CFPA I, Preemption, or What a Bad CFPA Would Look Like

So from Felix Salmon comes word that “an independent agency with its own source of funding would be established to regulate all federally chartered banks. The agency would have two divisions: one to conduct prudential regulation and one for consumer protection. The agency’s director would decide disputes between the divisions.” Kevin Drum and Matt Yglesias have more thoughts.

I think it might be good to step back and remember why a consumer financial agency should be independent. I will consider a piece of a financial reform bill to be a failure if it somehow took the worst parts of the recent financial markets and codified it into law. And my worry for consumer financial regulation is that we end up with a permanent regime of Hawke-ian Office of the Comptroller of the Currency (OCC) running campaigns of preemption of state consumer finance laws.


In order to get a sense of what that looks like, I want to walk through the OCC’s preemption of Georgia’s anti-predatory lending laws in 2003. This will involve some blockquotes, but it’s a fascinating story that is worth your time.

Preemption during the Bush years is a fascinating topic for any student of cronyism run wild. And if consumer protection is going to be run by bankers, it is a good time to refresh yourself on the material. Here’s a excellent 2008 BusinessWeek article, They Warned Us About the Mortgage Crisis, that has a lot of background on the subject.

The Georgia situation is luckily all in one speech. Let’s go to a lunch hosted by the Federalist Society on July 24th, 2003, where John D. Hawke Jr., Comptroller of the OCC, dropped the hint to the banking community that the OCC would be overruling Georgia’s anti-predatory laws during his speech. So what did this law do?

The OCC will, of course, continue to defend the right of national banks to be free from state efforts to regulate their business…

The GFLA [Georgia Fair Lending Act] imposes severe restrictions on so-called “high-cost” mortgage loans, requiring lenders who offer them to comply with a range of substantive and procedural requirements. The practices proscribed under the Georgia law include the financing of credit insurance, debt cancellation or suspension coverage, limitations on late fees and payoff statement fees, pre-payment penalties, negative amortization, increases in interest rates after default, and balloon payments. Certain categories of loans are restricted as to the number of times they could be refinanced and the circumstances under which a refinancing could occur.

The OCC sprung into action to make sure that a specific state couldn’t put into place simple “rules-of-the-road” type legislation: no negative amortization, no prepayment penalties, no balloon payments, and simple rules over second liens like home equity lines of credit. It also tried to get accountability into the situations where mortgages were securitized, which really upset certain banking interests (see the Businessweek article for more).

It wouldn’t be a story of the 21st century financial economic disaster if the ratings agencies weren’t there in some format. Now what is part of the motivation to do this? Who benefits? Hawke:

And the private investor secondary mortgage market in those states has been hard hit, particularly for subprime mortgages, because of actions taken by the rating agencies in reaction to those states’ predatory lending laws. Moody’s, Standard and Poors, and Fitch Ratings have all adopted policies that make it difficult, if not impossible, to pool loans originating in Georgia, New York, or New Jersey unless the issuer provides costly credit enhancements and/or certifications that the pool contains no proscribed loans.

We need to upheave this state law because it is getting in the way of the ratings agencies business models. Read that again. There’s a lot of interesting stories to be told about the ratings agencies going to state governments and saying “You need to make more negative amorting no downpayment ballooning NINJA loans, or we are going to shut down your state’s mortgage market.” This is what happens when your financial industry gets a little too much in control.

But it’s not just about cronyism. It’s also a philosophical difference in what regulation should look like. Hawke specifically invokes his mission of consumer protection for why he is overriding Georgia’s state law:

This outcome is particularly regrettable because it’s unnecessary. We know that it’s possible to deal effectively with predatory lending without putting impediments in the way of those who provide access to legitimate subprime credit. It’s an unnecessary consequence because the approach that’s been followed is an across-the-board, one-size-fits-all approach that applies to the good as well as the wrongdoers.

