Deep Dive Episode 166 – The CFPB Taskforce Report on Federal Consumer Financial Law
Recent years have seen a dramatic shift in the way in which American consumers use and shop for financial products and make payments, especially the rapid growth of electronic payments and electronic disclosures. These developments have raised both new opportunities for consumer choice and benefits but also potential new consumer protection threats. At the same time, repeated economic and financial crises, such as the 2020 global COVID pandemic, have illuminated the tensions in the existing institutional framework and suggested a need for modernization to respond to these challenges.
To address these challenges, in 2020 Consumer Financial Protection Bureau Director Kathleen Kraninger formed the CFPB Taskforce on Federal Consumer Financial Law to review the existing consumer financial protection framework and to recommend reforms. On January 5, 2021, the Taskforce published its two-volume report (available here). In this live podcast, Taskforce Chair Todd Zywicki joins us for an overview of the Report, its findings, and recommendations. He is accompanied by David Silberman, former Deputy Director (acting) of the CFPB and moderator Brian Johnson, also former Deputy Director of the CFPB.
Although this transcript is largely accurate, in some cases it could be incomplete or inaccurate due to inaudible passages or transcription errors.
[Music and narration]
Introduction: Welcome to the Regulatory Transparency Project’s Fourth Branch podcast series. All expressions of opinion are those of the speaker.
Colton Graub: Good afternoon and welcome to The Federalist Society’s Fourth Branch Podcast for the Regulatory Transparency Project. My name is Colton Graub. I am the Deputy Director of RTP. As always, please note that all expressions of opinion are those of the guest speakers on today’s call.
If you would like to learn more about each of our speakers and their work, you can visit www.regprogect.org where we have their full bios. After opening remarks and discussion between our panelists, we will go to audience Q&A, so please be thinking of the questions you’d like to ask our speakers.
This afternoon, we’re pleased to host a conversation discussing the recently released CFPB Taskforce Report on Federal Consumer Financial Law. Our moderator for today’s discussion is Brian Johnson. He is a partner at Alston & Bird’s Financial Services & Products Group and the Consumer Financial Services Team. Before joining the firm, Brian served as Deputy Director of the CFPB. Brian, the floor is yours.
Brian Johnson: Thank you, Colton. Welcome, listeners, to today’s podcast. I’m pleased today to introduce our discussion topic. Recent years have seen a dramatic shift in the way in which American consumers use and shop for financial products and make payments, especially the rapid growth of electronic payments and electronic disclosures. These developments have raised both new opportunities for consumer choice and benefits, but also potential new consumer protection threats. At the same time, repeated economic and financial crises such as the 2020 global COVID pandemic have eliminated the tensions in the existing institutional framework that suggested a need for modernization to respond to these challenges.
To address these challenges in 2020, CFPB Director Kathleen Kraninger formed the Taskforce on Federal Consumer Financial Law to review the existing consumer financial protection framework and to recommend reforms. On January 5 of this year, 2021, the taskforce published its two-volume report, and I should say it comprises roughly 900 pages. Topics covered by the report and associated recommendations include the history of consumer credit, supply and demand for consumer credit, small dollar lending, disclosures, competition, innovation, access and inclusion, privacy and data security, and consumer empowerment and financial literacy.
Our two panelists today are undoubtedly qualified to discuss all of these topics and more. Todd Zywicki served as the chair of the taskforce. He is a George Mason University Foundation Professor of Law at George Mason University School of Law. He is also a Senior Fellow at the Cato Institute, a Senior Scholar at the Mercatus Center at George Mason University, the Senior Fellow at the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics. From 2003 to 2004, Professor Zywicki also served as Director of the Office of Policy Planning at the Federal Trade Commission.
David Silberman served as CFPB’s Associate Director for Research, Markets, and Regulations from 2011 when the Bureau first opened its doors until 2020. For two of those years, he also served as Acting Deputy Director. David currently is serving as a Senior Fellow at the Center for Responsible Lending, a Senior Advisor to the Financial Health Network, and an Adjunct Professor at Georgetown’s McCourt School of Public Policy and at Harvard Law School.
Todd and David, welcome to you both. I look forward to today’s discussion. So let’s jump right in. Todd, I’d like to start with you. And I think our audience perhaps would benefit from hearing from you about an overview about the taskforce report itself, the recommendations, how the taskforce was formed and how you went about your business, and what the taskforce thought about in terms of presentation and the topics to be covered. I will turn the floor over to you. Thanks, Todd.
Prof. Todd Zywicki: Thanks, Brian. And it’s a real treat to be here with you, Brian, and David Silberman, two people who know more about the bureau, probably, than anybody in the bureau’s 10-year exitance. I’m very much looking forward to your observations and thoughts. And of course, I want to thank Kathy Kraninger, most importantly, for setting up the taskforce and trusting me to serve as the chair of the taskforce, which was a real treat. And it was an amazing group who was doing it. And I want to thank Brian, who was, in fact, the deputy director right when we started and was very instrumental in getting it started up and running, as well.
