Question

While there have been governmental, regulatory, and institutional initiatives regarding ethics in the financial arena, do you think there has been any improvement? What are your thoughts about the CFPB? Can ethical behavior really be legislated? What do you suggest from your own professional experience?

Answer 1

The CFPB has a core mission that drives its activities: “ensure… that markets for consumer financial products and services are fair, transparent, and competitive” (Horn, 2017). The financial transactions which are its primary concerns are consumer mortgages, personal loans and credit (covering student loans, credit cards, payday lenders and other small credit suppliers). The CFPB also has broad monitoring and enforcement power over the institutions, which provide these types of financial services, and additionally has extensive rule-making capabilities (Chanin, 2016). The financial institutions under the Bureau’s ‘jurisdiction’ include banks and credit unions with total assets over $10 billion, mortgage lenders, mortgage servicers, and payday lenders of any size, and any other consumer financial entity the CFPB considers important within consumer financial services (Chanin, 2016).

Aside from being a powerful agency, the methodology of its approach to financial reform is heavily data-driven, indicating a break from traditional bureaucratic methods of developing policy (Horn, 2017). For example, the CFPB maintains several databases of information on consumer habits, including the National Mortgage Database, from which the CFPB was able to conclude that “almost half of consumers who take out a mortgage for home purchase fail to shop prior to application.” (CFPB, 2015). The CFPB also maintains a consumer complaint database.

Legal Controversies

The CFPB has proven to be legally controversial. In recent months, triggered by the former Director, Richard Cordray, stepping down from his duties, there has been a legal tussle of succession between Leandra English (Cordray’s Deputy Director and favored successor) and Mick Mulvaney, a Trump appointee who has made clear his disdain for the CFPB and its mission, having called it a “sick, sad joke” (Vox, 2017). While the Trump administration secured an early legal victory, with Mulvaney now in effective control, the ongoing legal saga has clouded the effectiveness of an organization already facing a concerted effort by Republicans (and some Democrats) to stymie many of its proposed reforms. The legal situation is made more complicated by several legal proceedings challenging the constitutionality of the structure and funding processes of the CFPB, and the unusually independent nature of its Director who can be removed by the President only “for cause”, instead of at will (Simpson, 2016). The consequences of this situation for consumers and industry is uncertain.

CFPB’s Financial Reforms

The CFPB has been delivering financial reform at breakneck pace. The CFPB has captured approximately $3.6 billion in restitution to consumers, and assessed more than $550 million in civil money penalties (Chanin 2016). Compared to the organization it replaced (the Office of Thrift Supervision), the CFPB has been vociferous in its advocacy for the protection of consumers. Its latest fines have proven to be controversial. Wells Fargo, an American bank, was fined $100 million by the CFPB on September 8^th2016 for the “widespread illegal practice of secretly opening unauthorized deposit and credit card accounts”, which the CFPB charged had been an ongoing practice since at least 2011 (CFPB, 2016). This penalty is the largest imposed by the CFPB on a financial institution. While this may appear a strong win for consumers, some critics of the CFPB focussed on whether the Bureau played only a secondary role in uncovering the scandal, as compared to Los Angeles County District Attorney‘s office. In other words, critics argue the CFPB is an unnecessary bureaucratic layer in a system already capable of uncovering consumer financial scandals (CEI, 2017). However, the LA Attorney’s Office disagrees with this representation, in a statement contending that “the CFPB was integral to our collective work holding Wells Fargo accountable for fake accounts, including assuring Wells’ customers across the nation got relief.” (LA Times, Sep 2017).

A high point of the CFPB’s attempts to integrate data analysis and consumer protection came from its overhaul of TRID disclosures. The agency combined previous mortgage disclosures required under the Truth in Lending Act with data from the Real Estate Settlement Procedures Act (Center for Plain Language, 2012). On the proposed mortgage disclosures, the CFPB conducted both extensive qualitative and quantitative studies to show the new disclosure rules would benefit consumers. The study concluded there was a “statistically significant performance advantage of approximately 16 percentage points for the proposed disclosures” (Kleimann, 2013). The reception to these new disclosures was overwhelmingly positive, in that they allowed consumers a much easier understanding of their mortgage obligations. The new disclosures resulted in the CFPB being the recipient of the ClearMark Grand Prize in 2014 from the Center of Plain Language, with the organization’s chair remarking “the testing that went into this redesign – both before and after – is impressive, and it shows in the results” (BusinessWire, 2014).

