It’s Hard to Save Us from Ourselves

07/18/2011 9:45 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

You remember the old expression about “locking the barn door after the horse is out”? Well, that’s what’s happening in Washington this week...but the abuses the new consumer-protection agency are trying to prevent are more numerous than its leaders can even imagine, writes MoneyShow.com personal finance expert Terry Savage.

After many months of delay, the President is set to name a chief for the Consumer Financial Protection Bureau, just in time to meet the July 21 kickoff planned for the new agency.

But the new head of the bureau will not be Elizabeth Warren, former Harvard Law professor and noted consumer advocate, who has been organizing the start-up of the agency. She generated too much antagonism from the banking industry, which was fearful that she would take too much regulatory power away from existing agencies like the SEC and FDIC.

Instead, the new head of the CFPB will be former Ohio Attorney General Richard Cordray, who has been working along with Warren at the fledgling agency in recent months. Cordray faces a tough fight in Congress, but is likely to be approved by the required 60-member margin in the Senate.

The new agency was created by Dodd-Frank (the Wall Street Reform and Consumer Protection Act), to deal with gaping holes in regulatory authority that created the subprime mortgage mess. The bureau is expected to have broad authority to establish regulations and send investigators into financial-services firms, ranging from investment bankers like Goldman Sachs to credit-card issuers and commercial banks, as well as payday-loan companies.

The great concern on the Street is that the agency places a great amount of power in the hands of one person, who is nominated to the job by the President. Most other watchdog agencies, such as the SEC and CFTC (Commodity Futures Trading Commission) are managed by a “board” that reflects political diversity, and thus responds to constituents in the financial services industry and in Congress.

On the other hand, many consumer advocates have been concerned that the powers of this new agency would be diluted by political influence. They are certain that an aggressive watchdog agency could eliminate abuses like those that encouraged homeowners to take out home equity loans and take on mortgages with no down payments.

Regulating Human Nature
The real issue revolves around whether any regulator can stay ahead of the profit-motivated marketplace. It’s hard to convince people to act against their own human nature.

Surely, I wrote many columns warning against those types of loans. But it’s difficult to legislate against human greed—either on the part of the financial institutions seeking profits, or the individuals who figure they can get a little bit of something for nothing.

There are two strongly motivating forces at work in many financial transactions:

  • The first is the unwillingness to examine closely anything that seems “too good to be true.”
  • The second is the power of the crowd to overcome a realistic assessment of the situation. Whether it was the rush to take on unaffordable mortgages, or to accept all those credit-card offers, or to buy “dot-com” stocks with no earnings, there’s a herd mentality that takes over when “everyone is doing it.”

I’m not sure that any protection agency can stand against that kind of mentality. Even Alan Greenspan, former Fed chairman, admits he got caught up in it.

NEXT: Protect Against Products?

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Protect Against Products?
It’s notable that many of the financial products that were abused were not illegal. In fact, they were offered under the watchful eye of the FDIC, the Federal Trade Commission, the Comptroller of the Currency, and the Attorneys General of many states.

It wasn’t until useful financial products were pushed to extremes of irrationality that the trouble began.

What should the new CFPB protect us against? For instance, what do you think about payday loans? Yes, they can lead to danger—but are they less dangerous, or expensive, than loan sharks used to be? Should they be outlawed? What would take their place for desperate borrowers?

Or what about the lottery? Should the new CFPB outlaw lotteries, because statistics show that those who can least afford the few dollars they spend to buy a dream for a few days are the ones who play most consistently?

More states are legalizing gambling. Should the CFPB look into the very real possibility that the spread of legalized gambling could be devastating to consumers’ financial discipline? Or is it just a matter of posting the odds more visibly?

Or to go back to more traditional products, is there a time when the CFPB should step in and limit the number of credit cards a consumer can carry—in the name of protection against excessive debt? Should there be a 20% down payment requirement for a mortgage—or a rule that the monthly payment could consume no more than 40% of a homebuyer’s income? That would certainly protect against excesses.

Can one consumer watchdog agency spot the trouble in advance—and more importantly issue the regulations that will stop the stampede in time? I truly hope so, for as PT Barnum is reputed to have said in describing human nature: “There’s a sucker born every minute.”

The new Consumer Financial Protection Bureau has a big job ahead of it. And that’s The Savage Truth.

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