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Will Financial Reform Help Consumers Help Themselves?

Better late than never is perhaps the best way to describe the government’s latest attempts to introduce financial reforms and consumer protections that it hopes will prevent the US from repeating the mistakes that got us into this financial mess in the first place.

This morning, Austan Goolsbee briefed MintLife on the Obama Administration’s plans for financial industry regulatory reform in advance of President Barack Obama’s remarks Friday afternoon, particularly about the proposed Consumer Financial Protection Agency (CFPA). Goolsbee is staff director and chief economist of the President’s Economic Recovery Advisory Board, a member of the Obama’s Council of Economic Advisers and otherwise a University of Chicago economics professor.

For free markets to be fair and effective, they depend on two things: free flows of information and free choices for all parties. A comprehensive package about consumer protection and industry accountability will address both, Goolsbee says. The Obama Administration is essentially calling for more accountability from three parties: from the industry, from government itself and from you the consumer.

Industry Accountability

In terms of protection, the White House is calling for new “rules of the road” on at least three levels:
• Protections for individual banking and credit consumers against predatory lending practices, abusive credit card terms, and unfair charges and fees;
• Protections for individual investors against unclear terms and undisclosed risks in their portfolios and retirement savings—and protections from conflicts of interest by their investment advisors;
• Protections for citizens and taxpayers against another catastrophic economic meltdown caused by
irresponsible and unregulated financial practices and “innovations” .

Goolsbee points to a number of unfair practices that would be prohibited by new rules enforced by the CFPA: eliminating bait-and-switch teaser rates on credit cards, by forcing companies to honor their offers and commit to them for the specified period of time; preventing companies from retroactively raising interest rates on existing balances; no “gotcha” tactics to earn late charges, such as moving deadlines to early morning in payment due dates to early mornings (before mail deliveries); or no payment processing tactics to clear large items before small ones in ways that maximize overdraft charges.

Government Accountability

The CFPA would consolidate authority that has previously been fragmented among disparate efforts, making it easy for abusive or risky business practices to slip—or be slipped—through the cracks between seven different financial regulatory agencies. Having too many separate agencies “allowed certain actors in the financial system to wiggle their way between the regulatory cracks or to exploit those agencies that had the least amount of oversight,” he says. For example, Federal Reserve standards on housing lending by banks didn’t have jurisdiction over the other two-thirds of the subprime mortgage market.

Consolidating and streamlining oversight is also designed to improve the accountability of government in its role of preventing financial innovations or undercapitalization risky enough to endanger the whole system “with somebody who is accountable and whose job is to make sure consumers are being protected in the financial sphere,” Goolsbee adds. “There will be one person sitting there whose job it is to protect both the system and protect consumers.”

Consumer Accountability

But new rules have to apply to consumers as well. Accountability from institutions has to be complemented by more responsibility from consumers: not buying more house than they can afford, not charging more purchases than they can afford, and not making risky investments that they can’t afford to lose.
For example, on the transparency side, Goolsbee says the White House wants to see contracts and term sheets presented in “plain language” (despite his PhD in economics, he says even he can’t understand his credit card agreement). But such clarity is wasted unless customers make time to read their agreements before signing.

“Consumer protection is not intended to remove accountability from consumers. People still have to read their bills and read before they sign up for things,” he adds. “And there’s nothing wrong with borrowing money, but if you don’t pay it back there should be a penalty.”

Will rates and fees go down?

Not necessarily. Will there be fewer surprises in your monthly statements? Theoretically. Will new rules stay ahead of financial innovations that can bring down the economy? Let’s hope so.

“Part of our reform effort involves putting in place new safeguards that would help prevent the irresponsibility and recklessness of a few from wreaking havoc on our entire financial system. We want to close gaps in regulation; we want to eliminate overlap; and we want to set rules of the road for Wall Street that make fair dealing and honest competition the only way for financial firms to win and prosper,” President Obama said later in the day. “But a central part of our reform effort is also aimed at protecting Americans who buy financial products and services every day — from mortgages to credit cards. It’s true that the crisis we faced was caused in part by people who took on too much debt and took out loans they couldn’t afford. But my concern are the millions of Americans who behaved responsibly and yet still found themselves in jeopardy because of the predatory practices of some in the financial industry. These are folks who signed contracts they didn’t always understand offered by lenders who didn’t always tell the truth. They were lured in by promises of low payments, and never made aware of the fine print and hidden fees.”

Political Battles Ahead

The briefing was an economic transaction in its own right. Goolsbee was offering insights, but also asking for help from the largely liberal political bloggers on the call. Only Web-based activism, he says, can counter political vulnerability to special interest lobbying.

“Interest groups associated with the financial industry have decided they want to block or seriously change the effort of the administration to reestablish rules of the road and some kind of stability to the financial system,” Goolsbee said. “So the president is looking to amp up public pressure on what changes are needed. Just going back to the status quo, which got us into the worst financial crisis since 1929, is completely not an option.”
Expect the financial industry to war against these regulations with a lobbying campaign that’s even bigger than the one being waged over healthcare reform. Obviously, Republicans will fight Democratic proposals tooth and nail, but likely Democrats will fight among themselves, too. Undoubtedly, so will the various executive branch agencies fight for control of the new agency.

If so, this doesn’t bode well for effective regulation, does it?
A fact sheet (pdf) on the Consumer Financial Protection Agencyis posted on the White House website.