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.