Jack M. Guttentag The Mortgage Professor

Among the Obama administration's proposals for financial regulatory reform is one for a new Consumer Financial Protection Agency (CFPA). It is designed to replace the existing system of consumer protection where authority is fragmented among different federal agencies plus 50 states, where some non-depository firms are regulated loosely or not at all, and where regulators generally give higher priority to protecting the solvency of financial firms than to protecting consumers.

I have a strong predisposition favoring this proposal because I view it as the best and perhaps the only way to make mortgage disclosures useful to borrowers. The major shortcoming of existing mortgage disclosure rules is that critical information that borrowers could use often is not disclosed, and when it is, it tends to gets lost in a torrent of garbage. Borrowers are swamped with information they cannot use.

The proposal for a CFPA addresses most of the major causes of garbage disclosures and information overload. A critical one is divided responsibility, where no one agency has authority over the totality of disclosures. Divided responsibility encourages disclosure overload, as well as inconsistencies between disclosures mandated by different agencies. These problems would be eliminated by investing sole responsibility in a CFPA.

A second problem has been that the disclosures mandated by existing agencies, which are burdened with other more pressing responsibilities, are not kept abreast of market developments and are seldom tested to determine effectiveness. These would be required duties of the CFPA, for which it would be held accountable.

Not a Perfect Answer

However, a critical problem that is not addressed is that most of the existing garbage disclosures are embedded in the law. While the CFPA would have "sole authority to promulgate and interpret regulations under existing … statutes, such as the Truth in Lending (TIL) …" the disclosure requirements in TIL are very explicit and can’t be interpreted away.

For example, TIL states that mortgage lenders must disclose the total of payments over the life of the loan, and the amount financed, which is the loan amount less upfront lender charges. Both these disclosures are worse than useless, because they waste space and divert borrower attention.

Unless the CFPA can get out from under this type of legislated garbage, it will be extremely difficult to improve mortgage disclosures.

The authority of a CFPA would extend to all financial products offered to consumers, not just mortgages, and its powers would not be limited to mandating disclosures. CFPA would also have "authority to regulate unfair, deceptive or abusive acts or practices," and it would have the supervisory, examination and enforcement powers required for the purpose. These include the right to "place tailored restrictions on product terms and provider practices." This grant of widespread powers is what has made the financial community apoplectic about CFPA.

Limits Should Be in Place

The proposal includes examples of how this authority might be used. These include restricting or banning mandatory arbitration clauses in contracts with consumers,  banning payments made by lenders to mortgage brokers, imposing a "duty of care" or a "duty of best execution" on financial intermediaries, banning prepayment penalties on certain types of mortgages and requiring that loan providers offer "plain vanilla" products alongside whatever other approved products they want to offer.

(Note: The proposal for a "plain vanilla" mortgage is poorly explained and has been widely misinterpreted. It refers not to a type of mortgage but to a method of pricing which can apply to any mortgage. A "plain vanilla" mortgage is a no-cost mortgage, where the only price to the borrower is the interest rate. The lender absorbs all third-party charges, as well as his own. The advantage to the borrower is that no-cost mortgages are relatively easy to shop. Since many, if not most, mortgage lenders offer a no-cost option now, the challenge to the CFPA would be to make them more prominent.)

I believe that creating accountability for consumer protection is essential, but I would have preferred to see the initial powers granted to the CFPA limited to mandatory disclosures. A first-rate disclosure system based on modern technology and the insights of behavioral science, unshackled from the grotesqueries of past efforts, can take consumer protection a long way. In the future, as the limitations of disclosure become clear, the agency could request the additional powers needed to deal with the problems that remained.

The proposed wide-ranging grant of powers to a CFPA makes me nervous. To be sure, the proposal is not to require the CFPA to take any of the drastic measures cited above, but to give it the authority to do so if it decided that less intrusive measures would not work.

The trouble is that it is far easier to, for example, ban prepayment penalties than to find creative ways to disclose penalties so that they become a useful option to borrowers. Nowhere in the proposal is the CFPA put on notice that options are generally good for consumers, and that the agency should impose a rigorous burden of proof on itself before taking one off the table.