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Six Principles for Real Reform: Balancing Bank Safety and Sensible Lending

June 24, 2009
Consumer Financial Protection Bureau
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Reckless lending practices that became rampant in recent years have devastated the economy, costing Americans billions of dollars in lost wealth and resulting in the weakest economy since the great Depression. Unfortunately, the regulators overseeing bank safety and consumer protections fell down on the job. Congress has taken a number of actions to investigate the causes of the financial meltdown, and key legislation has been proposed or passed to clean up abusive lending practices on home loans and credit cards. Most recently, on June 17, 2009, the Obama Administration released its plan for reforming the financial regulatory system to correct many of the problems that led to today's crisis.[i]

As Congress considers how to address improving consumer protection and regulation of our financial system going forward over the next several months, we offer six essential principles for achieving true regulatory reform:

1. Real reform means having a regulator that is independent of the companies it regulates.

A major flaw in the current regulatory system is that federal banking regulators have a conflict of interest in supervising how financial institutions treat borrowers. Regulators are funded by fees paid by the institutions they regulate. Making this worse, our system allows banks to choose among several regulators, which means the most popular regulators get the most fees—essentially forcing regulators to compete against each other for the favor of the entities they regulate. For this reason, the regulators have every incentive to please the banks, sacrificing important consumer protection standards in the process.

2. Real reform means entrusting consumer protection to an agency with a clear commitment to protecting consumers.

Each of the regulators is primarily responsible for ensuring the banks' safety and soundness. Because charging consumers higher interest rates and fees than they qualify for appears to boost bank returns in the short run, regulators may regard consumer protection as conflicting with or irrelevant to the safety and soundness of the banks. The current crisis proves the fallacy of such reasoning over the long run, and demonstrates the dangers inherent in entrusting safety and soundness and consumer protection to a single regulator.

3. Real reform means protecting the ability of the states to address the particular abuses that arise locally.

In recent years, the states have been leaders in establishing the most effective rules for responsible lending practices and consumer protections. While federal policymakers failed to take sufficient action, individual states were able to move much more quickly to pass laws that addressed some of the most egregious financial services abuses. And state Attorneys Generals and banking supervisors pursued some of the most effective enforcement actions to stop bad actors. Unfortunately, federal law made these sensible standards inapplicable to federally regulated banks. More egregiously, federal regulators "preempted" – that is nullified – numerous important state laws, and interfered with state enforcement efforts as they applied to federally regulated institutions. Federal law should be the floor, not the ceiling, on consumer protection standards.

4. Real reform means protecting consumers from all abusive financial products, regardless of the type of company that provides them.

Many lenders – including the reckless subprime mortgage bankers responsible for the tricky and unsustainable loans that started the foreclosure crisis – were not regulated by any federal agency at all. The absence of consistent standards for mortgages allowed many abuses to go unaddressed and contributed to the high level of foreclosures we are now experiencing. Similarly, in the consumer loan context, different rules for different types of loans make it harder for borrowers to understand the real costs of abusive products and compare so that they can identify the most affordable options.

5. Real reform allows for creativity while also preventing "creative" new predatory lending practices.

A market is not truly free when the best interests of lenders and borrowers are not aligned – e.g., when lenders prosper most by originating reckless loans versus sustainable loans. Some lenders misused the banner phrase "free market" over the last 10 years to press for what in many ways was actually a lawless market, with no common sense effort to restrain excess, recklessness and, in too many cases, downright deception. Arguing that reigning in market abuses would lead to "unintended consequences," reckless lenders persuaded regulators and some policymakers to do too little for too long. In fact, the unintended consequence of an absence of regulation unleashed a race to the lowest standards possible, making it impossible for responsible lenders to compete.

6. Real reform means a commitment to transparency, so that agencies with responsibility are accountable to the public and to Congress.

All too often, regulators have been working in a "black box," with only scant information released about key decisions that affect the public interest. The public and public policy leaders should have enough information to evaluate how and whether an agency is achieving its mission.

As Congress considers how to implement regulatory reform, CRL urges members to keep these principles at front and center of their deliberations. To see a summary of specific items in the Administration's proposal, go to "Overview of the Obama Administration's Proposed Consumer Financial Protection Agency".


[i] "A New Foundation: Rebuilding Financial Supervision and Regulation" can be found at the Treasury Department's website at