How Will the Regulatory Reforms Affect Consumers?

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Paul Solman: We asked a number of people in the personal finance business and others close to the credit crisis to weigh in on the Obama administration’s new consumer protection proposal.

I’m struck by Doug Elliott’s admonitions, especially his last paragraph; Alyssa Katz’s coinage of “the Edmund Andrews syndrome” (know the score, take crazy risks anyway); and Robert Glovsky’s useful reminder that “the devil is in the details.”

Dean Baker, Center for Economic and Policy Research:
President Obama’s proposals should help to prevent the worst abuses by the financial industry. In principle, the proposed Consumer Financial Protection Agency would have prevented many of the worst abuses in the subprime market over the last decade, as well as in other areas of consumer lending.

It is not hard for an expert in finance to devise financial instruments that most people cannot understand. By blocking this path to profitability, these reforms, if effectively applied, will lead to a more efficient financial industry. The country does not benefit from having people at Goldman Sachs and Morgan Stanley spending their time devising ways to rip off small city school districts with auction rate securities. If the reforms prove effective, the boys and girls on Wall Street will have to do honest work for a living.

Douglas Elliott, Brookings Institution:
The biggest benefit for consumers from the reforms is the least tangible – a stronger financial system. This crisis has demonstrated vividly how important it is to have a working banking system that can provide the lending necessary for our economy. The proposed reform should limit the damage from future problems, although nothing can eliminate trouble altogether.

The establishment of a financial regulator specifically focused on consumer protection is both good and bad. It is clearly positive that we are focusing more on these problems. Consumers suffered massively in this crisis from bad mortgage products that were hard to understand, ill-designed, and sold to people who shouldn’t have bought them. The credit card problems are not as bad, but there are few people who fully understand all the fees and conditions that apply.

So, we need to make consumer financial products easier to understand and we ought to eliminate badly designed or excessively risky products. The tough part is to figure out how to do this while allowing useful financial innovations to go forward. It is going to be important not to be an over-protective parent that never lets their kid do anything. In particular, mortgage products for lower-income people could end up with so many restrictions that lenders are reluctant to make them available, which would make it difficult for lower-income people to buy a home and work their way up the ladder towards financial stability.

The agency needs to do two key things to succeed. One, keep firmly in mind that products with some risks may still be appropriate, if they are explained well enough that consumers can make an informed choice. America was not built by making only completely safe choices. Two, stay focused on true consumer protection rather than empire-building by trying to have a say in every financial product that has any conceivable connection with consumers.

Zvi Bodie, Boston University:
I believe the first order of business is for the government to create the legal infrastructure for a more trustworthy financial advisory profession. Currently there is a confusing alphabet soup of professional designations, some of which mean very little. In the future, any individual providing personal financial advice to consumers ought be legally certified to adhere to a fiduciary standard and demonstrate professional competency at the level of CFP. Investment advisors should be held to the same standard of fiduciary responsibility and competency as planners.

I strongly support the creation of a Consumer Financial Protection Agency. Consumers in the U.S. have long been indoctrinated to believe that stock-market funds promoted by the financial services industry are safe in the long run, when in fact they are quite risky. This misleading advertising should be stopped. Yet government regulatory agencies including the SEC and the DOL have reinforced rather than prevented it. Perhaps by creating a government agency dedicated to consumer financial protection, the government will do a better job of aligning the incentives of providers of financial services with the best interests of their customers.

Gail Hillebrand, Consumers Union:
A key piece is for Congress to enact legislation creating a Consumer Financial Protection Agency. Finally, one federal agency will have the job of setting standards for financial products offered to consumers.

It won’t take ten years to address the next new wrinkle in mortgages or credit cards that hides the true cost of that credit, or that tricks people into borrowing more money than they can really repay. We won’t have to wait for a new law every time a new trick pops up, or every time a new product outpaces the existing law. Strong fair rules will reward competition to serve the customer, instead of “gotcha” banking. Banks and other businesses who offer credit, bank accounts, and payments products will have to compete to offer the best products to consumers, instead of competing to develop new types of fine print to take away the promised benefits.