There were five of us on the taskforce. It was me, Howard Beales, the former Head of the Bureau of Consumer Protection at the Federal Trade Commission when I was at the FTC in the 2000s; Tom Durkin, who’s probably the leading consumer credit economist of his generation, was the chief consumer credit economist at the Federal Reserve for about 20 or 30 years; Bill MacLeod, who was the Head of the Bureau of Consumer Protection at the FTC in the 1980s and has had a very distinguished career as both a consumer protection and antitrust lawyer, he also served in the antitrust division at the DOJ; and finally, Jean Noonan, who has years of experience in this area. She was the first financial services lawyer at the Federal Trade Commission when the Division of Credit Practices was set up, later went on to be general counsel of the Farm Credit Administration and has for many years now been in private practice.
So it was an unusually diverse set of skills that complemented each other very well. And I think one person estimated we had about 150 years of experience all together.
Director Kraninger gave us three goals, which was to provide an independent analysis of the current state of the consumer protection system. And I want to thank her and Brian and the other people who were involved who backed us on that and really left us independent to do our work. Second, to provide recommendations on how to improve the consumer finance and consumer financial protection system. And finally, to do it within one year. And we were set up in January 2020, and we reported — we issued our report this year, the first week of January 2021. So it was actually a federal taskforce and a federal agency that reported on time.
And as Brian said, it was a very large report. Volume I basically provides our independent analysis in 13 chapters. That’s about 800 pages. And Volume II contains 102 recommendations. We basically organized the report around three themes, and I’m going to just spend a few minutes sketching these out and identifying some of the things we hit under each of these themes.
The first was inclusion, and this was something that was very important to all of us. The current consumer financial protection system works — and finance system works pretty darn well for most middle class and upper middle class Americans. We have a wide variety of — it’s not perfect all the time, obviously. We all fight with our credit card issuers and the like. But by and large, the system works pretty well. There’s a lot of choice, a lot of competition. People want our business, and we have a wide variety of products and services.
But that’s not the case for everyone, and we really felt that it was important to try to make sure that the consumer financial protection system and consumer finance system works for all Americans and all Americans are included. And so there’s three basic areas that we talk about under that heading. The first is research, which is that we found out that there’s a couple places in which there are real pockets of areas of financial exclusion that we don’t know that much about.
For example, formerly incarcerated populations, it turns out, have a terrible time getting access to financial services. If they’re in jail for several years, they may not even have a credit report when they emerge. While they are in prison, they are at a very high risk of identity theft. We identified that as a problem.
And rural populations is another group where we know very little, but we know that they have the highest rate of credit invisibility. Financial exclusion is a real problem for rural populations. It’s gotten worse over time as Dodd-Frank and other — the regulatory costs of Dodd-Frank as well as other developments in the market have led to closures of a lot of small town banks in rural areas and the like. They also don’t have the same access to internet services and high quality internet and the like in rural populations. So that’s an area in which it’s going to take a lot of study and, I think, research to try to figure out how to deal with increasing access of rural populations to financial services.
Otherwise, we look at two general areas. The first one deals with ways in which we can facilitate more inclusion. And there’s a lot of opportunities here. The report talks a lot about fintech in particular. The OCC has done a lot of really good work in the past few years in facilitating fintech and the opportunities for inclusion. The academic research and policy research on this is very clear that fintech can reach into populations that have previously been underserved and do a lot of good work there.
We actually recommend that the CFPB be authorized to become a chartering authority for non-depository fintech charters. And we can talk about that more later if we want, which is in no way a comment on the OCC’s operations the past few years, but we just thought was a way to deal with things going forward.
We also like the idea that the FDIC has been promoting more access to industrial loan corporations and non-traditional bank institutions entering in the financial services. We think the real poster boy here is Walmart, who about 10 years ago wanted to enter the banking industry but was blocked by incumbent banks at the FDIC, especially community banks who didn’t want the competition. But where Walmart has entered markets, they’ve really shaken up the status quo and driven down price and increased opportunities for consumers. And we think that there are more opportunities for that, and that the FDIC has moved in that direction in recent years and should continue to do so.
We also argue for greater portability of bank accounts, and we can talk more about that. But the bank account competition is not as good as other markets. Bank accounts are very sticky for consumers, and we’ve come up with the idea, and it’s been tried in other countries, that allow so-called open banking. And certain developments have made open banking more possible here, but they’re kind of workarounds. But we think that is a good way of empowering consumers to be able to get more competition in bank accounts.
We also are very bullish, and the CFPB itself has been very bullish on greater use of alternative data beyond the traditional criteria that deal with credit, that go into a FICO score, things like cashflow data, reporting of things like utilities and rent and the like. We heard from some members of industry that they thought that they weren’t sure about the regulatory environment for that, so we call on that for some clarification.
We also think that credit unions should be able to broaden their base, and that credit unions that serve lower income populations should also become easier to charter. And we also look at faster payments. And the Fed, for whatever reason, has dragged its feet for years in creating faster payments and check clearing, which we think would help consumers.
A second category or a third category to look at are areas where we can eliminate or reform or amend statutes that we think have unintended consequences, the Durbin amendment obviously being one which has led to higher bank fees, especially for low income consumers, but also various aspects of the Card Act such as for college students. And the Card Act makes it difficult for college students to get credit cards.
