House Hears Financial Industry Perspective on Reform Plan

By W. Bernard Mason

On July 15, 2009, the House Financial Services Committee held a hearing to obtain financial services industry representatives' perspectives on the Administration's regulatory reform plan. Testifying were: Steve Bartlett, representing the Financial Services Roundtable; John Courson, representing the Mortgage Bankers Association; Chris Stinebert, representing the American Financial Services Association; Steven Zeisel, representing the Consumer Bankers Association; Todd Zywicki, Professor of Law; Denise Leonard, representing the National Association of Mortgage Brokers; Edward Yingling, representing the American Bankers Association; and, Michael Menzies, representing the Independent Community Bankers Association.

Committee Chairman Barney Frank (D - RI) opened this hearing by indicating that he will be attempting to complete mark-ups on some pieces of the regulatory reform effort by the end of July, but other portions (he specifically mentioned issues dealing with systemic risk) will not be completed until September. He stated that he had scheduled a separate hearing for July 21 specifically to deal with the issue of "too big to fail". He stated that, while he felt the Administration's proposal had dealt with this matter in a reasonable way, he wanted to provide an opportunity to air all points of view on the issue.

Regarding matters relevant to the current hearing, he mentioned that his staff had compiled documentation regarding the many consumer complaints that he said had been received from Members on both sides of the aisle regarding the actions of credit card companies doing things in anticipation of the effective date of the recently signed legislation. He said that there had been agreement to hold off the effective date of the law as an accommodation to the industry, but he now questions to wisdom of the action because of moves taken by credit card lenders. He specifically cited a move by lenders to significantly increase minimum monthly payment requirements on existing balances, which he feels is particularly egregious, as it is "changing the rules after people have starting playing". He said had borrowers known their payments were going to be increased, they might have made other choices regarding their loan balances. He said credit card holders of one major lender had been told by bank personnel that the payment increases were mandated by federal law. He said these actions are the very types of things that strengthen the case for the creation of a Consumer Financial Protection agency. He said "We cannot pass a law every time there is a set of complaints." He said what we need are rules, and it has not been the case that existing regulators have used the statutory authority given to them. He said the complaints about credit card banks have become very significant.

Chairman Frank stated that the hearing's witnesses may object to the creation of a new consumer agency, but he made clear that no objection should be raised based upon a concern that this might cause a regulated institution to get conflicting messages from two regulators. He said he can guarantee that this law can be written to prevent that. He admits that, in his view, the Administration made a mistake in including CRA as a matter to fall under the purview of the new agency, as he believes this "is of a different order or activity". On another issue, he said that the concept of merging the OTS and the OCC would be a true "merger" of the two, not a take-over by the OCC, since Rep. Frank believes the thrift charter and function should be preserved and there will be no move to abolish the charter. He said the intention would be to narrow the focus of the charter so that it is "a thrift charter only" and not a license to engage in other activities.

Rep. Randy Neugebauer (R - TX), in his opening remarks, stated his concern that the entire process had been directed toward new legislation. He said the fact is there is already legislation on the books that addresses much of the problem areas; the problem is that regulators didn't do their jobs regarding proper enforcement.

The first witness, Mr. Bartlett, stated there were many factors that caused the problems that brought us to this point, but he believes the main one was a regulatory system in chaos that was just not functioning properly. He said the Financial Services Roundtable supports bold, comprehensive reform. He said the Roundtable strongly opposes creation of a new consumer protection agency and strongly supports the designation of the Federal Reserve as the systemic risk regulator. He believes the creation of a strong federal insurance regulator should be an essential part of this regulatory reform.

Mr. Courson seconded most of Mr. Bartlett's statements, emphasizing the need for uniform regulation of all mortgage service providers. Mr. Stinebert remarked that the proposed legislation has the potential to "roll back the clock 30 years", back to a time when consumers had no choice of products, and he believes this proposal will stifle industry innovation. He also pointed out that, under this proposal, institutions could "wind up with 50 different state requirements" and "that is not a formula for simplification." He also emphasized the importance of preserving the industrial bank charter, since it played no role in the current crisis and he believes they should be part of the solution.

Mr. Ziesel stated that safety and soundness and consumer protection are intimately related and the two functions should not be separated. He said there should be stronger supervision of non-bank lenders so there is consistent and competent oversight of mortgage lenders. He also cited the problem of subjecting retail banks to the consumer laws of 50 states, making nationwide lending a costly and complex undertaking. He indicated that this would limit the range of products and perhaps drive banks to avoid doing business in certain states. Even simple uniform disclosures, one of the goals of this legislation, would have to be supplemented to meet the requirements of each individual state, he stated. He believes the better approach is to maintain a uniform national standard. He further stated that the push for "plain vanilla" products makes it unclear that banks will be able to offer the range of products they now do. This is because the proposal discourages the offering of other products consumers may find useful by creating regulatory uncertainty regarding how these "non-vanilla" products must be described, how they can be advertised, and what disclosures will be required to accompany them. He said it is also unclear if institutions would be required to offer the same "plain vanilla" product to everyone regardless of whether they qualify.

