Dodd to Defang Financial Reform?

Senate Banking Committee Chairman Chris Dodd's effort to house a new
Consumer Financial Protection Agency under the Federal Reserve is
fatally flawed. For the past two decades, the Fed has aligned itself
with any policy that boosts short-term profits for America's largest
banks, regardless of the consequences for consumers or the broader
economy. But even worse is Dodd's effort to block the new agency from
enforcing the rules it writes, leaving enforcement up to the same
regulators who ignored rampant predation and outright fraud throughout
the housing bubble.

The bank lobby and its boosters in the Republican Party have been
targeting the CFPA since President Barack Obama proposed creating it in
July. It's easy to see why: for the first time, a regulatory agency
would be concerned with protecting the public, rather than bank balance
sheets. That's good news for the economy, but bad news for quarterly
earnings at major U.S. banks. Republicans are doing anything they can to
gut the proposal, and several back-lobby-backed Democrats are reluctant
to push for a strong agency. But instead of forcing lawmakers to cast
vote siding with the bankers, Dodd appears ready to let the agency die
without even extracting a political pound of flesh.

If the new CFPA cannot enforce its own rules, it is effectively
powerless. All the good rules in the world don't amount to anything
without strong enforcement, and the existing federal bank
regulators--the Federal Reserve, the Office of the Comptroller of the
Currency (OCC) and the Office of Thrift Supervision (OCC)--have proven
time and again that they simply are not interested in enforcing consumer
protection laws.

All of the major federal banking regulators were fully aware of the
dangers of predatory mortgage lending well before the mortgage meltdown
destroyed the financial system in 2008. In 1994, Congress gave the Fed
power to police the entire mortgage market, from small specialty
subprime shops to banking behemoths. As early as 2001, the Fed and other bank
regulators issued a guidance warning about subprime loans. That guidance
included simple, common-sense standards: make sure you can afford to
make these loans, and watch out for predatory lending. The trouble is,
as soon as these rules were issued, the Fed and fellow regulators
developed a policy of actively looking the other way on abusive subprime
lending. The rules were good. They simply decided not to enforce them.

The Fed identified three key aspects of predatory lending that
it was would crack down on with its 2001 rules, including:

"Making unaffordable loans based on the assets of the borrower rather
than on the
borrower's ability to repay an obligation;

Inducing a borrower to refinance a loan repeatedly in order to charge
high points
and fees each time the loan is refinanced ('loan flipping'); or

Engaging in fraud or deception to conceal the true nature of the loan
obligation, or
ancillary products, from an unsuspecting or unsophisticated borrower."

All three of these practices were rampant from at least 2004 through
2007, but the Fed, the OCC and the OTS ignored all of them. Everyone in
the mortgage business began issuing loans based on the assumption that
home prices would increase forever, ignoring pesky details like whether
or not a borrower could afford the loan. Industry lobbyists don't even
dispute the point. Denise Leonard of the National Association of Mortgage
Brokers admitted to Congress in April 2009 that, "Underwriting
standards for mortgage loans were significantly relaxed and greater
emphasis was placed on home valuation as opposed to other factors
traditionally used to determine a borrower's likelihood of repaying a
loan."

"It now appears that the most elementary notion of predatory lending -
failure to underwrite based on the borrower's ability to pay - became
prevalent in the subprime mortgage market," FDIC Vice Chairman Martin J. Gruenberg said in a 2007 speech.

And the mortgage industry was an absolute fraud nightmare. Loan officers
and mortgage brokers actively falsified paperwork without borrower
consent in order to push borrowers into expensive loans they could not
afford. As a result, the loan officers would get rewarded with
kickbacks, and the bank would get an expensive loan they could sell off
to investors at a handsome profit. When the borrower finally ran out of
rope and couldn't pay off the loan, it wasn't the bank's problem
anymore--whoever bought the loan had to deal with the mess.

The Fed, the OCC and the OTS had clear authority to police this
activity, and had even said they believed it to be predatory, yet
refused to go after lenders who systematically engaged in the behavior.
Under Dodd's latest legislative capitulation, these same regulators will
be responsible for enforcing the rules issued by the CFPA. The FBI
warned of an "epidemic" of mortgage fraud as early as
2004, and continued
sounding the alarm for years, only to watch bank regulators cover
their ears and ignore the catastrophe.

