'Consumer Protection' in Financial Services? It Won't Work

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by: Tom Brown

Not convinced by my brilliant arguments why a consumer financial protection agency like the one contemplated in the banking reform bill is a terrible idea? Fine. I can’t win ’em all. Still, the agency would be a disaster. If you won’t take my word for it, imagine instead how a consumer protection agency would work in the real world. Hint: it wouldn’t be pretty.

I got an up-close look at just how non-pretty this week, during a meeting with the chairman and CEO of a small business bank out west. It was 3:55 in the afternoon. The chairman was in the midst of explaining some underwriting issue or another when, in mid-sentence, he stopped, got up and walked over to the window, and pointed to six people who were leaving for the day.

They were from the consumer protection division the FDIC, he explained. The six had arrived on Monday and had told him they were there to review the bank’s compliance with consumer lending standards. They’d be there for two weeks.

So, what’s the matter, you’re thinking? That's what regulators do.

Here's the problem: the bank that the six regulators were planning to camp out in for two weeks doesn’t make consumer loans. It’s a business bank, whose consumer loan book consists of all of 20 loans that add up to a grand total of . . . . $1.3 million.

Do the math, and, per regulator, that works out to just over three loans of around $217,000 each. Two weeks! Thus you see the bureaucratic mindset at work. What in the world can those people be thinking?

I can’t think of a better illustration of why a new regulatory bureaucracy would be totally pointless. We already have regulators in place that are supposed to ensure the safety and soundness of the banking system by insisting lenders adhere to prudent lending standards. Did they do their job during the boom? No. And we have regulators in place to detect fraud and abuse on Wall Street. Did they do their jobs during the boom? Er, no. And we have regulators in place to keep the thrifts in line. Did they do . . . . ? Don’t even ask.

So now we’re supposed to believe that a new regulatory bureaucracy is somehow going to be more effective than the old ones? You’ll get no argument here that financial system needs oversight. But more regulation doesn’t equal better regulation—particularly when, under the current system, some bureaucrat somewhere thinks it’s a great idea for six people to spend two weeks poring over 20 loans. Before Congress creates any new agencies, it ought to have confidence that the existing ones are effective.

At best, the new consumer protection agency will be expensive and useless, and be manned be people like the ones I saw waddling around in the bank’s parking lot. At worst, it will be a nuisance that will undermine the soundness of the banking system and make credit less available in the process.

Regardless, in that banking conference room this week, I saw the future. Believe me, it really, really doesn’t work.