Consumer Protection? Read the Fine Print

After months of delay, on Friday the House of Representatives passed its "Wall Street Reform and Consumer Protection Act," 223-202. That fairly tight vote should tell you something: this reform is a 1279-page tissue of compromise. Let's leave the first part to others to dissect, for now, and focus on what "consumer protection" actually means here.

The big news is that the bill establishes the Consumer Financial Protection Agency, which will have the power to regulate not just mortgages but most kinds of "financial products" you or I might be tempted to buy, from credit cards to electronic funds transfers (with one huge exception: car loans from a dealer).

But the reason we've got this bill is mortgages, mortgages, mortgages, and the many features of the products and their sales practices that set borrowers up to fail. One example the Obama administration gave when it first proposed the agency early this year is the "yield spread premium," -- a bonus that mortgage brokers get from a lender when they sell a customer a loan with an interest rate higher than the one he or she qualifies for.

I'm actually not sure the bill as passed would give the agency a slam-dunk case against yield spread premiums or other harmful product features. The agency can't crack down unless the product or practice is likely to cause "substantial injury" that consumers couldn't reasonably avoid, and that injury is not outweighed by benefits "to consumers or to competition."
Here's the problem: A lot of the traps that sank borrowers in the crash – adjustable rates and prepayment penalties are some others – are also basic lubricants in the financing machinery that creates mortgages.

Take prepayment penalties -- fees assessed (mainly to subprime borrowers) for paying back a loan early. These fees effectively prevent many subprime borrowers from refinancing into better loans. Bankers invented them to help give investors in mortgage-backed securities confidence the borrowers were in it for the long haul, so the investors could anticipate their future cash flow. Without that confidence, investors would have likely snubbed subprime-packed securities, and the subprime industry would have starved and died before it ate the world economy.

A happy ending, right? But one big reason subprime metastasized for years was that financial lobbyists successfully argued to government regulators that making mortgage loans available to people with bad credit who wouldn't otherwise qualify was, on the whole, a good thing – that basically these fees and penalties were the price of admission for borrowers who'd proved themselves unreliable. And nothing in the Consumer Financial Protection Agency bill stops the lobbyists from staging that show all over again.

State regulators won't be able to step in either, thanks to an amendment pushed by Rep. Melissa Bean of Illinois (D) that gives the feds the power to override state rules when they can prove it "significantly interferes" in the banks' business.

Let's hope that the new agency scripts some mighty clear disclosure forms for borrowers about the terms of their loans and that the Office of Financial Literacy established by the bill will actually do its job and teach consumers about the real benefits and risks of financial products. Because this bill ain't going to be getting any more consumer friendly when it hits the Senate.
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