But what we’ve seen is that this isn’t uniform, which is for kids from wealthier backgrounds, higher income backgrounds, their parents can just co-sign and get them a credit card, where for kids from lower income backgrounds, they can’t co-sign. They’re basically left without a credit card. And what we know is that when the credit cards are usually the first way people establish credit, and if you don’t have credit when you’re young, you’re less likely to have credit when you’re older.
The second category after inclusion we look at is focusing consumer financial protection on consumer harm. Disclosure has been the primary focus of consumer financial protection for many years now. And while disclosure is a very good thing that can facilitate shopping, it can also be too much of a good thing. And so what we point to is trying to use disclosure more readily and in a more tailored manner so that consumers get access to the information they need, but otherwise focusing on consumer harm and misuse of data and the like with consumers rather than mere disclosure.
And we also have a variety of other things that we do such as making enforcement more predictable, such as by adopting the FFIEC schedule or guidance for penalties and tying enforcement more closely to consumer harm.
The third area we talk about is modernization—and I will wrap up on this—which is that the pandemic, which has been a horrible thing, sort of highlighted to us as we were doing the taskforce — there was already a recognition of the need to modernize the consumer financial protection system, as Brian said, to take account of changes in technology and consumer preferences and the like.
The pandemic basically highlighted that, which is we’ve basically seen 10 or 15 years of development squeezed into 6 month in terms of adoption of electronic payments. And what we saw was that created havoc for the traditional system. A lot of states, for example, still require in-person real estate closings or in-person real estate appraisals. And we thought there needs to be a way for the financial protection regulation to cut through those sort of state laws, especially where those laws reflect special interest activity more than anything else.
We also talked about the idea of using more principles-based regulation instead of prescriptive rules-based regulation that would allow the system to evolve as technology and consumer preferences develop. And that would be new for the financial system, which is very heavily predicated right now on prescriptive regulation.
So we could come back to all of these ideas as we develop, but I’d like to hear from David now. Thanks.
Brian Johnson: Thank you, Todd. And I will turn this over to David. David, when we worked together, I was a great admirer of your intellect and, in particular, your capacity to absorb huge amounts of information as the head of the rulemaking division within CFPB. So there’s perhaps nobody better suited, based off of your experience and interest and capabilities, to absorb this entire report and recommendations and offer, I think, some wisdom and great observations.
In particular, I’d love to hear a little bit about your perspective on the report, having been at the bureau over the greater part of the last decade and seeing the agency grow from an upstart into the agency that it is today. So we’d love to hear from you a bit on areas where you may agree, areas where there may be disagreement, maybe some topics not addressed that you think are front and center as part of the bureau’s mission, or other areas not covered fully. So with that, I will turn it over to you, and greatly appreciate your observations.
Prof. David Silberman: Thanks, Brian. Thanks for the kind words. It was great having the opportunity to work with you. And thanks to The Federalist Society for inviting me today.
I guess to start, I couldn’t help, as I was preparing for today’s session, to recall a story that one of my former law partners told me about his first oral argument. It was in the Fifth Circuit. And his client was one of the leaders of the Alabama Bar at the time, and so he brought my colleague in and introduced him to the chief judge before the argument started.
And my colleague reported when he got up to argue, the chief judge looked down at him and said, “Mr. Gottesman, we understand this is your first argument. We just want you to know that there’s nothing you’re going to be able to say today that’s going to be able to persuade us of the merits of your client’s position, but we’re going to very much enjoy listening to you try.” So I’m not naive enough to think that I’m going to persuade very many people today, but I hope you’ll at least enjoy the conversation.
And let me — I want to take it up a level and start with some — look forward to having the opportunity to talk about the three themes that Todd laid out and some of the specifics, some of which I agree with, some of which don’t agree with. But let me take it up a level and offer three more general observations.
The first, obviously, is to express admiration for just the volume of work that the taskforce was able to accomplish in the time it was able to accomplish it. The taskforce was modeled after the Commission on Consumer Finance from the 1960s, but that commission had 20 staff and consultants, a whole bunch of student research assistants. It was focusing on a narrower area of consumer finance than the taskforce was.
It took three years to do its work and produced a report about half the length of the report that this taskforce had produced, although the taskforce — the commission in ’68 or ’72 did produce volumes of staff reports as well. So just the amount of work that the taskforce was able to accomplish in this period of time is breathtaking.
Having said that, the second point that I would make is that, from my perspective, the structure and processes here fall in ways that affect the utility of what the taskforce came up with and how it will be utilized. And again, if I draw contrast with the commission on which this taskforce was [inaudible 20:31], the commission was a bipartisan body representing a fairly wide range of views, initially chaired by Professor Braucher at Harvard, who was at that time the Reporter for the Restatement of Contracts. Then when he became a justice, he was replaced by attorney Ira Millstein. The commission held six days of hearings, heard from 100 or more places.
This taskforce, in contrast, I think it’s fair to say, ran an ideological spectrum closer from A to B than A to Z. I have enormous respect for the members of the taskforce, for Howard and Tom as economists, and for the attorneys. But their particular place on the political ideological spectrum, if you will, there’ve been public reports that academics who held different views applied to be members of the taskforce and were not selected because of their views. And so I think that created a taskforce whose processes — with some serious problems the Constitution and, therefore, the outcomes.