Mr. Zywicki stated his view that there are three fatal problems with the proposal to create a new consumer agency: it is based on misguided paternalism; it misdiagnoses the underlying problems and could lead to unintended consequences; and, it creates an unworkable new government planning apparatus.

Ms. Leonard said her organization supports the general concept of a separate consumer agency. She said consumers would greatly benefit from a uniform disclosure requirement that clearly and simply explains critical loan terms. She also pointed out that the board structure of the new agency, as proposed, is flawed, since its board members would not be limited as to party affiliation. She said the five-person board should have no more than three members of any one political party.

Mr. Yingling said ABA believes there are three areas that should be the primary focus of regulatory reform: the creation of a systemic regulator; the creation of a new resolution mechanism; and, filling the gaps in regulation of the shadow banking industry. Regarding systemic regulation, Mr. Yingling said this should not be about focusing on specific entities or institutions, but about looking at information and trends on the economy and different sectors within the economy. Such problematic trends from the recent past would have included: the rapid appreciation of home prices; the proliferation of mortgages that ignored the long-term ability to repay; excess leverage in some Wall Street firms; the rapid growth and complexity of some mortgage-backed securities and how they were rated; and, the rapid growth of the credit default swap market. The new regulator should be focused and nimble; involving it in day-to-day regulation would be a distraction. He noted that, while most of the early focus had been on giving this systemic risk authority to the Federal Reserve, now the focus is on giving it to an independent council. He said this approach makes since, but it should not be a committee. The council should have its own dedicated staff, but it should not be a large bureaucracy. The council should have "carefully calibrated back-up authority" when systemic issues are not being properly addressed. He believes a board consisting of the primary regulators plus Treasury seems logical. He believes the systemic regulator should have authority over accounting rulemaking, due to the critical relationship of accounting rules to systemic risk. Regarding systemic resolution authority, Mr. Yingling said whatever is done on this front will set the parameters for "too big to fail". He said ABA is concerned that this issue is not adequately addressed in the Administration's proposal. ABA believes the goal should be to eliminate, as much as possible, moral hazard and unfairness. When an institution goes into this resolution process, its top management, board, and major stakeholders should be subject to clearly set out rules of accountability, change, and financial loss. He said no one should want to be considered "too big to fail". He said the ABA strongly supports maintaining the federal thrift charter.

Mr. Menzies said ICBA supports identifying specific institutions that may pose systemic risk and systemic danger, and subjecting them to stronger supervision, capital and liquidity requirements. He said the Administration's plan could be enhanced by imposing fees on systemically important holding companies for their supervisory costs and to fund, in advance, a new systemic risk fund. He said the plan should also implement procedures to downsize "too big to fail" institutions in an orderly way. He stated that ICBA urges continuation of both the state bank and the federal thrift charter. He said ICBA opposes the proposal for a new consumer protection agency, in its current form. ICBA urges the addition of an Assistant Secretary for Community Institutions within the Treasury Department to provide an internal voice for main street concerns.

Chairman Frank observed that most of the witnesses hold concerns regarding the extent to which the proposal would recognize state consumer protection authority. He said he assumes it is the position of the witnesses that any proposal should include federal preemption of such state authority. Except for Ms. Leonard, they all concurred that a national uniform standard was called for.

Rep. Neugebauer observed that, in his past experience as a banker, he was often called upon to tailor products to fit specific customer needs. He fears that the Administration's proposal is not a consumer protection bill, but a product regulation bill. He requested the panel's views on the federal government becoming very prescriptive in the types of products allowed to be offered. Mr. Bartlett said the government should regulate for safety and soundness and consumer protection but should not dictate products. The other panelists agreed with that observation.

Rep. Paul Kanjorski (D - PA) asked the panel if any of them believed either CRA or the activities of Fannie Mae and Freddie Mac had been contributing factors to the current crisis. None of the panelists felt that those factors were contributors to the crisis. Rep. Kanjorski then asked the panel if any of them recognized this problem building. Mr. Bartlett said the Roundtable saw troubling signs in 2006 but did not move quickly enough to deal with them. Mr. Yingling said that the failure to recognize the signs is clear evidence and support for the creation of a systemic risk authority.

Rep. Edward Royce (R - CA) stated his view that both Freddie and Fannie were driven by the misguided altruistic belief that the highest possible stretch for homeownership was to the benefit of consumers. He believes it would be very difficult to create a separate regulatory entity, charge it with consumer protection oversight, and then not expect it to come up with a similar, politically driven mandate. He believes these politically driven mandates caused the financial collapse. He asked the panel to comment on the prospect of the Consumer Financial Protection Agency being used for politically mandated purposes in the future. Mr. Courson said he is concerned that we are attempting an experiment that may ultimately cause safety and soundness concerns. Mr. Zywicki agreed.

Rep. Maxine Waters (D - CA) inquired as to why mortgage servicers cannot understand that we have a crisis and that we need to intensify the loan modification process to avoid massive foreclosures. Mr. Bartlett said Roundtable members are now modifying approximately 250,000 mortgages per month and he admitted this pace was woefully inadequate.

