Make the CFPB a Good Cop

Banks have millions of customers, but so do supermarket chains, oil companies and Walmart. Banks have cheated customers on overdraft fees, credit protection, debt collection and foreign exchange. Yet you don't read about oil companies systematically cheating at the pump, or supermarkets selling mislabeled canned goods. Why are banks different? 

Neil Weinberg, in an excellent column in this space, suggests that bankers who cheat their customers expect that any punishment they suffer will be much smaller than their ill-gotten gains.  Again, why are banks different?

The answer: Because banks have regulators whose primary goal is to protect them and see that they survive and thrive. 

If a regulator discovers a bank wronging its customers, the first priority is to prevent the resulting liability from escalating and avoid a scandal that could harm the industry and give the regulator a black eye. Keep it quiet! No public admission of guilt, no punishment of responsible executives, and only token or fractional restitution. 

Walmart has no such regulator. And although the retailer has been accused of many things, primarily relating to how it treats employees and vendors, it would be very surprising to see the company systematically mistreating customers—despite a strong performance-focused culture. 

It's bad business to cheat your customers … unless you have the protection afforded by a regulator assiduous in its desire to keep you afloat and paying fees.

Changing the DNA of the prudential regulators would be a multi-generational task, worthy of Don Quixote, or maybe Teddy Roosevelt. They don't make 'em like that anymore, so we need a different remedy.

As of July 21, 2011, we've a new regulator with absolutely no mandate to keep banks looking good by sweeping dirt under the rug: The Consumer Financial Protection Bureau. But Congress has pointed it in the wrong direction, and it's not headed towards the goal.

The CFPB needs a clear Congressional mandate to detect the forms of financial mischief that are most harmful to customers, and to assure appropriate punishment that deters recidivism and dissuades others. Enforcing the laws against unfair, deceptive and abusive practices requires establishing basic principles whose application Congress can oversee.

Here's a first stab at enunciating such principles:

The CFPB should be protecting all bank customers, including businesses, pension funds and municipalities, not just consumers. (Think of the recent auction-rate securities, foreign exchange and interest rate swap abuses in which the victims were institutional clients.) Why do these other customers deserve less protection?

When abuse is detected, the CFPB should promptly assess a penalty that assures both total restitution for all possible damages and a fine that is a multiple of this amount. Double the penalty again for failure to admit fault or for covering up. 

These penalties would be subject to expedited appeals to an administrative law judge and then into the court system. No scuttling with settlements. No sticking our heads in the sand when a class action is settled for a tiny fraction of the harm done. Every such settlement should trigger an immediate disciplinary response. 

When a penalty is exacted, the CFPB should investigate within the institution, either directly or through an independent party, to determine which managers initiated, approved or had guilty knowledge. These people should be assigned penalties ranging from termination to banishment from the financial industry.

Such violations cannot occur unless there are also serious defects in a bank's legal, compliance and risk organizations. Remediation of these faults, specifically including replacement of the responsible individuals, such as the general counsel and the chief risk officer, should also be mandated.

These are not draconian or novel remedies. The SEC is already banning people for life from the securities industry. The prudential regulators are already requiring replacement or strengthening of bank managements. 

The difference here is not the nature of the remedy, but the purpose. The CFPB won't do this out of concern for the deposit insurance funds or consumer confidence, or even for bank shareholders, but rather to punish and hence dissuade egregious, endemic wrongdoing while delivering full restitution.

We can only hope that after the elections and confirmation of a director, the CFPB might desist from its current charm campaign—making nice with everyone in sight and focusing on disclosure and interminable rule-making processes rather than enforcement. If it doesn't, then tee up another new regulator. 

The impetus for the CFPB was to assure consumers a fairer deal. Ten months later, this hasn't started. New rules won't help if we don't enforce the old ones. But if more legislation is needed, let's enact it.

Can you think of any bankers, even in the largest banks, who would appreciate and actively support such a cleansing initiative? I can. Bad banking drives out good. If you want to run an honest business, then rid the industry of its crookedness. And most bankers, like most customers, keenly desire an industry that doesn't cheat.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.