (the Fed, FDIC, OCC, OTS, and NCUA) charged with safety and soundness were, the ABA claimed, inappropriately trying to combine issues of safety and soundness with consumer protection concerns.  Now that the White House is trying to pull consumer protection away from safety and soundness, the very same lobbyists are complaining that this, too, is deeply wrong-minded.

So, which is it?  Was the bank lobby making an unprincipled argument then, or now?  The answer:  both.  The ABA was then, and is now, simply making whatever jurisdictional argument suits its perceived short-term interests.

Do not misunderstand my point; the ABA was simply doing its job.  It is not the bank lobby’s job to make good policy decisions, nor does the bank lobby necessarily have the foggiest notion of how one should engineer a prudent credit policy, capital strategy, or liquidity plan.4 

They are in the business of making arguments, on whatever (sometimes meager) fact base they can cobble together, to support the short-term (and frequently short-sighted) financial interests of their clients.  That is their job.  They are not elected; they are not officers of the court; they are not looking out for the public good.

Let’s not forget that.

A Framework on Organizational Structure

But we are still faced with the core substantive question:  Should we create a centralized entity tasked with consumer protection, or leave consumer protection de-centralized, and resident with the various state and federal safety and soundness regulators?  

I trust we can agree on where not to look for guidance on structuring this inquiry.  But that doesn’t solve the problem; after all, just deciding to do the opposite of what the ABA recommends is also unprincipled.

Let me suggest an approach that parallels how similar private-sector organizational structure questions are sometimes resolved.  Granted, corporate re-organizations are sometimes maligned as pointless exercises.5  But judicious re-alignment of organizational resources can make or break strategic change.6  Virtually every organizational change implies trade-offs; determining whether any given change makes sense is a matter of weighing those trade-offs systematically.

In this context, we should weigh four considerations:

1. 1.Inter-relatedness of missions across regulators
   

2. 2.Uniqueness of issues across regulated firms
   

3. 3.Commonality of capabilities across regulators
   

4. 4.Redundancy of external contacts
   

This is a reasonably close question, but I believe the right answer is clear.

Starting from the the bottom of the list, it seems that adding a contact point between the CFPA and regulated firms creates interactions that are, inevitably, going to be either redundant with, or require coordination with, existing regulators’ interactions with regulated firms.  That is not a crippling problem, of course, but on the margin, the redundancy of external contacts does militate against centralizing the CFPA.

The middle two factors (commonality of capabilities and uniqueness of issues) favor the opposite conclusion -- that is, towards centralizing the CFPA.  It is difficult to argue with a straight face that existing regulators have remotely sufficient capabilities to handle consumer financial protection; thus, building strong capabilities at the CFPA can hardly be redundant.  Moreover, the relative fairness and transparency of consumer product offers are much more driven by product structures and the markets in which they operate, and much less on the particular vagaries on any given institution’s context.  In other words, consumer protection issues at Bank of America look a lot like consumer protection issues at Wells Fargo; and not much at all like, say, asset-liability management issues at either bank.

Mission:  Inextricable?

So the swing factor, it would seem, is the level of inter-relatedness between the CFPA’s mission and that of safety and soundness regulators.  The argument that the two are inextricably linked is made in various forms, and not just by the bank lobby.  Take this recent argument by the FDIC:

The current bank regulation and supervision structure allows the banking agencies to take a comprehensive view of financial institutions from both a consumer protection and safety and soundness perspective. Banking agencies' assessments of risks to consumers are closely linked with and informed by a broader understanding of other risks in financial institutions.7

This argument seems true, but only to the extent that it seems tautological.  It is easy to say that safety and soundness and consumer protection missions are closely linked because they provide an integrated viewpoint.  But that just begs the question:  why, specifically, is an integrated viewpoint important?  What, precisely, does it allow you to do differently as a regulator?

The answer, on closer inspection, is that an integrated viewpoint actually isn’t especially critical, or at least not so critical that it cannot be reconciled with inter-agency communication and coordination.

Indeed, the only meaningful linkage relates to the evaluation of consumer credit risk.  To the extent that customer-unfriendly product structures and practices invite adverse selection, that certainly informs credit loss behavior in a bank’s consumer portfolio.  But unfriendly structures and practices are just part of what drives adverse selection; adverse selection is just part of what drives consumer credit trajectory; consumer credit trajectory is just part of credit exposure more broadly; and credit is just part of safety and soundness evaluation.  To bootstrap from consumer protection responsibility to safety and soundness responsibility is an attenuated argument indeed.

