Questions! Questions! Will an independent Consumer Financial Protection Agency -- championed by consumer advocates and included in the financial regulatory reform bill passed by the House last year -- become a reality? Or will a Consumer Financial Protection Bureau housed in the Federal Reserve with oversight from something called the "council of regulators" at the Treasury Department, as proposed on last Monday by Senator Dodd (the Chair of the Senate Banking Committee) and passed out of committee yesterday, emerge from the Congress?
The differences and distinctions between an independent agency and a mere bureau housed at the Federal Reserve overseen by the Treasury Department has captured the attention of policy makers. But I think what is really going on is a misguided debate is about how powerful the new regulator should be. The idea is that the less "independent" the regulatory body is, the weaker it will be (hence the "independent-to-a-point" approach taken in the Dodd/Senate bill). However, history instructs that the "independence" of the regulator is beside the point. Real consumer protection depends on altering the fundamental relationship between the buyers and sellers of financial products. "Independence," if needed, can come later. Allow history to be our guide.
Americans associate securities regulation with a well known Federal agency called the "Securities and Exchange Commission." Heard if it? But what if I told you that the first Federal law regulating securities predated the SEC? It's true. The first Federal securities law was the "Securities Act of 1933" (commonly called the "'33 Act"). The SEC, however, did not come into existence until 1934. It was established up by the aptly named "Securities Exchange Act of 1934" (The "'34 Act"). Yep, it's right there in Section 4 of the '34 Act: "There is hereby established a Securities and Exchange Commission. . ." Both laws, of course, were part of the raft of early New Deal legislation championed by none-other-than President Franklin Roosevelt.
The '33 Act, which still exists today, addresses disclosure requirements for sellers of securities. It sets a uniform disclosure standard for financial information (and other prescribed information) that applies to every person or company who sells securities. The disclosure requirements are, to this day, constantly being tweaked and updated. For example, the SEC just came out with a guidance for the disclosure "climate change risk". The '33 Act also has penalties for false disclosures. What the '33 Act does not do is establish any regulator to enforce its provisions. That's right: a regulation without a regulator.
So how is that possible? How is it possible that President Roosevelt, a President that, among other things, is known as the father of the Federal "alphabet soup" bureaucracy, set up a regulatory regime without a regulator at its center? Simple: Roosevelt understood that sound regulation is not necessarily about who administers a policy, it's about the policy itself. When Roosevelt proposed the '33 Act to Congress on March 29, 1933, his message read, in part, as follows:
Of course, the Federal Government cannot and should not take any action which might be construed as approving or guaranteeing that newly issued securities are sound in the sense that their value will be maintained or that the properties which they represent will earn profit.
There is, however, an obligation upon us to insist that every issue of new securities to be sold in interstate commerce shall be accompanied by full publicity and information, and that no essentially important element attending the issue shall be concealed from the buying public.
This proposal adds to the ancient rule of caveat emptor, the further doctrine "let the seller also beware." It puts the burden of telling the whole truth on the seller. It should give impetus to honest dealing in securities and thereby bring back public confidence.
The purpose of the legislation I suggest is to protect the public with the least possible interference with honest business.
It's important to note two things. First is that the '33 Act did nothing to prevent stock manipulation on the secondary market; that important reform, long championed by consumer advocates would have to wait for the '34 Act. Second, as mentioned earlier, the '33 Act did not specify what agency would be in charge of administering the '33 Act's disclosure requirements. There was no concern at the time with whether the agency would be "independent" or otherwise. In fact, no agency is even mentioned in the President's letter to Congress. As a side note, the agency that was eventually chosen to administer the disclosure requirements of the '33 Act was the Federal Trade Commission. Also among the contenders: the United States Postal Service since one of the only ways to sell stocks at the time was through the mail. Eventually, in 1934, the SEC took over. It was incrementalism at its best and it has a lot to tell us about today's reforms.
Roosevelt focused on the idea that those who sold stocks to the public had a duty to the purchasers -- the duty to tell the truth. It was an idea, not an acronym. Jonathan Alter in his book The Defining Moment: FDR's Hundred Days and the Triumph of Hope explains Roosevelt's' reasoning:
Even if the bill [the '33 Act] did not have teeth, this was strong stuff for progressives who had been out of power for more than a decade. . .
Without directly saying so, FDR was beginning to redraft the American social contract, adding a clause in which the U.S. government acknowledged a duty at least to try to protect investors from ruin at the hands of unscrupulous players in the market. Exactly how such protection would work was less important to Roosevelt than that it was offered in the first place.
So why is this relevant today? In today's world of mutual funds, 401ks and Exchanged Traded Funds, it's difficult to appreciate that back when the '33 Act was drafted and passed buying a stock was a lot like buying a house -- seller, broker and all -- and it was average Americans looking for nothing more than a sound investment who were preyed upon. It's also easy to forget that the 1920's had been a time of robust laissez-faire economic thought. The prevailing regulatory regime (if you could call it that) for the "Roaring '20s" was "buyer beware." Put the two together and the idea was that market participants were self regulating because if an investor was unhappy with the amount of information that was being disclosed the investor put his money elsewhere. But Roosevelt's people understood that the basic issue was not that consumers were being naïve (willfully or otherwise), it was that complex products (at the time) were being sold to somewhat unsophisticated investors. Thus, Roosevelt oriented his reforms toward equalizing the relationship between sellers (who had all the information and sophistication) and buyers who, too often, had neither. Sound familiar? The decision was made that the best way to remedy that imbalance was through "disclosure." Not just any disclosure, mind you, but a disclosure regime created and enforced by the Federal government. Elegant. Brilliant.
Fast forward to today: equalizing the relationship between the sellers of financial products (credit cards, home equity lines of credit, adjustable rate mortgages, payday loans, the list goes on and on) and the buyers of those products should be the focus of financial regulatory reform. It really doesn't matter whether the regulator is independent. What matters is that we once and for all bury the arcane idea of "buyer beware" and decide that those who sell financial products to consumers have a duty to disclose their terms -- not the other way around. It's not a new idea. It's the New Deal.
[As a side note, I regard the provisions dealing with Federal preemption of State consumer protections laws -- a specialty of the Office of the Comptroller of the Currency -- to be the more significant provision of both the House and Senate bill. See, neither the House nor the Senate bill allows the new consumer protection "agency" or "bureau" (respectively) to determine which state consumer protection laws are preempted by what are surely to be the bureau's (or agency's) regulations. That determination is made by others. I think that is a mistake. The consumer protection entity will be in the best position to understand whether the assistance of enterprising State Attorney Generals (and even more enterprising plaintiffs' lawyers) is needed to protect consumers or whether the enforcement of State laws will interfere in new consumer protection agency's regulations.]