Elizabeth Warren: New paradigm needed to protect consumers

BY MATTHEW HUTCHINS

What is the highest actual interest rate that you pay on a credit card? What would it take to bring a lawsuit against the issuer if they cheated you? What would happen if you  missed a payment on your student loans? If you own a house, how much will the  mortgage cost you over its lifetime? If you think you can answer these questions, Elizabeth Warren thinks you are probably wrong.

Prof. Warren captured national headlines as the head of the Congressional Oversight Panel for the Troubled Asset Relief Plan, appeared on Jon Stewart’s Daily Show, and was on Time magazine’s list of the 100 Most Influential People of 2009. Now she is fighting to bring transparency and accountability to American consumer finance, and with bills in the House and the Senate, she hopes the creation of a Consumer Financial Protection Agency will become a major legislative priority during the run-up to this year’s midterm elections. Speaking at Harvard Law School on March 30th, she outlined why we need a new agency to regulate consumer financial products and how such an agency should change the way we think about consumer lending.

According to Prof. Warren, the current regulatory regime is fundamentally deficient because it is not comprehensive enough to stop evasive lenders from side-stepping a regulatory net that is cast by seven separate banking regulators, none of which is charged with the primary responsibility over consumer finance. Federal consumer  finance regulation has to this point worked by imposing a series of unconnected restrictions without laying out a comprehensive statutory framework.

“This is like putting down fence posts on the prairie with nothing between them,” Warren observed. “Anyone that hires a lawyer can just step right or left and avoid hitting one.”

The core problem, according to Warren, is that the credit agreements for almost all consumer lending arrangements are far too complicated for even contract lawyers to understand. Long credit agreements with complicated provisions like stepped-in teaser rates, sixteen pages of small print, and “double reverse half twist” interest calculation make it impossible to compare, side-byside, the price of financial products in the same class or understand the rights granted to each party. “This is all about obscuring the risk associated with these financial instruments.” Warren believes that these agreements should be simplified to a two-page term sheet that a high-school level reader could understand with 95% comprehension.

“Whenever the consumer can’t price the item,” she remarked, “we’ve got a broken market.”

According to Prof. Warren, the current “tricks-and-traps” model of banking has evolved in the wake of a series of changes in federal preemption that made it possible for national banks to take advantage of the permissive lending laws in states like South Dakota and Delaware. Usury laws, which date back to biblical times and the book of
Deuteronomy, have thus lost their effectiveness, and with states curtailed from enforcing maximum interest rates, banks have navigated the array of federal regulatory regimes by devising complex provisions like double-cycle billing that will go unnoticed by most consumers but that generate large amounts of fees.

Warren sees past efforts at regulating consumer lending as misconceiving of the entire problem. “This is not contract law” she said. “These are products.” She likened the need for a consumer finance regulator to the need for a body that ensures the safety of  pharmaceuticals, food products, clean water, or toys for children. Like the manufacturers of toasters, Warren said that banks should be forced to meet certain standards of reliability before a product can be put on the market, and that instead of foisting tricks-and-traps and ticking time bombs upon their customers, banks should be required to compete with the most visible and understandable components of a loan.

Warren admitted that she herself once thought that the function of a regulator could be fulfilled by a quality certification system, and she said that she even worked to develop something like the Underwriters Laboratories method of guaranteeing the quality of financial assets. But she said that in her experience, bank executives that initially found the idea of transparent disclosures appealing would ultimately resist change, fearing that “people wouldn’t use credit cards if they knew how much they really cost.” Indeed, according to Prof. Warren, even banking industry representatives have advocated the creation of a separate consumer finance regulator, have admitted that many of their own practices are difficult to understand, and have expressed concern that some financial products should be flatly prohibited.

Questions about the final shape of a consumer finance regulator or the time frame for its creation remain unanswered, but Prof. Warren said that now is the right time – in the wake of a financial crisis and while the economy remains weak – to get an agency in place. Whether it sets forth pre-approved “plain vanilla” financial product contracts as she has envisioned or merely acts as a single body to concentrate political accountability for regulatory authority over consumer lending, Prof. Warren said that she sees the creation of a new agency as a way of creating a “keeper of the flame” in  Washington. “If what you care about is family economic security, there’s no place there.”

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