How to Save Consumer Regulation

WASHINGTON — The Consumer Financial Protection Bureau's repeated revisions to its new mortgage rules are doing more harm than good, according to a paper released Tuesday by Federal Financial Analytics.

The paper, which was provided to American Banker, suggests the fledgling agency is sacrificing simplicity in its effort to explain new regulations, making it harder for financial institutions to follow them.

"Substance is being swamped by detail," said Karen Shaw Petrou, a managing partner at Federal Financial. The industry "is looking for certainty and the problem is when certainty comes through lawyers and pages of detail, the accountability for institutions and for regulators is really obscured."

The 11-page white paper recommends that the CFPB focus its rules on core expectations for lenders, particularly for board members and senior management, by showing key criteria rather than a laundry list of policies and procedures. It points to a "precedent-setting statement" by the Federal Reserve on the need for economically-intuitive criteria that leaves decision makers able to evaluate their own firms. Such an approach contrasts sharply with the CFPB's methods to date, including its recent mortgage rules, which run more than 4,000 pages and include five revisions since they were issued in January.

"Undue complexity in the body of rule creates only confusion and legalism, while hands-on guidance to those with their hands actually on implementation promotes effective consumer protection and efficient, accountable regulation; and recognition that information asymmetry cannot be fixed by websites and detailed guides alone," the paper said. "Instead, rules should be made increasingly flexible as consumers are deemed increasingly 'accredited' based on factors like income or the product requested."

The CFPB has repeatedly argued that its numerous clarifications are meant to answer banker questions and make its massive mortgage rulemaking — as required under the Dodd-Frank Act — easier to implement by the Jan. 10 deadline.

"We have made these adjustments with one aim in mind: to ensure the effectiveness of our rules by making it easier for industry to comply," CFPB Director Richard Cordray said last week in a speech. "By addressing and clarifying industry questions, we are reducing the need for individual institutions to spend time reaching their own uncertain judgments."

But the white paper, while acknowledging the CFPB is limited by Dodd-Frank, says that using blog postings and how-to guides as part of the rulemaking process "are of little practical value because of the significant legal and reputational risk" posed by the complexities within the rule. The potential legal challenges, particularly with the Qualified Mortgage rule, have already raised concerns with many consultants who fear the legal safe harbor given to lenders who write a QM loan have so many requirements that it leaves plenty of ways for a borrower to challenge the lender.

"The industry is legitimately questioning the QM rule's safe harbor and how safe is it because there are so many details in it," Petrou said. This is not just an issue for smaller lenders "but for the larger institutions who do have capacity to handle the complexity but know they're jailbait in that sense."

Cordray has defended the rule, claiming that it would be difficult for a borrower to successfully sue if the loan were made according to QM standards.

"We drew bright lines to define the contours of a qualified mortgage," Cordray said at the same bankers' conference. "If those lines were not drawn as sharply as they are, then much would have remained to be fought out in the courts for years and years. … So you should keep this perspective in mind if you hear people dreaming up hypothetical factual disputes in an effort to sow anxiety about potential litigation under the rule."

The white paper also says the CFPB's use of data collection to guide its rulemaking and enforcement seems to reflect "post hoc" thinking that could have it focusing on yesterday's problems rather than emerging threats in areas such as mobile payments, prepaid cards and social media.

"The most vulnerable consumers are the ones at the particular point in time when products start to morph," said Petrou. "And the riskiest institutions are the regulated ones that succumb to temptation because the boards don't know how the product is being altered or have the appropriate supervisory provisions to care."

How the regulators approach social media is particularly unclear and "poses a major risk" to financial services, the paper says. The Federal Financial Institution Examination Council has proposed guidance on social media but the paper says it's unclear how the prudential bank regulators and the CFPB will apply this to supervising companies.

That raises another issue, including how regulators collaborate — or fail to — on new retail products that pose risk to consumers. For example, the paper notes that regulators took vastly different approaches to payday-like products earlier this year.

"The Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) have proposed standards in this area, but CFPB's efforts to curtail payday lending have yet to advance beyond the talk stage," the paper says. "And, even as the OCC and FDIC have acted, the Federal Reserve Board has not signed onto a comparably tough proposal. In short, different rules will apply to different institutions offering functionally equivalent products to the same customer in the same state."

The paper also says that regulators should not wait on big-data studies of the nation's entire population or lengthy projects "suitable for doctoral dissertations" before they take action. The paper advised the CFPB to track the Fed's "horizontal" approach to intervene quickly when products or practices are migrating into unregulated territory and determine whether it's based on legislation or "regulatory arbitrage."

"By the time the most comprehensive database is constructed, we will have missed the forest because we're counting the trees," Petrou said. "There are some [product issues] clearly coming and we don't need to know everything about everybody to start identifying and defining potential risks to protecting consumers."

While the white paper may appear to be critical of the CFPB, Petrou said it was only meant to get regulators, policymakers and the industry engaged in productive conversations that would reinvent the regulatory process in a more clear and impactful way.

"If we just keep doing what we're doing, how can it be better?" she said. This white paper "may not be better but I really want to have these issues discussed to start a different type of debate in a better way."