Rep. Frank Lucas (R - OK) asked Messrs. Yingling and Menzies to comment on the effect of the Administration's proposal on community banks and small businesses. Mr. Yingling said his main concern is the directive that products should be standardized, since loans in small communities are not "cookie-cutter", they are individually designed. Based upon the strong language in the Administration's proposal, community banks would be discouraged from making custom-designed loans due to the potential adverse consequences from the consumer agency. Mr. Menzies said community banks were the victims in this crisis due to the toxic products created by Wall Street and the mega-banks. He said the government should not take away his ability as a community banker to be creative in order to take care of the needs of his customers.

Rep. Mel Watt (D - NC) said he recognized the opportunity for conflict between two regulators working on the same turf, but he does not necessarily see the conflict between safety and soundness and consumer protection disciplines. He said there may be cases where the two overlap, but he says he is troubled by the notion that if the two are separated, there will be some sort of inherent conflict. He understood the resistance to change, but in his view the current structure "didn't work". He believes the industry's "conflict" argument is more a motivation to keep consumer protection subordinate to the other objectives. He said he is also puzzled about Mr. Bartlett's suggestion that the federal government set up a new insurance regulator, which will represent new costs, yet we shouldn't spend the money to set up a new agency whose sole responsibility is to deal with consumer issues. Mr. Bartlett said he is not advocating the status quo. He said important pieces of existing consumer protection legislation are not in the hands of the safety and soundness regulators, and they should be.

Rep. Judy Biggert (R - IL) asked how a federal standard would promote consistent regulation if it allowed the states to add on their various requirements. Mr. Courson said that is one of his concerns. In his view, if there had been a national standard, many of the current problems could have been avoided. He pointed out that state requirements would add more complexity, which is the opposite of the Administration's stated intention.

Rep. Gary Miller (R - CA) said he disagreed with many of his Republican colleagues that Fannie and Freddie should be phased out. He believes they perform an essential function, but need to be more strongly regulated. He then cited some consistent thoughts among the witnesses' testimony: concern about creating winners and losers; more government could be more confusion; more uniformity; need for systemic risk oversight; national standards; and inconsistent or inadequate enforcement. He asked the panel their views regarding an alternative outcome had the regulators enforced the rules already on the books, and if they believed the regulators already have most of the authority needed to accomplish the goals stated in the Administration's proposal. Mr. Zeisel stated that there are a lot of tools already available and some new ones that have just now been implemented that would permit the Administration's objectives to be achieved. Mr. Bartlett said the laws themselves may be adequate, but the allocation of responsibility for enforcement is inadequate and needs to be addressed by Congress. He said this does not mean that a new agency is justified; the existing agencies should be further empowered.

Rep. Dennis Moore (D - KS) asked about the costs of the Administration's proposals. Mr. Yingling said the cost of the new consumer agency is entirely unknown; however, it would be mandated to examine and administer enforcement actions with respect to the currently unregulated lending entities now operating, and that would require a significant budget. He stressed that the ABA wants this done, but the question is how to pay for it. He said if the budget is prepared "on the cheap", it cannot do what it is required to do and will end up discriminating by concentrating its enforcement actions on insured institutions. Mr. Courson says his organization has advocated for more regulation of the "shadow" banking industry, and has argued that these entities will have to share in the costs of running the agency. He said everyone recognizes there will be additional costs associated with more consumer regulation, whether it is housed within the existing safety and soundness regulator, or in a new agency.

Rep Jeb Hensarling (R - TX) asked if, under the proposed legislative language, a prepayment penalty included in a 30-year mortgage would be considered "fair". Mr. Yingling responded by stating that the regulatory discretion contained in the language of this legislation "changes everything". "There has been no law authorized by Congress in the consumer area, no regulation that isn't trumped by this." Rep. Hensarling observed that this legislation is aimed at consumers but, based upon Federal Reserve data, most small businesses use credit sources under an individual name and would thereby be brought under the legislation's purview. He inquired if this proposed legislation, and its potential to limit financing choices, could harm small businesses and job creation. Mr. Zeisel said small businesses definitely would be impacted by this.

Rep. Adam Putnam (R - FL) asked whether the crisis is far enough behind us for us to understand the causes and make the sweeping regulatory reforms that are being contemplated. Mr. Menzies said there are differing opinions as to whether the problem is fully behind us, and it also presupposes a need for legislation to deal with the problem. He said it is very important to focus on what caused the problem. "We can have all the product legislation in the world, we can do everything possible to protect the consumer, but the greatest damage to the consumer was the failure of the system because of concentrations and excesses across the board of the Wall Street vehicles that gathered together substandard, subprime, weird mortgages that community bankers didn't make, created a warehouse to slice and dice those entities, made huge profits selling off those items and had very little skin in the game, very little capital at risk." He emphasized that this is what deserves attention. He said "too big to fail" and "too big to regulate" are issues that must be dealt with. "And from the perspective of community banks, that is the crisis of the day, that's what destroyed the free market system", he concluded.