The “Financial Autopsy” CFPA Amendment

I’ve just been informed by people in Washington DC that there is a newly proposed amendment to the Consumer Financial Protection Agency, an amendment that I find promising. Here is a first draft:

Today we will offer the “Financial Autopsy” amendment. The Grayson/Clay/Miller amendment is essential to attacking the root problem of consumer bankruptcy and foreclosure because it requires the CFPA to do a financial audit of products that have caused the highest rates of bankruptcy and foreclosure annually. Not later than March 31st of each calendar year, the CFPA will list these anti-consumer products, submit their conclusions on why these products “fail” consumers, the companies and employees that underwrote these products, and authorizes the CFPA to take action to restrict these products.

Financial Autopsy Amendment:

- Requires the CFPA conduct a “Financial Autopsy” of each state’s bankruptcies and foreclosures (a scientific sampling), and identify financial products that systematically led to a large number of bankruptcies and foreclosures.
- Requires the CFPA report to Congress annually on the top financial products (the companies and individuals that originated the products) that caused consumer bankruptcies and foreclosures.
- Requires the CFPA take corrective action to eliminate or restrict those deceptive products to prevent future bankruptcies and corrections
- The bottom line is to highlight destructive products based on if they are making people “broke”. Thank you for your consideration, we hope you will join us in supporting this amendment.

Sincerely,
Alan Grayson Wm. Lacy Clay Brad Miller

A few thoughts:

- The CDC has a response team for when it finds cancer clusters. I like the idea of the CFPA having a similar response team, that can be called in for expert opinion in the case of foreclosure and bankruptcy clusters. A team of forensic accountants and financial experts who can be called in by members of Congress, or as a result of their own statistical samplings, to give opinions on what is going on on the ground in a member’s district when it comes to the end result of financial innovations. Financial detectives, if you will, who can shift through all the noise one finds with dealing with consumer finances to see if there’s any signal that is the result of changing products and options available to consumers.

- Some readers may ask: Can’t the Federal Reserve do this? Let’s look at a previous time the Federal Reserve tried to do this. Here’s the transcript of “Morning Session of Public Hearing on Home Equity Lending, July 27, 2000.” There were worries among people in North Carolina that there was a problem with subprime loans and home equity lending causes bankruptcies and foreclosures. So what did the Federal Reserve do? They called up all the local subprime lenders and some community organizers who brought this problem public and asked the subprime lenders if they were doing anything wrong. You might be shocked to learn that, after some deep reflection, the subprime lenders found that they were not. Here’s a representative exchange between the Fed Chair and Martin Eakes, community financial lending organzier (later of the CRL):

GOVERNOR GRAMLICH: “…The last few years have seen enormous growth in subprime lending. …This is mainly, surely, a good thing in the sense that this growth in the subprime lending market has brought credit to low and moderate income households…But there are also seemingly some abuses.

There have been a series of anecdotes, a series of TV programs mentioning some of these abuses, there has been a rise in the foreclosure rate, and these adverse statistics have attracted our attention….We want to keep a relatively analytical focus and focus on specific things that the Fed might do, trying to make sure that, in technical talk, the benefits of what we do outweigh the costs….If predatory lending is as significant a problem as some people are alleging….”

MARTIN EAKES: “[later]…The first point I want to make is to say that predatory lending or loans that have abusive characteristics are not anecdotal as the Federal Reserve notice and your opening comments mentioned….”

Note the setup from the Fed Governor: “seemingly some”, “anecdotes”, “TV”, “as some people are alleging.” When Eakes replies that there were statistical efforts carried out, you can practically hear the crickets chirping in the silence. Now imagine if there was an independent congressional team, dedicated to investigating the consumer angle instead of bank safety and soundness, who could have testified here after doing ground work for some time, and could give expert opinion on the dynamics at play in this area. It would have changed the whole approach that could have been taken at this meeting.

- This is going to have, by nature, an adversial relationship with financial institutions. No detective has gotten anywhere in a murder mystery by yelling “Hey! Did anyone kill this guy? No? Must be natural causes.” The can be limited to some degree – smart banks who know they are not using tricks or traps on consumers would have incentives to co-operate with any autopsy investigations.

- This strikes a good balance on the the need we have for new financial innovation; it lets more in on the front end, with the idea of looking at the results at the back end. It’s a conceptual focus that is less focused on gatekeeping and more on detective results of what has happened as a result of the newest innovations.

All in all, a promising front for consumer financial reform. What do you think?

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9 Responses to The “Financial Autopsy” CFPA Amendment

  1. Not the Mike You're Looking For says:

    I can think of three possible objections to this:

    (1) How does one determine what “caused” a bankruptcy? Say I’ve been keeping up payments on my credit card, which I used to pay off a huge medical bill that my insurance didn’t cover. Then my bank, for reasons unrelated to me (for example, a credit crunch), jacks up the interest rate on my card. Was it the card or my faulty insurance? Remember that the “coroner” will not have time to determine causes on a case-by-case basis. If she’s judging by aggregates, won’t mortgages and credit cards come up every time?

    (2) What about privacy? I know that whether I’ve filed for bankruptcy is public information, but are the intimate details of my finances?

    (3) Autopsies on bankruptcies will be unlikely to uncover abusive savings products, such as mutual funds with hidden fees.

    I may be making too much of these, but they were the first thoughts that came to mind.

  2. Mike says:

    NTMYLF – Great comments.

    (1) So in aggregates you’ll see a lot of medical bills and long unemployment spells at testing at random. So it’s important that they have the latest statistical methods to find abnormally high results. The government is good at hiring accountants and demographers.