Ethical Concerns

Considering the various actions of the CFPB, it is clear there are two ideological strands that largely govern how it operates. Elizabeth Warren, and her successor Richard Cordray, favoured a ‘cop on the beat approach’, that would concentrate the agency’s considerable influence on curbing suspicious activities of financial institutions and their financial products. This ideological approach can be witnessed in the current issue of payday loans, as the CFPB seeks to clamp down on the industry’s often laissez-faire lending practices (CFPB, 2017).

Competing against this strategy is an alternative approach that favors consumer information and education rather than dealing directly with financial institutions. Supporters of this perspective contend the former approach limits options of consumers and is paternalistic in nature. Reforms enacted by the CFPB utilising this approach include various information databases it maintains to give consumers more transparent information, and redeveloped compulsory disclosures accompanying certain financial products. The opposing views of the CFPB’s strategy often results in an ethics deadlock within the CFPB: Is paternalism justified if its consequences are preventing consumers from accessing bad financial products, or is this cost of limiting financial freedom too high?

The tension is evident with payday loans: Simply improving consumer awareness may not be enough when dealing with these usurious financial products, particularly when the target markets for such products are typically at risk financially. This is exacerbated by the apparent willingness of some sectors within the payday loan industry to attempt to avoid oversight: “Regular non-bank payday lenders are constantly gaming the system; that is, circumventing state laws intended to regulate their loan products” (Johnson, 2012.) Clearly, both elements are required to work together, but the correct proportion has led to criticism of the CFPB from both sides, perhaps hampering its ability to deliver on consumer protection.

Effects on Industry

The CFPB has been the recipient of sustained criticism since its creation. The financial industry has been divided on whether the CFPB is welcome news. One study, for example, shows the extra work required by its regulations may have a harmful effect on the ability of small community banks to succeed (Pierce, Robinson, Stratmann 2014). While the assets of these rural banks are under $10 billion, the CFPB regulations still apply as the majority of these financial institutions are involved in mortgage lending, which the CFPB monitors regardless of the size of the entity. The study found that compliance costs had risen, small banks were concerned about the CFPB’s activities, and 25% of small banks surveyed were considering mergers (Pierce, Robinson, Stratmann 2014). The effect on small banks is a negative one, and the last point is of particular concern for consumer advocates. Because of bank consolidation and reduced commercial competition, consumers may face dwindling choices and increased costs over time. Congress is currently working on legislation to exclude small banks from certain portions of Dodd-Frank and CFPB oversight given these concerns.

Other Elements of Dodd-Frank

Despite the focus on the CFPB, other aspects of the Dodd-Frank reforms are important enough in their effects on consumers and industry to merit mentioning. Two of its major legislative enactments, aside from protecting consumers, are focussed on preventing another systemic financial collapse. To this end, the so-called “Volcker” rule (separating deposit-taking and proprietary trading) seeks to stop financial institutions that trade in risky financial transactions from also participating in regular deposit-taking activities (Whitehead 2011). This rule prevents regular banking from being exposed to the kinds of speculative trading that was in part responsible the global financial crisis of 2008. Some argue that, while the Volcker rule was set up with good intentions, it doesn’t quite reflect the increasingly interconnected reality of markets and risk management (Whitehead 2011). Related to this point is Dodd-Frank’s intended aim of ending the concept of “too-big-to-fail”. While a prominent group of economists and academics called for overly large institutions to be broken up (Ritholtz, 2013), Dodd-Frank took a softer approach and began supervising the activities of banks with over $50 billion in assets, categorizing these institutions as being “systemically important”