By Don Baylor

Commercial innovation remains at the heart of the American tradition. However, innovation should be used to increase American wealth, not destroy it.

Leading up to the financial crisis, gaps in our financial monitoring system unleashed a financial virus still worming through the American economy. Products like overdraft fees, payday loans, and “pick-a-payment” mortgages all damaged our economy. The resulting system crash led to historic levels of foreclosures, lost wealth and chronic unemployment.

As new, complex financial products enter the marketplace, our regulatory firewall must be able to detect toxic financial products and safeguard Americans from financial harm. We need a national solution that honors state authority in order to protect American wealth from future meltdowns. The proposed Consumer Financial Protection Agency (CFPA) would help avoid repeat financial disaster by ensuring that all “off-the shelf” financial products can be monitored by one inspector with a clear code book.

The financial crisis taught us several lessons. First, banking regulators are ill-equipped to be consumer watchdogs. Second, when financial institutions can shop around for the “regulator of least resistance,” Americans get the short end of the stick. Finally, economic crises transcend state lines, so we need a national standard for financial product safety and a strong watchdog entirely focused on consumer protection.

These lessons indicate the need for a better firewall to protect us from financial “malware.” Our federal regulatory structure stretches across seven agencies attempting to enforce 20 statutes. As a result, no one agency is accountable for financial product safety, and many consumers do not know where to file an effective complaint about financial services.

We should consolidate and strengthen consumer protection to prevent another viral outbreak from taking down the system and destroying American wealth. The CFPA would make this regulatory structure more efficient and effective by centralizing these functions and personnel.

We need a robust, independent body to protect consumers from unfair credit, payment and debt management products, no matter what company or bank sells them and no matter what agency may serve as the regulator. Financial institutions offering similar products should be held to the same standard for consumer safety.

The CFPA would examine commonplace checking account product “services” such as overdraft loans or fees. Most banks automatically include this “coverage” without consumer consent. Many financial institutions charge at least $35 when the customer overdraws by as little as $1, setting up a potential cascade of very expensive short-term loans. The FDIC calculates that the typical overdraft loan equates to a 3,520 percent annual interest rate. The customer is not typically given a choice to decline the fees at the time of transaction. Last year, banks made nearly $37 billion on overdraft charges, about $300 for each banking customer in the U.S.

This unfair “loan without consent” reduces consumer confidence and drives existing customers away from banks into higher cost, fringe financial markets that drain wealth. CFPA could require that issuers notify debit card users that a transaction would overdraft their account.

The proposed CFPA could also help increase the national savings rate. Over the past few decades, the national savings rate steadily declined to a point at or below zero, as recently as 2006. With the economic crisis, savings rebounded somewhat, but are still far below healthy household saving levels. The CFPA could make savings easier and more automatic so that more Americans build financial cushions and retirement security, leaving them more resilient when the economy dips. This agency would use a research-based approach to understand how Americans approach saving, investing and borrowing.

In Texas, we know a little bit about toxic financial products. With the lowest average credit scores, lax financial regulation and runaway payday loans, Texans are especially vulnerable to dangerous products that strip wealth from households and communities. Under the CFPA, many high-cost, “rinse and repeat” products like payday and automobile title loans—offered by credit services organizations—might receive increased scrutiny. That would be a welcome innovation.

Properly implemented, the CFPA will spur innovation through new asset-building products that promote a “race-to-the-top” challenge and lead to better consumer choice. The CFPA’s goal would be to ensure safety and transparency of financial products, and to detect and quarantine products designed to destroy wealth.

In other words, CFPA will help prevent another collapse of our economy due to hazardous financial products.
Baylor is senior policy analyst at the Center for Public Policy Priorities, an Austin think tank.
Copyright (C) 2009 by the Texas Lone Star Forum. 11/09