CFPA: Yet Another Administration Idea Whose Time Will Not Come

05/29/2010 05:12 am ET | Updated May 25, 2011

For an Administration which claims to be committed to economic recovery through free markets, the Obama Administration does a good job of confusing the issue. Its advocacy of a Consumer Financial Protection Agency is exactly what our economy does not need as it tries to recover from the Great Recession. Both directly and through its close ally, Harvard Law Prof. Elizabeth Warren, the Chairperson of the TARP Congressional Oversight Panel and rumored to be the first Chair of the CFPA if it is created, it argues that this agency is needed to protect the masses and our economy from the depredations of mortgage lenders and credit card issuers who are hell bent on deceiving them. Its mantra is "simplification" of consumer financial documents.

Yet it offers no evidence (other than anecdotal examples) that a significant number of individuals have been deceived by lender documentation. Belying the hypothesis that the subprime mortgage meltdown was caused by deceptive documentation, are the facts that (i) mortgage modification efforts aimed at reducing interest rates -- the element of transactions most susceptible to obfuscation -- have had little macroeconomic benefit by most accounts, and (ii) commercial mortgages -- which were much more likely than residential mortgages to have been entered into by sophisticated borrowers and reviewed by counsel -- are encountering significant defaults as well. Our mortgage problems were caused by people knowingly borrowing too much money, and not by concealed or obscured interest rate adjustment or negative amortization language.

The effort to justify a financial safety agency by reference to the general Consumer Product Safety Commission is likewise fundamentally flawed. Consumers can not determine if the lawn mower they propose to purchase is poorly shielded and will hurl debris at those on their property or if the children's clothing they propose to purchase is a fire hazard. An agency performing controlled tests of such matters and barring the sale of dangerous physical products that consumers can not evaluate for themselves is essential for the public safety. However, individuals do have the ability to evaluate and assimilate the terms of financial documentation simply by reading it and asking questions regarding matters they do not understand. Even for those who are quite unsophisticated, they have the opportunity to obtain guidance from counsel, either private or at Legal Aid clinics, before they sign documents. In any event, a "plain English" requirement for financial documentation -- even if it describes a complicated structure -- similar to what the SEC has prescribed for securities documentation, would seem to be the most that is needed.

Apart from its being superfluous, the CFPA is likely to be quite detrimental to our economic recovery. Prof. Warren has advocated the use of this agency to encourage or require the use of plain vanilla financial products so as to avoid consumer confusion. Apart from the fact that fixed rate, self-amortizing mortgages are already readily available, prohibiting more complicated alternatives will only suppress both the demand for and supply of credit, which is exactly the opposite of what we need to expedite economic recovery.

Many lenders are able to reduce the cost at which they make credit available and ultimately make more credit available, by transferring to borrowers the risks of interest rate fluctuations through "complicated" language. Many borrowers knowingly and intelligently accept these risks and the risk of negative amortization in return for lower rates or payment schedules reflecting their own circumstances. Telling lenders that they may not offer credit in the manner that they feel is appropriate given market conditions can only reduce credit which is offered. By the same token, forcing borrowers into a deal which they do not desire and may not be able to afford will prompt many of them to withdraw from the market.

As is true with many of its exercises in condescension, this Administration should promote economic recovery by withdrawing its proposal for a CFPA.