Running Circles around the CFPB

Lauren Willis has posted The Consumer Financial Protection Bureau and the Quest for Consumer Comprehension to SSRN.  It addresses an important subject — the cat and mouse game of the regulator and the regulated. The abstract reads,

To ensure that consumers understand financial products’ “costs, benefits, and risks,” the Consumer Financial Protection Bureau has been redesigning mandated disclosures, primarily through iterative lab testing. But no matter how well these disclosures perform in experiments, firms will run circles around the disclosures when studies end and marketing begins. To meet the challenge of the dynamic twenty-first-century consumer financial marketplace, the bureau should require firms to demonstrate that a good proportion of their customers understand key pertinent facts about the financial products they buy. Comprehension rules would induce firms to inform consumers and simplify products, tasks that firms are better equipped than the bureau to perform. (74)

The Bureau has worked hard to tackle financial education in a meaningful way, but Willis is right that this is a Herculean task given the profit incentive that financial institutions have to run circles around consumers and the Bureau itself. Willis explains

the feebleness of mandated disclosures, the inherent flaws in the alternatives the CFPB has been pursuing, the advantages firms have over regulators in ensuring their customers’ comprehension, and the CFPB’s legal authority to require customer confusion audits and enforce comprehension rules. I then elaborate on a few examples of how this form of regulation might operate in practice, including these four key elements:

1. Measuring the quality of a valued outcome (comprehension) rather than of an input that is often pointless (mandated or preapproved disclosure);

2. Assessing actual customer comprehension in the field as conditions change over time, rather than imagining what the “reasonable consumer” would understand or testing consumers in the lab or in single-shot field experiments;

3. Requiring firms to affirmatively and routinely demonstrate customer understanding, rather than relying on the bureau’s limited resources to examine firm performance ad hoc when problems arise ; and

4. Giving firms the flexibility and responsibility to effectively inform their customers about key relevant costs, benefits and risks through whatever means the firms see fit, whether that be education or product simplification, rather than asking regulators to dictate how disclosures and products should be designed. (76) (footnotes omitted)

Hopefully the Bureau will take a serious look at Willis’ critique.  It is important, of course, to get consumer financial literacy right in order to benefit consumers directly. But it is also important for the Bureau to get it right in order to protect its reputation as an effective regulator that brings real value to the consumer finance sector.

What Should the 21st Century Mortgage Market Look Like?

Treasury is requesting Public Input on Development of Responsible Private Label Securities (PLS) Market.  Comments are due on August 8, 2014. The request for information wants input on the following questions:

1. What is the appropriate role for new issue PLS in the current and future housing finance system? What is the appropriate interaction between the guaranteed and non-guaranteed market segments? Are there particular segments of the mortgage market where PLS can or should be most active and competitive in providing a channel for funding mortgage credit?

2. What are the key obstacles to the growth of the PLS market? How would you address these obstacles? What are the existing market failures? What are necessary conditions for securitizers and investors to return at scale?

3. How should new issue PLS support safe and sound market practices?

4. What are the costs and benefits of various methods of investor protection? In particular, please address the costs and benefits of requiring the trustee to have a fiduciary duty to investors or requiring an independent collateral manager to oversee issuances?

5. What is the appropriate or necessary role for private industry participants to address the factors cited in your answer to Question #2? What can private market participants undertake either as part of industry groups or independently?

6. What is the appropriate or necessary role for government in addressing the key factors cited in your answer to Question #2? What actions could government agencies take? Are there actions that require legislation?

7. What are the current pricing characteristics of PLS issuance (both on a standalone basis and relative to other mortgage finance channels)? How might the pricing characteristics change should key challenges be addressed? What is the current and potential demand from investors should key challenges be addressed?

8. Why have we seen strong issuance and investor demand for other types of asset-backed securitizations (e.g., securitizations of commercial real estate, leveraged loans, and auto loans) but not residential mortgages? Do these or other asset classes offer insights that can help inform the development of market practices and standards in the new issue PLS market?

These are all important questions that go way beyond Treasury’s portfolio and touch on those of the FHFA, the FHA and the CFPB to name a few. Nonetheless, it is important that Treasury is framing the issue so broadly because it gets to the 10 Trillion Dollar Question:  Who Should Be Providing Mortgage Credit to American Households?

Some clearly believe that the federal government is the only entity that can do so in a stable way and certainly history is on their side.  Since the Great Depression,when the Home Owners Loan Corporation, the Federal Housing Administration and Fannie Mae were created, the federal government has had a central role in the housing finance market.

Others (including me) believe that private capital can, and should, take a bigger role in the provision of mortgage finance. There is some question as to how much capacity private capital has, given the size of the residential mortgage market (more than ten trillion dollars). But there is no doubt that it can do more than the measly ten percent share or so of new mortgages that it has been originating in recent years.

Treasury should think big here and ask — what do we want our mortgage finance to look like for the next eight or nine decades? Our last system lasted for that long, so our next one might too. The issue cannot be decided by empirical means alone. There is an ideological component to it. I am in favor of a system in which private capital (albeit heavily-regulated private capital) should be put at risk for a large swath of residential mortgages and the taxpayer should only be on the hook for major liquidity crises.

I also favor a significant role for government through the FHA which would still create a market for first-time homebuyers and low- and moderate-income borrowers. But otherwise, we would look to private capital to price risk and fund mortgages to the extent that it can do so.  Round out the system with strong consumer protection regulation from the CFPB, and you have a system that may last through the end of the 21st century.

Comments are due August 8th, so make your views known too!