Consumer Advocates Fear Missed Opportunity for Bank Reform

House Financial Services Committee Chairman Barney Frank (D-Mass.) (WDCpix)

As a House committee begins tackling major financial regulatory reform, consumer advocates find themselves shaking their heads over why something that should have been a slam dunk — reining in the financial industry in the wake of the subprime crisis — has turned into a hard-fought battle instead.

Proposals for a Consumer Financial Protection Agency, a new federal authority to regulate mortgages and other financial products, and for oversight of the private and unregulated market for derivatives, risky financial instruments cited in the subprime collapse, are under debate by the House Financial Services Committee this week. In the immediate aftermath of the financial crisis, it seemed to many consumer advocates that those proposals, and other efforts at financial regulatory reform, would have been already been in place by now.

Illustration by: Matt Mahurin

But what seemed back in 2007 like a clear path ahead was upstaged by the health care battle, which stalled momentum on the biggest overhaul of financial regulations since the Great Depression. Yet there’s even more to the reform slowdown, noted Kathleen Engel, a Suffolk University law professor who specializes in predatory lending and subprime securitization.

A weakening economy has left homeowners worried about paying their mortgages and keeping their jobs, leaving less time and attention for larger problems in the banking system. Regulating mortgages and securitization are complex issues that are difficult to translate, making it hard to get the public engaged in the debate.  And banks are in a better position to fend off regulation, now that their bottom lines are stronger and the government needs them to modify as many mortgages as possible to bolster the economy, she said. “They really have the federal government over a barrel right now,” Engel said.

She added that people feel “relieved” that banks are stable these days, which contrasts with their emotions when the subprime collapse first hit. “I was really hopeful at the beginning that the rage that people felt about the banks getting us into this mess would lead to needed regulation,” she said. “But people are so strapped right now, they’re stressed out how to get a loan mod, or how to get a job, that they’re not able to focus on what the government should be doing.”

Banks, for their part, continue to argue that new regulations aren’t needed, and will only choke off financial innovation. The American Bankers Association, the Financial Services Roundtable, and even small and community bankers are opposing the agency, saying it presents a new and unnecessary layer of regulation. Those arguments have gained a foothold because of a long-held distrust of any new rules coming from Washington, noted Cathy Lesser Mansfield, a Drake University law professor and consumer law expert.

“For the last 20 or 30 years, we’ve kind of bought this notion that all regulation is bad regulation,” said Mansfield, who also chairs Americans for Fairness in Lending, a nonprofit consumer advocacy coalition that supports reforms. “The reason the banks are getting away with this is they’re saying, ‘We’re already regulated. We already have a regulator.’”

Lax regulation, however, is often cited as one of the contributors to the financial crisis. And the nation’s top banking regulator, John Dugan, the Comptroller of the Currency, recently gave a speech arguing that banks weren’t responsible for the financial crisis.

As overhaul begins to move forward, the financial industry remains an enormous influence on Capitol Hill, causing committee chairman Barney Frank (D-Mass.), to dilute his proposal to get industry defenders on board.

In order to win wider support from conservative Democrats and others for the consumer agency, Frank already has dropped from the proposal a “vanilla” option which would have required mortgage brokers and banks to offer consumers a plain, 30-year fixed mortgage, along with more exotic mortgage products. Frank also eliminated a reasonableness standard, which would have required bankers to ensure consumers understood their products, and could afford them. He proposed that an oversight panel for the agency be staffed by top bank regulators, and said he would exempt most non-financial businesses, including retailers, merchants, and real estate agents and brokers, from oversight.

The committee is likely to end up approving some sort of consumer financial agency, “but we’re worried about how watered down it will be,” said Lauren Saunders, a lobbyist with the National Consumer Law Center. She also said it’s hard to believe that the banking and financial industry has any credibility regarding its arguments against regulation, given its role in the financial crisis. But the sector has managed to mount an aggressive opposition effort, with the U.S. Chamber of Commerce in particular putting its clout into fighting the proposal with a multi-million dollar ad campaign.

“The banking industry is highly profitable,” Saunders said. “They’ve put a lot of money into this, both through lobbying and campaigning. We can’t even come close to them.” For the 2010 election cycle alone, commercial banks already have contributed $3.7 million to members of Congress, according to the Center for Responsive Politics.

Said Alan White, a Valparaiso University law professor who studies subprime loan modifications: “What saddens me the most is the extent to which Congress still allows the bank lobby to veto legislation it doesn’t like, and this includes the Democrats. You would think banks would have lost some credibility on Capitol Hill, but money still talks.”

For White and others, the ability of the finance industry to benefit from loopholes in the current regulatory system adds to the frustration. Goldman Sachs managed to refinance some of the toxic mortgages it controlled into Federal Housing Administration-backed loans, shifting the risk to the government. Former top executives of failed subprime lender Countrywide Financial, whose toxic loans were a major contributor to the subprime collapse, stand to earn millions of dollars by buying delinquent home mortgages that the U.S. government took over from other failed banks, sometimes for pennies on the dollar, and reselling them. Bailed-out insurance giant AIG is once again under fire, after a government report on Wednesday found that controversial retention bonuses intended to retain key employees went instead to workers in the firm’s troubled financial products unit, with even a kitchen assistant receiving a $7,700 bonus. “They’re totally taking advantage of the system,” Saunders said.

Advocates aren’t giving up. They noted that both the Federal Reserve and the Federal Trade Commission have been more aggressive regarding consumer protection lately, although they pointed out their actions may be due to fear of giving up power to a new agency. Congress also approved credit card reform, and some Democrats want to move up the timetable for putting new rules in place.

Frank has vowed to bring a reform package to a floor vote in the House by November. In the Senate, Banking Committee Chairman Christopher Dodd (D-Conn.), also strongly supports the creation of consumer agency, but there is significant Republican opposition to the idea. Dodd also has proposed merging four bank agencies into one super-regulator, an idea that goes beyond the scope of the Obama administration’s proposals. Dodd has said he hopes the Senate will act on some kind of financial reform before the end of the year.

Unless there is substantial financial regulatory overhaul, however, the opportunity for reform presented by the financial crisis will have been lost for good. “We would never have gotten into this financial crisis if the financial industry and these products had been regulated in the first place,” Engel said. “If we don’t manage to get reform done now, then we haven’t learned any lessons here.”