    (2) The bankruptcy materials are a matter of public record. So are certain provisions of mortgages, which need to be reported. Reports written can be stripped of identifying markers to help privacy rights.

    In general though, people love to complain. If enough get together, and petition their congressman about something going wrong in their local financial market, said congressman now has someone specific to bring into play to investigate.

    (3) Very true! However, this isn’t the end all and be all of the CFPA. There are other parts. This is just an additional team that can be deployed to do on the ground work and report back to whomever requested it. There have been times in the past decade this would have been useful for policy measures, besides just the NC event listed above.

    And worst comes to worse, we have some wasted research. That’s not the worst thing ever.

    • Not the Mike You're Looking For says:

      Very good responses.

      I’m a little confused, though–is the amendment supposed to be a complement or a substitute for other provisions of the CFPA? It’s a big difference whether this is just another tool in the toolbox, as you seem to suggest, or an attempt to tie the CFPA’s hands to some extent.

      I had thought that the idea was to get rid of the “prior restraint” objections to the original bill–that is, instead of evaluating products ex ante, the CFPA would investigate them ex post, thus allowing financial innovations to appear until they start doing harm.

      While I know less about them than you, I’m skeptical that statistical techniques can uncover toxic products without the statistician having some hypothesis already in mind to test. Perhaps data mining is a solution, but I say that only because I haven’t the foggiest what it is and what it can and can’t do.

      As a general rule, I’m suspicious of these proposals that require a lot of regulator discretion to implement. My litmus test is, what will happen when the next Republican administration is elected? Since Reagan, the GOP has handled regulation not by getting rid of laws or institutions, but by appointing people whose beliefs are antithetical to the goals of the departments they were supposed to lead (e.g., James Watt as Secretary of the Interior). Will the regulation be effective then?

      A few months ago, I watched a panel of economic historians discuss the financial crisis and was struck by something Brad DeLong said: “I think we should have dumb capital requirements [for banks].” In other words (as I understand them), attempts to regulate in a “smart” way (like Basel I and II) have really failed us, while hard-and-fast rules like Glass-Steagall have been more robust.

      I realize there are problems with this argument, the most obvious being that the regulated can still game the system. But at least there’s some stability to the rules of the game and an objective standard by which we can judge deviations. Plus, it would take an act of Congress to change the rules, which would make the situation public.

      This comment got to be a lot longer than I intended, but the main idea is that I’m skeptical about the ability of experts to regulate the system over the long term. There may be exceptions, such as the FDIC between 1933 and 1980, and it would be interesting to see under what conditions either option would be more successful.

      Perhaps the best solution, as some have said, is to make banking boring again. For decades we’ve had our best people going to Wall Street–to what end? Maybe if we overregulate the financial sector, people will start becoming scientists and engineers again.

  3. financeguy says:

    “You might be shocked to learn that, after some deep reflection, the subprime lenders found that they were not.”
    Ha! Great line. The Fed has pretty well established that it’s not a very good regulator, and certainly, above all, not a very good consumer-oriented regulator. Remember the WaPo’s story about how the Fed screwed up regulation. One theme that emerged: they don’t do anecdotes. They’re august practitioners of economics, and they’re really not interested in trying to make sense of messy anecdotal evidence. I think a lot of good consumer protection arises from anecdotal evidence (that then leads a curious mind to the larger problems at hand), and if the Fed really can’t be bothered with getting their hands dirty with it, don’t let them get near any sort of CFPA.

  4. Pingback: Revisiting the Crime Scene « The Baseline Scenario

  5. dana says:

    The CFPA would have authority to determine which products consumers can choose from. In short, the bill would create a regulatory overlay of the entire business community, extending far beyond traditional financial services. We need to take control of consumer choice. How does CFPA affect you? http://www.friendsoftheuschamber.com/issues/index.cfm?ID=469

  6. Unsympathetic says:

    I disagree with this premise completely.

    Financial innovation is an oxymoron in terms.

    The burden of proof should be on the FINANCE companies that their so-called “innovation” is in any way worth pursuing. This amendment is not an “add-on” but rather a removal of anything remotely resembling sound regulation.

    Remember that ALL subprime “innovations” were only useful for the super-rich who did not need the mortgage in the first place but rather had a capital project which (they hoped) would net HIGHER returns in the pre-reset phase of the loan. In other words, the subprime loan was not an innovation at all but rather a complete lie from the very beginning.

    NO MORE FINANCIAL ENGINEERING – of any kind.

  7. A says:

    dana , on October 21, 2009 at 9:05 am sent us to the
    http://www.friendsoftheuschamber.com/issues/index.cfm?ID=469
    to oppose the CFPA. The comments there are hilarious, and saddening, in that they expose the misinformation of so many posters.
    I couldn’t help it but add a comment that all this government regulation would have prevented me from profiting more in my investment in Berni Madoff’s firm.
    As said there,”…having CFPA would close again more profit-making opportunities in the (especially low-end) consumer market, which many of us now have to rely on for our bonuses. Thank you, Chamber of Commerce, for being again on the right side of this struggle.”

    On the topic of this post, one needs both regulation to prevent problems, and post-mortems, to see if new problems crop up. (In the medical analogy, after eradicating smallpox, you’d go after some other disease, and you’d still like to prevent heart attacks). Only with all this financial legislation, one has to watch very carefully, that the subtle wording does not undercut other regulation (or prevents state regulation).

  8. Rebecca Z. says:

    As with all regulation, the devil’s in the rule making. What sounds good in conception falls apart in rule making, always subject to regulatory capture.

    You can be sure there’s already an army of experts exploring the methods of capturing this regulation for financial benefit; what might they be dreaming up?

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