To meaningfully link consumer protection and safety and soundness, one would have to be willing to force an institution to offer a product that would be customer-friendly but imprudent.  That seems a patently bad idea.  (Picture a regulator’s call to Bank of America:  “Ken, we know it would further threaten your solvency, but we’d like you to go ahead and increase auto finance approval rates across the board, because customers seem to like getting loans”).

Or, one would have to be able to identify a product or practice that is otherwise unacceptable from a consumer protection point of view, but that would be deemed acceptable because a financial institution’s overall health depended on it.  (Imagine a call to Citigroup:  “Vikram, we know that universal default re-pricing of credit cards is a bit of a rip-off, but we know you really need the money to help stay solvent, so go right ahead”).  That appears, on its face, comical.  Indeed, it would seem among the worst dynamics about combining safety and soundness and consumer protection in a single entity.

And yet, there is at least anecdotal evidence that this phenomenon occurs in reality:  the co-existence of the two responsibilities causes regulators to gloss over consumer protection when vigorous enforcement would be neutral to, or would impair, safety and soundness. 

Take, for example, the practices that persist under the banner of “free checking” in the industry.  Those practices (e.g. item sequencing) can seem aggressive to the point of unfairness, but they tend not to get much attention, because on balance, those practices help banks’ safety through fattened fee income streams.

Or, consider how most top banks, at the most frothy point in the cycle, owned affiliated mortgage banking units that offered non-traditional mortgages of questionable customer value and dubious credit quality.  Because most of those banks could argue that they were, or could be, selling those loans into still-receptive capital markets, regulators could have been lulled into believing that no major safety and soundness issues existed.  As a result, regulators took -- literally -- years to begin addressing a consumer protection problem that ultimately helped bring the real economy to its knees.

* * *

The question of how to structure consumer protection responsibilities is a close one, but the answer is still clear:  the CFPA should be structured as an agency independent from existing safety and soundness regulators.

Raj Date is the Chairman and Executive Director of the Cambridge Winter Center for Financial Institutions Policy.  He is a former McKinsey & Company consultant, bank senior executive, and Wall Street managing director.

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1 Come to think of it, it was probably Señor Santayana who came up with this aphorism before Mr. McFly.  The saying is called the “Law of Repetitive Consequences.”  George Santayana, Reason in Common Sense,  The Life of Reason, vol. 1 (1905).

2 Edward L. Yingling, Testimony on behalf of the American Bankers Association before the Committtee on Financial Services, U.S. House of Representatives, p. 6 (June 24, 2009), available at http://www.house.gov/apps/list/hearing/financialsvcs_dem/yingling.pdf.

3 Paul A. Smith, Public comment on behalf of American Bankers Association regarding Proposed Interagency Guidance on Nontraditional Mortgage Products, 70 Federal Register 77249, p. 7 (March 29, 2006), available at http://www.fdic.gov/regulations/laws/federal/2005/05c23guide.pdf.

4 Even aside from the questionable positions that it was advocating, the magnitude of the ABA’s substantive misreading of the credit bubble is striking:

Much of the tenor of the [proposed regulatory] Guidance is that nontraditional mortgage products are inherently riskier than other products. We believe that is incorrect; rather, they simply present different types of risks that may be well-managed by prudent lenders.

Id. at p. 2.  The industry lobby also seemed to have genuinely missed the impact that a stagnant housing market would have on borrowers’ ability to refinance out of trouble:

For example, payment shock would not be an issue if the borrower pays off the loan during the initial period, which is often the case, and lenders should be allowed to recognize runoff rates. Institutions with significant experience with these mortgage products state that a significant segment of borrowers in fact prepay principal at a faster rate than would occur on a 30-year fixed rate loan.

Id. at p. 4.

5 See generally Scott Adams, Dilbert and the Way of the Weasel (2002).

6 See generally Jonathan D. Day, Emily Lawson, and Keith Leslie, How Reorganization Works, The McKinsey Quarterly (June 2003).      

7 Sheila C. Bair, Modernizing Bank Supervision and Regulation, Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate (March 19, 2009).