Banks also paid mortgage brokers a special kickback for steering
borrowers into expensive subprime mortgages, when those borrowers would
have qualified for cheaper prime loans. According to the Center for
Responsible Lending, in 2002, between 85 percent and 90 percent of
all loans that banks issued through mortgage brokers included these
kickbacks. By 2006, over half of subprime
mortgages were refinancings--banks had set up exactly the kind of
predatory incentive structure that the Fed said it wanted to prevent
back in 2001. In 2007, Federal Reserve Chairman Ben Bernanke even
admitted that this predatory behavior had become standard practice under
the Fed's watch, noting that, "Fees tied to loan volume made loan sales a higher
priority than loan quality."

"This was a festival of fraud," according former Capital One Financial
executive Raj Date. Date left Capital One shortly after the company
acquired subprime lender GreenPoint Mortgage, and is now a strident
financial reform advocate at the Cambridge Winter Center for Financial
Institutions Policy.

Astonishingly, even after the FBI
warned that 80 percemt of the fraud involved in mortgage lending was
perpetrated by lenders, not borrowers, bank regulators continued to
pretend there was nothing wrong.

So the Fed, the OCC and the OTS refused to enforce all three tenets of
their regulatory guidance from 2001. This charade was repeated in 2006,
when all three regulators again issued guidance on "non-traditional"
mortgage lending, only to look the other way when abuses occurred.

All of today's bank regulators are all charged with both protecting
consumers and making sure that banks do not fail (this is called "safety
and soundness" regulation), but in practice, they're only interested in
one thing: bank profits. The more profit a bank books, the harder it is
for that bank to fail, and regulators consider anything that threatens
profitability a major threat, including consumer protection rules. If
the CFPA says that banks can't gouge customers with outrageous credit
card fees, deceptive mortgage maneuvering or even unfair payday loans,
the OCC isn't going to enforce the law.

Consumer advocates want the CFPA to be independent for a reason: They
don't want to see this kind of profit-pressure dictating the CFPA's
rule-making and enforcement powers. The Fed is a particularly poor place
to house the new agency. For years, the Fed has maintained a Consumer
Advisory Council, but Fed policymakers have routinely ignored its
warnings. University of Connecticut Law School Professor Patricia McCoy
served on the council from 2002 to 2004, and notes that Fed Chair Alan
Greenspan did not attend a single meeting of the consumer board during
her entire tenure.

"At that time, I had recently moved from Cleveland where I was aware of
some pretty dicey subprime lending by national banks, so I was very
concerned that the OCC was not going to get the job done," says McCoy.
"And the reaction of the Fed staff--there were no governors at this
meeting, it was only Fed staffers--was, 'We're not going to discuss
this. We refuse to engage. That's not our problem' . . . . There was no
political will to even have a discussion.'"

In addition to its reputation as a consumer scourge, the Fed is the
single most secretive agency in the American government, and it defends
that secrecy to the point of absurdity. The Fed is currently embroiled
in a lawsuit with Bloomberg News over a request for Fed documents under
Freedom of Information Act. The Fed maintains--with a straight
face--that it is not subject to FOIA requests, despite its status as a
public agency that even prints the public's money. The case is still in
court, but it's easy to imagine the Fed blocking the CFPA from issuing
strong rules, and then blocking any public disclosure about its
bureaucratic maneuvering.

Democrats have a significant majority on the Banking Committee, and can
get a strong, independent CFPA to the Senate floor if they want to. The
question is whether the bill can then overcome a filibuster. Dodd can
either preemptively cave at the Committee stage, and allow Republicans
to vote on a weak bill that doesn't protect consumers, or he can force
politicians of every stripe to take sides. If Dodd includes a strong
CFPA in the bill at the committee level, then every lawmaker in the
Senate will have to tell the public whether they're backing the bailout
barons or ordinary citizens. Republicans would be very reluctant to side
with our financiers over the rest of their constituents, but if they did
so, it would be a huge political gift to the Democratic Party. Imagine
defending that vote ahead of November's elections.

President Barack Obama and Congress had three major tasks they had to
accomplish with financial reform: End too-big-to-fail, rein in the
over-the-counter derivatives market that brought down A.I.G. and put an
end to consumer abuses. Obama punted on too-big-to-fail before even
submitting a plan to Congress, refusing to break up the big banks into
small-enough-to-fail units. In the House, lawmakers effectively
sacrificed derivatives to salvage the CFPA. If Dodd proceeds with a
gutted version of the CFPA, every aspect of the Wall Street overhaul
will have been entirely undermined.