Quite frankly, I can’t imagine what we would have heard if, when Director Cordray was Director of the CFPB, he had created a taskforce drawn entirely from one part of the ideological spectrum, made those folks employees, and not had a process subject to the Federal Advisory Committee Act. I think there would have been a real outpouring of outrage over that process, and I think with good reason. So I think the process here is problematic.
And the result is a report which, from my perspective, is quite imbalanced in the set of recommendations. Obviously, the themes that Todd outlined are themes with which I think everybody can agree, that inclusion should be certainly an important goal to pursue, that there is a need for modernization. And I think many — some of the recommendations make a great deal of sense, and that focusing on harm, hard to object to that, and that makes a lot of sense.
Again, if we contrast what the taskforce came up with, with what the commission came up with back in its day, the commission did make some recommendations which the taskforce highlighted to improve competition. But it also made a number of recommendations to enhance consumer rights, to impose new duties on creditors, and recommendations to enhance supervision and enforcement, including, interestingly, a recommendation for, quote, “a federal watchdog agency with full statutory authority to issue rules and regulations and supervise all examination enforcement functions under the Consumer Credit Protection Act.” So in many ways, the commission anticipated — or its recommendations were the precursor of the creation of the CFPB, for which Senator Warren is typically given credit.
The taskforce recommendations, in contrast, are quite different. There are a lot of recommendations for new research, many of which are interesting ideas. There are some addressed to the CFPB internal organization and structure and processes. We could get into those if anybody’s interested. I tend to disagree with those in general.
But there’s about 30 or so recommendations by my count that are in the nature of calls for substantive changes in the law or clarifications of the law. And they’re almost entirely of a deregulatory nature, relaxing prohibitions, clarifying permissions, as the way to achieve the goals the taskforce set out. And so at the highest level, I would say that it’s not my view from my experience that substantially all the problems facing consumers or all the tools to achieve inclusion or to address change are in the nature of reducing regulation and freeing up competition.
The taskforce talks about a framework using, actually, a speech that Brian gave when he was at the [inaudible 25:04], and it talks about the framework of consumer protection resting on a three-legged stool, the three legs being competition, the law of private contract, and regulation or policing of the market. And my overall perspective is that taskforce recommendations would cut the last of those legs rather short and create an imbalanced stool.
From my perspective, there are a number of areas where markets, as they exist, there’s a misalignment of interests between the providers of consumer financial product services and consumers where more regulation is needed. There are markets where the competitive forces have led to an equilibrium in which those least able to bear the costs of the consumer financial services are subsidizing people like me who don’t need those subsidies. There’s markets where regulation has not kept apace of actual change, and I think there’s a need for enhanced regulation in light of what new technologies allow.
And I would say that we’ve created for the [inaudible 26:13] in large extent a new system with lots of consumer rights, but we have neutered the system private enforcement that was established to enforce those rights without funding public enforcement in a way sufficient to enforce those rights. And that’s, I think, a large gap in the consumer finance system that the taskforce doesn’t talk about.
So with that at a high level, let me stop. And I look forward to the conversation about those specific topics Todd laid out and some of the more specifics.
Brian Johnson: Thank you, David. That, I think, goes a long way towards helping set up some of the difference of opinion here inherent not just between maybe yourself and the taskforce view, but difference of opinion that have been longstanding now for 50 years and perhaps longer in terms of the approach to consumer protection and the role of federal agencies like the CFPB.
So Todd, let me go back to you, and let me pivot for a second and do a bit of a deeper dive on one of the themes of the report that you already alluded to. And actually, I was surprised to read and, in fact, hear from you that if this is, in fact, a deregulatory type of report that there was a recommendation for even more authority for the CFPB in the role of now being a chartering authority for fintech. But I view that really as one aspect of the broader debate that advocates across the spectrum have about financial access and inclusion. And I was struck at how the report did some deep dives in to aspects of that.
And of course, one of the top priorities for the CFPB now with Acting Director Uejio is racial equity. And certainly, the bureau has authority to enforce nondiscrimination statutes on the ECOA Reg B, and soon, the Section 1071 small business lending rule. So the principle of nondiscrimination in policing markets to free market participants and consumers from discrimination is one aspect of promoting financial access inclusion.
But also, Todd, you touched on another aspect, which is the promotion of innovation in the marketplace to help address some of the problems observed by bureau researchers and others about credit invisibles or folks who are not currently participants in the mainstream banking or financial system. I would love to hear your thoughts, Todd, on how the taskforce thought about those issues and, importantly, how it addressed them and what recommendations it made in that regard.
Prof. Todd Zywicki: Thanks, Brian. And that’s obviously an issue that everybody cares about always, and especially nowadays. So I’ll say a few things, which is, first, there are some things, really, under the heading of regulatory modernization that also fit with this. So for example, we recommend that Congress consider or at least study the benefits and the costs of adding disability to ECOA. It’s obvious that social norms have changed, and the Americans with Disabilities Act obviously covers some of that. But the testimony we got and the research we did suggested that there might still be issues involving disability in ECOA. So one of the areas in which we call for congressional exploration and possible action would be to include disability.