The plan also recognizes that consumer money problems start locally, so it allows for states to enforce the new federal rules and their own rules to protect their residents from financial rip-offs. The Consumer Financial Protection Agency proposal is a real chance for something good to come out of the economic pain we are all feeling because of the failures of the current regulatory system. See here for more of these issues from Consumers Union.

Alyssa Katz, author of Our Lot: How Real Estate Came to Own Us::
Anyone who expects to borrow, save or spend money in the future – that is to say, all of us – has a lot to cheer in the Obama administration’s financial industry regulatory reform plan. If Congress agrees to create the plan’s proposed Consumer Financial Protection Agency it will be first time since the Community Reinvestment Act of 1977 that federal law will comprehensively advocate for the interests of consumers in their dealings with financial institutions.

The Obama plan puts forward four one-word principles for consumer protection in financial transactions: transparency, simplicity, fairness, and access. It gives the new agency much latitude to take measures toward those goals, and to err on the site of consumers. Its new powers would include measures consumer advocates have sought for years, such as the ability to require financial product brokers to work for the benefit of clients, dismantle pay incentives to steer customers into worse terms than they qualify for, ban features, such as prepayment penalties on mortgages, that routinely sabotage consumers.

Yet the administration really has two objectives. On the one hand, it seeks to rein in abusive practices that prove harmful to consumers of financial products. On the other, the plan reflects a determination to nurture a robust, growing financial industry reaching as many customers as possible through whatever legal means bankers choose to. It risks perpetuating familiar failures out of confidence that the new consumer agency will serve to correct them.

New regulatory regimes create jobs for attorneys; this one also serves as an employment program for social science PhDs, urging surveys and tests to gauge everything from consumers’ comprehension of disclosures on mortgage forms to their ability to handle prepayment penalties. The new protection agency is expected to restrict practices and products only if and when they prove in future rounds of research to be harmful, and then apply those restrictions only to specific combinations of products and consumer characteristics where the harms of the products appear to be greater than their benefits.

Such evidence may lead to uncomfortable outcomes, such as patterns of exclusion closely tied to race or ethnicity. The emphasis on making sure consumers understand what they’re buying fails to acknowledge that many fall prey to these products not because they fail to comprehend their risks but because they choose to overlook them – call it the Edmund Andrews syndrome. And products that are safe in one market context can prove harmful as conditions shift.

Essentially, the plan seeks to answer the question: how far can well-engineered financial products stretch, how many consumers can they reach, before they snap and break? If Congress goes along, we’re going to find out.

Robert Glovsky, chairman-elect of the Certified Financial Planners Board of Standards:
I applaud the administration for recommending that all those who offer financial advice or products to the public should be governed by a fiduciary duty of care. The historical lines between the two have blurred to the point where the consumer cannot grasp the difference between a broker with a suitability standard and an investment adviser with a fiduciary standard of care. Harmonizing both around a fiduciary standard of care is overdue. However, the devil will be in the details of the definition but the reasoning and recommendation should be applauded. Lastly, if the consumer is truly to be protected, this fiduciary duty of care should be coupled with competency standards and oversight for those doing financial planning.

Jonathan Pond, author of Safe Money in Tough Times:
I am of two minds on the proposed enhanced oversight of the financial markets. As a capitalist, I’m always wary of the unintended consequences of more government tinkering with the free markets. But as a consumer advocate, I am disgusted with the harm that unfettered capitalism has had on the financial status of far too many consumers. I only hope that the new regulatory authorities can strike the balance that protects consumers from the worst abuses in the financial markets while allowing the industry to continue serving effectively consumers of all financial circumstances. In sum, two cheers for the administration’s proposals.

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