Meaningful Financial Regulation

04/04/2010 05:12 am ET | Updated May 25, 2011

Congress and the White House contemplate the creation of a new entity to regulate consumer financial products, even as opponents of reform sharpen their swords. The House reform bill, passed last month, provides for an independent Consumer Financial Protection Agency. The Senate Finance Committee is working on a bill that will also create a new regulator of consumer financial products. The president recently stated that establishing a CFPA is non-negotiable, a sentiment echoed during his State of the Union address in the form of a threat to veto meaningless financial reform legislation.

A new CFPA would limit the availability of highly risky consumer financial products -- credit cards, payday loans, and not least of all mortgages. The new agency would thus protect not only consumers, but the stability of the economy generally, given the reverberating effects of mortgage defaults. This is not nanny-state regulation. While there is nothing wrong with protecting vulnerable consumers from financial products they do not fully understand, a CFPA would help stabilize the housing and credit markets. Good for everybody.

Now for the hard part. The question becomes how to design the new agency, and exactly what powers to give it.

Financial crises of the past have generally led to the creation of independent agencies -- that is, bipartisan, multi-member commissions comprised of commissioners who serve for fixed terms and cannot be fired by the president for political reasons. Thus the SEC, FDIC, and predecessor to the National Credit Union Administration were created in the 1930s as independent agencies. The establishment of the independent Commodity Futures Trade Commission in 1974, following unprecedented grain and bean prices attributed to excessive speculation and market manipulation, provides another example. A strong argument could be made that a fully independent consumer financial regulator with robust rulemaking, investigation, and enforcement authority also makes sense. Independent agencies can be less susceptible to the wrong kinds of political and interest-group interference, regulatory variance, and mission erosion.

The new CFPA might also be designed as an executive agency -- an agency led by an administrator chosen by the president and removable at the president's will. Though not independent from the White House (present and future), an executive agency could nevertheless be given considerable regulatory autonomy. A serious argument could also be made, then, for an executive agency endowed with regulatory tools commensurate with its mission. Those tools include independent rulemaking authority and the power to conduct inspections, issue subpoenas and cease-and-desist orders, and undertake enforcement litigation against those who market crummy financial products.

Then there are undesirable scenarios. For one, a new regulator created as an office or bureau within another agency, lacking independent legal authority or a dedicated budget, would be regrettable. Housing a consumer financial regulator within another agency upon which all of its regulatory authority depends would make the new regulator susceptible to subordination to -- or intended neglect by -- its parent agency. Large agencies containing many bureaus must balance their regulatory priorities, not to mention their budget priorities, and often make compromises across their many missions. Sometimes even bureaus created with the best of intentions prove impotent. Creating something called a consumer financial regulator that lacks regulatory autonomy would be a mistake.

To be sure, in politics compromise is often necessary. Half a loaf is better than none; take what you can get. But here, some versions of a new CFPA could well be worse than nothing, reform merely in name. An efficacious CFPA certainly must have budgetary independence. Like other financial regulatory agencies, the CFPA should be funded by small assessments against regulated entities, and not depend on the budgetary grace of a parent agency much less the uncertainty of appropriations. (By way of cautionary example, the Consumer Product Safety Commission, on which the idea of a CFPA is based, saw its budget drastically reduced during the deregulatory 1980s.) Just as important, however, a new CFPA must have its own full rulemaking, investigation, and enforcement authority. Without such powers, the CFPA's ability to carry out its mission will depend on the unstable priorities of other regulators who, in the long run, may or may not be sympathetic to its charge.

The stakes are high. The opportunities for meaningful reform are infrequent. The CFPA should be done right.