There are some things also that might be accurately considered to be deregulatory, but we thought were appropriate just in terms of modernization. So for example, Jean Noonan pointed out there’s a whole market now of technologies that didn’t exist in the ’70s involving assisted reproductive technologies. And ECOA prohibits a lender from asking somebody what their childbearing plans are. Well, obviously, if you’re a woman who wants to go in and get a — to finance one of these expensive IVF or other procedures, it’s kind of natural to ask whether or not you’re planning on using it to for childbearing plans.
And so some of this is things like that, archaic rules that maybe have served their function or are no longer relevant, such as that one and some of the other issues involving women and discrimination against women on the basis of gender are things that I guess could accurately be considered deregulatory, but which seem like pretty obvious cases in which the continued benefits seem small relative to the cost of things like that, or asking about phones in their own name, or things like that. So that’s a group of things that I think are directly relevant to this.
A secondary that’s relevant on this whole question relates to, as you said, competition and the like. And so as we looked at this, one of the things we saw is that the evidence — obviously, fintech raises all sorts of potential costs and benefits. But one area in which fintech seems to have particular potential is to break down the disparities in pricing. And we really go through the evidence here, and there’s a lot of evidence, particularly some great studies by some economists at the Philadelphia Federal Reserve who find that fintech and entry into the market by fintech providers tends to reduce disparities in pricing on the basis of race.
The other thing that we flag, and this may be an area I’m sure that David would disagree with our recommendations, but at least on something such as the Card Act, as I mentioned on the outset, I think our — really, where the taskforce comes down and says, look, the way that some of these things are implemented right now clearly has costs and unintended consequences. And maybe the benefits exceed the costs, but it’d at least be worth revisiting the question to see whether or not we could get whatever benefits we want at lower costs.
So I gave the example of college students, but another example is subprime credit cards. And one of the things we see in the CFPB’s report on credit invisibles is that, as I said earlier, credit cards are the way in which most people first get access to credit.
The second thing we see in that report is that when you are credit invisible, you tend to stay credit invisible. And traditionally, a way in which people would become credit visible would be through an unsecured subprime credit card. And that has largely disappeared from the market, and it’s not really clear what has sprung up to replace it. And a lot of the things that consumers have turned to, consumers in that situation, are not very attractive options either, such as payday loans and the like, which also have the additional effect that they don’t really help people to establish credit.
So there are these tradeoffs, especially with immigrants, young people, people who have impaired credit, all these who have these challenges. It’s kind of a chicken and the egg problem involving becoming credit visible and being able to get access to mainstream credit. And it may be that people would disagree with our conclusions, which is perfectly reasonable, as to what should be done. But we hope at least that people will take the empirical evidence seriously and look at the potential unintended consequences of this and really put good thought into how to get the benefits of some of these regulations without the unintended consequences and costs.
Brian Johnson: Thanks, Todd. David, I’ll turn it back to you. Still on the topic of financial access inclusion, you obviously have the long view and were a thought leader, senior leader within the bureau who wrestled for years with this issue in terms of what the bureau’s priorities should be and how it should be addressing these issues. Is there anything you care to share about the bureau’s approach which may be represented or not represented in the taskforce report? In other words, do the report recommendations represent a departure from the status quo or simply a different area of emphasis? I’d love to hear your thoughts.
Prof. David Silberman: Thanks, Brian. So I hadn’t thought about the question of how the taskforce recommendations bear to the CFPB approach. I’d start by saying, as Todd said, inclusion is a key goal. Equity is a key goal. They’re not one and the same. One can have an inclusive system that’s not equitable, of course, but they’re both important goals.
I think the recommendation — so one aspect of inclusion is so that there is a significant segment of people who are unbanked, don’t have a checking account. That’s come down significantly over the past 10 years, but there’s still an issue. I think open banking is a great idea. It might help some there, although I would doubt it’s going to help very much.
Fintech has made a difference, and encouraging that makes sense. But ultimately, we’re now talking about a population — about half of the people who are unbanked earn less than $15,000 a year; three-quarters earn less than $30,000 a year in household income. My own sense of what’s going to address this problem, it’s going to require some form of either the government as a provider of last resort or subsidies. And the taskforce report talks a little bit about it, but there’s no recommendations. I don’t think we’re going to solve that problem through a more competitive marketplace.
When it comes to credit invisibles that Todd talked about, the data indicates there is a significant segment of people who do not have any credit report. I quite disagree with Todd in suggesting that once you’re invisible, you stay invisible. As one of my colleagues used to say, “Nobody’s born with a credit report or a credit score or a birth certificate. And most people [inaudible 36:47] have one.” So this does [inaudible 36:50] over time.
I don’t think it’s true that the way into credit visibility was at any time subprime credit cards of the type that the Card Act restricts, which is to say those where the upfront fee is more than 25 percent of the credit line. That was a product offered by only one issuer. Mainstream credit cards, such as the ones offered by Capital One, have never been affected — have never had those kinds of features. They’re not affected by the Card Act.
