Pre-Emption Deal in the Works?

Keep an eye out for a deal that would allow for pre-emption of state consumer financial protection laws by federal regulators, a rumored development that should disturb financial reformers. The CFPA at the Fed seemed to be in a good position, with Dodd working to make it as strong as possible while being housed at the Fed, efforts to replace it with something ineffectual defeated, and a potential last minute move to bring it out of the Fed. But if allowing the CFPA to preempt state laws is in the works, that’s really bad for the overall effort to the idea of consumer financial protection.

Here is a letter from Elizabeth Warren and Illinois Attorney General Lisa Madigan:

Wal-mart operates in all 50 states, but it doesn’t come to Washington insisting that Congress protect it from state laws that demand workplace safety or environmental standards. As far as the law is concerned, they compete straight up with the local businesses–no special favors. What the big banks are really saying is that they are already spending $1.4 million a day just to block federal reform, and they don’t want to spend more money blocking state laws too. Washington lobbyists don’t want to have to have to venture out into real America; they are comfortable inside the Beltway….

The states were the first and often the only responders to the oncoming foreclosure crisis. Beginning more than a decade ago, [Illinois] brought enforcement actions against subprime mortgage giants such as Household, Ameriquest, and Countrywide for illegal conduct, while the federal regulators did nothing to rein in the lenders under their control. States also moved swiftly to enact tougher laws where federal inaction had left a void. It is imperative that the states be able to protect our citizens from abuses in the marketplace. In a time of global economic crisis, we clearly need more enforcers of consumer protection laws, not fewer.

Here’s some stuff I wrote on preemption and the nightmare it created for Georgia earlier. Why is preemption worth fighting against, which is to say why should states be able to write consumer financial protection laws against national banks?

Local Knowledge: Texas is not Wisconsin is not Vermont is not Florida. States themselves have both better knowledge of their local economies and the policy tools to address issues occurring locally. This should not be controversial.

I think there will be a fair amount of research over the next decade on this topic, but preliminarily evidence is that tougher consumer protection laws, particularly those centered around home equity loan restrictions and prepayment penalties, helped prevent a massive wave of foreclosures. The Dallas Federal Reserve found that: “Due to the state’s strong predatory lending laws and restrictions on mortgage equity withdrawals, a smaller share of Texas’ subprime loans involve cash-out refinancing, which reduces homeowner equity and makes default more likely when mortgage payments become unaffordable…”

We looked at Vermont’s consumer protection laws in a similar light here. Whatever the motivation for these practices – Texas’ laws date back to Homestead Act of 1839, an accident of history – they are by far our best first line of response to consumer protection.

Consumer Activism: In terms of making political changes, activists are far more effective at the state level than at the federal level. Here’s Kate Sheppard writing about anti-poverty, religious, and consumer advocacy groups partnering up to protest payday loan lenders in Virginia. It’s impossible to imagine such a group being as effective at the federal level, especially the more grassroots it was.

Game Theory: You have two regulators, the state and the federal government, they are in conflict. The federal government is easier to corrupt: you can bribe 1 federal regulator with 50x the money of 50 state regulators; and in so much as bad regulation may be felt more heavily at the state level, there’s even more of a incentive misalignment. If they are forced to compete, because the entity being regulated can choose, it’s even more favorable to that entity. One way to solve these nasty equilibria is to choose the stronger regulation proposed between the two parties, which is what happens when you exclude pre-emption.

Corruption: I will take it for granted that it is easier for there to be corruption at the federal level than at the state level. The elections are more expensive, the tenure is too strong. And if it is forced to be the law of the entire country through pre-emption, the more it will necessarily have to cover (since the states will be unlikely to try). And you don’t want states to be subject to the whims of banker captured beltway insiders.

So what’s the argument for? The best argument is that national banks don’t want to have 50 legal divisions to have offices in 50 different states. If Texas is not Wisconsin, then you need a Texas law team and a Wisconsin law team. This is excellent business logic for large banks, as it forces through law a return to scale on their legal infrastructure. However we don’t make laws to benefit how profitable being large is to national banks – we make laws to make sure contracts are valid and well-informed, that property rights that involve debt and uncertainty are maintained properly and that borrowing and lending market are as complete as they can be without being exploitive. In so much as this amendment hurts our ability to do those things and all we get in return is that shareholders of the largest national banks get a slightly better return, this approach is a terrible deal.

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8 Responses to Pre-Emption Deal in the Works?

  1. Pingback: Links 5/11/10 « naked capitalism

  2. Moopheus says:

    Well, when you put it that way, it sounds like Congress will almost certainly want to do it. After all, it will mean that they will remain the center of Wall Street’s largesse.

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  4. Ed says:

    50 legal deparments isn’t accurate. Its 50 legal departments, and a multitude of different financial products (because the same product can’t be offered in all states unless you meet the “lowest common denominator” which sometimes doesn’t even exist).

    As for “all we get in return is that shareholders of the largest national banks get a slightly better return”. Thats inaccurate. The primary result will be more expensive products for consumers. “Consumer advocates” don’t seem to understand the concept of “no such thing as a free lunch”. If you raise compliance costs on any product or service (even when needed), be prepared for the end user’s costs to go up.

    A much more reasonable solution would be to allow state AGs to enforce federal law, if the relevant federal regulator “passes” on a investigation.

    • Hi Ed, I’ve hear this ‘it’ll make products more expensive’ argument ad infinitum lately. It’s just a veiled threat designed to keep things the way they are.

      It will make BANKING more expensive, I think you mean. Consumers will go where the price and product is right. Meaning TBTF banks will have higher costs, and be able to monetize those less easily due to their uncompetitive prices as they relate to smaller local banks.

      Enforcing state laws, therefore, creates a competitive rein on TBTF banks’ local influence. Which I think is a good thing.

      Net/Net, if you can’t cover your TBTF costs and remain competitive in local marketplaces, you will naturally have to re-think your business plan, and shrink your footprint, by definition reducing the size and influence of your bank.

      Some will argue, then, that economies of scale make consumer banking cheaper and more accessible. Well guess what? We don’t have to guess the real answer to that one. It’s no longer a hypothetical – we’ve followed that logic to it’s natural conclusion today. And banking has not gotten cheaper or more accessible for the consumer. Cheaper it isn’t – and that’s obvious to everyone. More accessible, not either, b/c TBTF banks have used their size to exert monopoly power and acquire any smaller competitor they could get their hands on thereby REDUCING access to banking for consumers AND reducing the competitive landscape by design.

    • CogWheel says:

      Ed,

      Free lunch is when a more limited number of banks, with higher and higher influence in washington, realize they can kneecap consumers and make money doing with federal regulation.

      Might you be somebody who is all fired up about ‘Obamacare’, who is fully behind one of many state Attorney Generals seeking its repeal? Well, you can’t be if you are for this level of pre-emption because they would be powerless to move forward against what are agrueably insurance companies.

      Different issue, same playing field, one answer.

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