New US consumer body needs broad mandate

June 22, 2009

Securities regulators are famous for fighting the last war and not paying enough attention to the newest financial products that Wall Street banks are pushing.

The Securities and Exchange Commission, for instance, was still doling out fines for mutual fund market timing — a 2003 offense — up until last year. Yet the regulator played ostrich as the banks kicked it into overdrive in churning out risky mortgage-backed securities.

That’s why the new Consumer Financial Protection Agency the Obama administration wants to create must have a broad mandate and not be narrowly focused on mortgage abuse. But disturbingly, too much of the early discussion surrounding the proposed agency appears focused mainly on stamping out past excesses in the mortgage market.

Now there’s no disputing the need for a regulator to force banks to write mortgage documents in plain English.

Just imagine how many foreclosures would have been avoided if borrowers with little equity in their homes had better understood the hidden danger in an adjustable rate mortgage with an artificially low teaser rate, or an interest-only payment option.

But the odds are that the next big plundering of the U.S. consumer won’t come from the peddling of dubious subprime mortgages. Wall Street’s been there, done that and paid a heavy price — as have all of us.

A more likely place for Wall Street banks to mine for new money-making opportunities is the rapidly aging population of baby boomers, suddenly in desperate need of replenishing their depleted retirement accounts. This is where the real need for consumer protection will likely emerge.

Regulators shouldn’t be surprised, then, to find Wall Street bankers and all of those out-of-work mortgage brokers looking for new opportunities in the already existing markets for life settlements, reverse mortgages, structured settlements and structured notes.

Now, in and of themselves, none of these financial innovations are necessarily bad ideas. Consumers and investors should be able to turn unwanted life insurance policies into cash payments, tap the equity in their homes without having to make monthly payments, get an early payout on a personal injury settlement or invest in a basket stock with limited exposure to a decline in equity prices.

But all of these exotic financial products are ready-made for abuse — given that each is often pitched to the cash-poor, the elderly or those nearing retirement. The life settlements market, for instance, has been ripe with scams, in which elderly policy-holders are pressured by unscrupulous brokers into selling their insurance policies for a sum that’s a fraction of the potential death benefit payout.

Now in some cases, this new financial consumer protection agency might find itself bumping heads with state regulators, the Federal Trade Commission and the SEC. But there’s nothing inherently wrong with regulatory competition, if it fosters more aggressive enforcement.

In fact, if this new consumer protection agency were to act with a bit more foresight in targeting abusive practices, it might find itself quickly jumping to the head of the regulatory pack.

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No matter how you slice it, this is bad news for American consumers. This unelected regulatory body will strip the reward out of lending and cause lenders to only lend to those consumers who don’t pose risks. For the rest of Americans it will be almost impossible to obtain sufficient credit.

Is this more of the change we can believe in?

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