I think if you’re going to deal with the problem of invisibility, I agree with Todd and the taskforce that alternative data is an important playbook. But here, I would say that some type of alternative data is transactional data; that is, data for checking accounts. My perspective, the biggest obstacle to prevent [inaudible 37:37] is that it’s not in the best interest of bank to allow others to access the data. And there’s a need for — Dodd-Frank Act has a provision to never really [inaudible 37:47] to assure that data can be accessible.
Other promising data which the taskforce talks about is transactional data. Todd mentioned utility payments. Telecom payments is particularly promising because such a large percentage of people have mobile phones these days. That data is not available, largely because it’s not in the interest of the telecom providers to make it available. They’ve created their own system so they can get the benefits of credit reporting without being reporters. And then if an account goes delinquent, they can turn it over to a debt collector, and the debt collector then reports the lines. So they get the benefit of negative reporting but no positive reporting.
So it’s another area where I think if you want to deal with the issue, you need to think about more regulation and taking at least minimally reporting and perhaps mandating reporting in order to expand access and inclusivity. So let me stop at that point.
Brian Johnson: Well, thanks, David. Let me turn to another topic, which I think is a general theme throughout the report. Certainly, there are a number of areas we could discuss, but one I wanted to focus on is small-dollar credit. And I think the main theme is, to David, your point, I think everybody can agree that the purpose of the bureau or of federal consumer financial law generally is to prevent consumer harm. But there are areas of strong policy disagreement which we’ve seen play out, for instance, in the Cordray era versus the Mulvaney-Kraninger era. And I think payday lending or small-dollar credit is one of those areas where the differences in thinking are most stark.
Todd, in the report, the taskforce did address small-dollar credit, so I would love to hear from you about the taskforce thought about small-dollar lending from a consumer protection or prevention of consumer harm perspective.
Prof. Todd Zywicki: Thanks, Brian. Obviously, that is a big issue and one we talked a lot about. And the point we make in Chapter 5 is this is a perennial issue. This is an issue to which there is really no solution and only tradeoffs, and there always has been. And if you look back at U.S. history, you can see this. And the basic problem — there’s that old joke about when you have construction, you can pick cheap, fast, or good; pick two.
And that’s sort of the case when it comes to small-dollar lending, which is that you can — the fundamental problem is that the cost of making loans does not scale to the size of the loan. And so in terms of dollar costs, a $300 loan costs — a $3,000 does not cost ten times more to make than a $300 loan, and a $30,000 loan doesn’t cost 100 times more than a $300 loan, or whatever the math would be. And so if you want to have small-dollar loans, it is going to be expensive.
The second thing is that these small-dollar loans tend to have very high risk. They have high default rates. And so the reality is that small-dollar loans are, in terms of measured APR and the like, are going to be expensive. The taskforce, as the NCCF itself did, takes no position on the moral question as to whether or not a loan above a certain cost should not be allowed to be made. Basically, what we say is that the evidence suggests that usury ceilings in particular can be used to get rid of the supply of a small-dollar loan product, but it doesn’t get rid of the demand. And when you try to get rid of the demand, what that ends up doing is pushing consumers to other things.
Historically, for example, it caused consumers to rely very heavily on retail store credit and loan sharks. Loansharking in the United States used to be a big issue. To give you a sense of the problem, in the 1960s, the best estimate I’ve been able to find is that all loansharking in the United States was about a $10 billion industry, which, to give you a translation, was about $69 billion in today’s dollars, which is about double the size of the entire payday loan market in the United States today. So when we didn’t have small-dollar lending, when it was illegal, loan sharks proliferated, which isn’t to say that would be the case today. But if you get rid of the supply, you don’t get rid of the demand. And that’s basically where we come down on is basically saying there are tradeoffs here.
The second thing we point to is that it’s not really clear — a particular concern has been so-called debt traps. And it’s not really clear what’s meant by that, which is to say that what we know is that a lot of consumers roll over their payday loans. The evidence suggests quite clearly that on average, most consumers who roll over their payday loans are expecting to do so. New research by John Zinman and his co-authors finds that consumers are actually better than experts, academics and the like, at predicting their likelihood of rolling over their consumer loans. So they don’t seem to suffer very much from this overoptimism problem that people are concerned about.
And we don’t really know why they roll over their loans. The idea seems to be that something terrible will happen to them if they default, but it’s not ever really been specified as to what that is. And so they don’t seem to be deterred from rolling over their loans. The default rate is obviously very high, which means a lot of people don’t actually default. And so I think if that’s the particular concern, we’d want to try to figure out exactly — there’s more research that would need to be done, I think, to understand what’s going on with that. And so there’s a lot of assumptions about small-dollar loans, why consumers use them, how they use them. But there’s a lot of open questions as to whether or not all those assumptions are correct.
Brian Johnson: Thanks, Todd. David, let me give you the floor to respond. You’re obviously no stranger to the bureau’s approach in this area, both from a market research and economic research perspective. But also, the bureau has been active, as you know, in writing rules covering this space. We’d love to hear your thoughts on what Todd has shared or any observations you have about how the taskforce tackled the topic.
Prof. David Silberman: Sure. So let me start with where Todd — I agree with — I guess you’d possibly be surprised. I agree with much of what Todd has said. It is certainly true that the cost of making loans don’t scale, that small-dollar loans are going to be riskier loans, and that they are going to be more expensive. I think there’s no denying that.