We believe a far more effective approach would be to focus on the abusive practitioners, bringing to bear our formidable enforcement powers where we find abusive practices – after clearly articulating our expectations.

Hawke thinks that the states should no nothing, that “rules-of-the-road” style consumer protection laws are bad, and that he will simply find all the wrong-doers. This is the exact opposite of what I think, and hopefully the writing here may have pushed you more into my camp. I think simple, blunt, widely applicable laws at the federal level, where the real power is setting the architecture and not in rooting out the bad guys, with the states filling in the gaps based on their own regional markets. That the housing market in California is not the housing market in Iowa should be obvious to anyone, and states should fill in those gaps.

In case you still think the housing crisis is about community organizers bullying around bankers, what did people think? Association of Community Organizations for Reform Now said “Georgia’s legislature went through a lengthy, careful process, put a lot of thought and a lot of hard work into protecting their homeowners because the federal government wasn’t doing so, so for the federal government to preempt that law, partially or entirely, gets things backwards.” And this press release: “Consumer Bankers Association applauds the OCC’s Order today preempting the Georgia predatory lending law for national banks and their operating subsidiaries…” You get the picture.

How did that turn out? We know that Texas and Vermont had simple rules about consumer finances, keeping some options off the table. Here is data, on state foreclosure rates, and Texas and Vermont are 28th and 50th, respectively.

Georgia currently has the 7th highest foreclosure rate in the nation.


So if you’ve been watching the financial reform bill in the House, and saw some drama about preemption (see here, or this Ryan Grim story), this are the stakes that people are playing for.

The banks don’t want a consumer financial protection agency. But if I was a bank lobbyist, having a consumer financial protection agency housed in the basement of the new OCC, an agency whose primary goal in practice is to break states of backup regulation in terms of consumer finance, that is a pretty sweet goal if it can get on the table.

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5 Responses to CFPA I, Preemption, or What a Bad CFPA Would Look Like

  1. Bryan says:

    Just to clarify, Comptroller Hawke was appointed by President Clinton in 1998.

  2. Pingback: CFPA II, Some Additional Thoughts « Rortybomb

  3. Mike says:


    Absolutely. The deregulation of the financial industry in the late 1990s was a bipartisan affair, though a lot of the seeds were placed in the early 1980s. And assuming the newer parts of the financial market regulate themselves was a key deal in the later Clinton years. But I consider placing lobbyists in prominent positions in their regulatory departments more broadly to be a feature of the post-1980s landscape.

  4. chris says:

    legitimate subprime credit

    Is this an oxymoron, and if not, what does such a transaction look like? AFAIK, subprime describes a deal that no borrower in his right mind would take if he understood it, which is why it’s a market segment focused on finding people who don’t have much knowledge of finance and then making them an offer they can’t understand.

    Is that too harsh? And if so, how?

  5. Ebenezer Scrooge says:

    It’s not cronyism, and might not even be ideology.

    The OCC’s actions can all be explained by institutional aggrandizement. They want turf–regulation of all banks. To get it, they must make their charter as attractive to banks as possible. Interstate banking was a major boon to the OCC, but was not enough. State regulators–who wanted to keep their turf–cooperated in prudential supervision. The national bank charter was still cheaper for the largest banks, but wasn’t particularly attractive for small or medium-sized banks. The OCC fees tended to be higher, for one thing.

    To get the medium-sized banks (I’m not sure they wanted the small banks), the OCC started to use its preemptive powers as an offensive weapon. Get a national bank charter; lose effective consumer regulation. Good deal! For the banks, at least.

    There was another dimension of OCC aggrandizement–the Fed. The Fed was supervising nonbank and holding company activities. The OCC wanted this business, and began expanding bank powers so that these activities could be done within the bank, in the purview of the OCC. If all activities that bankers wanted to do could be done within the bank (or its subs), the bank holding company would be irrelevant. The Gramm-Leach-Bliley Act of 1999 is best viewed as a regulatory armistice, brokered by Congress, preserving the status quo.

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