There is this question of whether it’s a moral question as to what point would you want to try and have regulation so that a lender’s interests are more or less aligned with the consumers rather than this business works no matter how high the defaults go. And that I think is a fundamental moral policy question which the bureau, because it doesn’t have usury, the ability to regulate rates, didn’t have to get into.
I guess the places where I would disagree with Todd is that getting rid of supply doesn’t get rid of demand, at least to some extent. We do not know, for example, one of the areas — there are 20 states, plus or minus, which do not have payday lending at all. And the evidence that I know of, maybe more research to be done, that loansharking is more prevalent there than it is in states which allow payday lending. The data seems to be that although there’s internet payday lending to some extent, it doesn’t seem to take place with greater prevalence in a state where there’s not storefront payday lending.
And we know from other credit markets that supply seems to stimulate demand, that as credit lines increase in credit cards, for example, people who had plenty open to buy on their existing credit cards will increase their debt because they’ve been given more credit. So I think this is an old question, not a clear question.
The other area where I disagree with Todd is with respect to the extent to which consumers who take out these loans understand what are the likely consequences. The Zinman research to which he referred, all that it says is that a sample of people who had been in debt for a period of time, when asked what is the likelihood they’re going to take out at least one more loan within 45 days, they were fairly good at predicting that, although those who had the least amount of experience were least good at predicting that. So the research doesn’t suggest that people understand what’s going to happen.
I think the evidence from Ronald Mann’s study is quite clear that the folks who want—I get that it’s a smaller sample—but the folks who ended up in long periods of indebtedness had no idea, ex ante, that that was going to be their likely outcome. So whether the bureau took, given its tools, to say that the best approach was to try and assert an ability to repay but to create some exceptions first to allow certain loans. Other states have simply capped the number of loans. Other states have created cooling off periods.
I think there is a need to try and do something to prevent this phenomenon of consumers taking out a loan, not realizing what the likely outcome is going to be, and ending up paying $300 to borrow $300, and in 14 weeks still owing $300, which is not an uncommon result within the payday loan market.
Brian Johnson: Thanks, David. In the interest of time, I think I’ll open this up to questions. But I do have one follow-up question on this, which is a fascinating aspect of consumer credit regulation generally, which is, David, you’d pointed out that some 18 plus states have simply prohibited the type of short-term, small-dollar lending that’s typically known as payday lending. Others have regulated that form of lending.
So the question, which I think is somewhat obvious for both of you, is it’s one thing to identify the need for a regulation; it’s a second question is who should regulate. And it’s unclear that any state lacks the capacity to regulate. So what are both of your collective thoughts on who should regulate in this space? And to the extent that there’s a role for federal regulation, what is that role?
Prof. Todd Zywicki: David, why don’t you go first this time?
Prof. David Silberman: Sure. So I guess, Brian, that’s really a question to one’s philosophy as to what the appropriate role of the federal government in vis-à-vis the state government. It’s not a question unique in any way to the area of consumer finance and to what extent one wants to have federal standards.
I guess, having been a federal regulator and having been tasked by — given authority by Congress to establish national standards in a world in which that is sort of the norm is that most state law in this area is follow-on to federal law rather than — not in small-dollar, but consumer finance generally, it was Congress who enacted many truth in lending acts. Congress enacted their debt collection practice acts, and states followed. So I tend to take as a given that having federal standards makes sense. But that really depends on whether one believes what the role of the federal government should be viewed vis-à-vis state governments.
Prof. Todd Zywicki: Yeah, I would agree with that. And I would add one more thought, which is David mentioned the NCCF, and the NCCF was sort of the second wave of financial regulatory modernization. The first one was in the 1920s. This is when we first had consumer credit become a big thing, when people moved into the cities from the farms, and immigrants came in, and they needed credit for the first time. And there was a need to update and amend consumer credit laws to provide access for small-dollar loans for wage earners.
And then, really what happened in the 1970s was in that intervening period, we saw the rise of a national consumer finance market, whether it was the department stores who operated — there were a lot of mergers and national department store chains where they operated their credit operations out of a central office that created a need for federal regulation, or simple things like declining cost of telephone services, which caused — made it easier to be able to collect debts across state lines. And that’s one of the reasons why we saw the Fair Debt Collection Practices Act and the like was because states weren’t really able to get at a lot of unfair debt collection practices.
And that brings us up to the current era, which is the internet, which isn’t just national, obviously. It’s kind of nowhere and everywhere. The CFPB is unusually well-positioned to deal with that. It has the kind of reach that the states don’t have. And so one of the reasons why, for example, we suggest the CFPB would be a good chartering authority for non-depository fintech institutions is precisely because the traditional safety and soundness issues aren’t as important with respect to those entities, but the consumer protection issues really are. And the CFPB potentially has the reach to do that. In addition, we’re concerned that the big banks might be able to strongarm the OCC into imposing unnecessary barriers to entry on fintech companies such as unnecessary capital requirements and the like.
But that is the way of framing your question, Brian, which is I think the larger question is what does competition look like in this market to the extent that payday loans, for example, compete against fintech and compete against bank-issued overdraft protection and these variety of things that are national internet, state and local. I think a prudential question and sort of common sense—and not banking prudential—but a common sense question could be asked, which is how do we best draw the jurisdictional boundaries, understanding that from the consumer perspective, payday loans don’t operate in a local market. They also operate in a market in which payday loans compete against internet payday loans.
And so there’s actually an interesting question to determine what the federal-state balance should be that will best facilitate consumer choice and consumer protection and not just think of it as a question of traditional states’ rights, federalism, sovereignty, but think about federalism through the lens of promoting competition that benefits consumers.
Brian Johnson: Thanks, Todd. In the interest of time, I think I’ll turn this over to Colton for audience questions if anybody wants to chime in. And of course, we’ve only scratched the surface both of the report itself and the topics that the report represents more generally. So we’d love to have more time. Unfortunately, time is running short, but do want to provide the opportunity for audience participation here and ask questions of our panelists. Failing any questions, I, of course, have many more, so we can address those until we’re at the top of the hour. Thanks.
Colton Graub: Thanks, Brian. Let’s now go to audience Q&A. We’ll go to the first one now.
Chris Mufarrige: Yes, hi. This is Chris Mufarrige, and my question is for both of the panelists. But in particular, David, you brought up the Mann study and how it relates to payday lending. So I was curious if you two could talk a bit more about what the Mann study says and its relationship to the original payday rule.
Prof. Todd Zywicki: David, I’ll let you go first on that since you are involved.
Prof. David Silberman: Sure. So this is study by Ronald Mann, a very high-quality study, where he actually was able to link survey data, ask people before they took out a loan how long they expected to be in debt, and then link that with administrative data. He found that on average, people were predicted reasonably well, within one or two, I think, two or three weeks, but that on average, there was a tail of people who had substantial sequences of debt and that none of them predicted that.
When our economist tried to draw a — see a correlation, it was a correlation of close to zero between predictions and length of indebtedness. And when they reviewed that with Professor Mann, he agreed that there did not seem to be any correlation between their prediction and then length of indebtedness.
Prof. Todd Zywicki: And I’ll just add a few words on that, which is the first is that it is clear that consumers don’t always accurately predict. But what Mann generally found was that on average, consumers correctly predicted in the fashion that David described, but also that errors tended to be unbiased, which is to say that for those who made errors, they on average were just as likely to pay back the loan earlier than they expected as opposed to later than they expected. And ironically, this one study that was done on auto title lending found the same thing, even though the authors didn’t appreciate it. And so there is a bit of a dueling interpretation question here.
The other thing that was interesting about the payday loan rule was that the CFPB focused on the number of loans and, really, the question of consumers that take out above six loans — it’s more complicated than that, but basically six loans in a given year, and then kind of go beneath that. I’ve got a paper that I’m finishing with the economist Tom Miller where we find, for example, that one of the things that predicts the number of loans that somebody takes is whether a given state limits how much you can borrow at any given time. So states that have low loan caps where you can only borrow like $500 at a time, consumers take out more loans, and in the end, by and large, end up borrowing the same amount of money.
And so the CFPB, because, as David said, it doesn’t have authority to impose usury ceilings, instead tried to get at this particular problem of consumers taking out more loans than — taking out a lot of loans or roll over the loans. And I think still there are questions that, if that is revisited, I think that there are questions that need to be asked about why consumers do that, what causes that and the like, in addition to the questions about the Mann study.
Colton Graub: Thanks, Todd. Thanks, David. As we approach the top of the hour, I’d like to throw out again another request for questions if anyone has them. Seeing none —
Brian Johnson: — This is Brian. I’m going to squeeze one more in this last minute that we have, and then thank the panelists and turn it over to them for any closing thoughts they have. So it’s not lost on anybody that we’re now under new management at the CFPB. Rohit Chopra has his nomination hearing before the Senate Banking Committee next week. Presumably, confirmation means the next confirmed director takes over with new priorities.
David, unique to you, you’ve seen kind of a long view and lived through the first major leadership transition for the bureau. Now there will be another one which we’ll observe from the outside. Todd, you’ve also seen how the FTC handles things and how that may have — that experience for Mr. Chopra may have influenced maybe the way he thinks about some of these issues.
But I guess the general question I have is the way the bureau is designed essentially begs for these types of policy shifts and the pendulum swing depending on which party is in the White House and who, therefore, can be confirmed into the director role. From a big picture perspective, again, seeing how things have played out over the last 10 years, does that pendulum swing back and forth serve the interest of consumers? Does it serve the interest of markets? Does it help the stability of the agency itself?
I know that’s in some sense a loaded question, but in another sense, it is really the big picture question here, which is how do folks prepare for whether a consumer operating in a market or market participants, even financial institutions, how do you prepare for the inherent uncertainty of the political process? And is that a problem, or is that a feature of the system that is both natural and ultimately beneficial for consumers in markets?
Prof. Todd Zywicki: Well, thanks for that question, Brian. And I think, obviously, there are costs associated with changes in direction from time to time. I also have a fear that the costs are not necessarily borne equally by all members of industry or consumers, which is to say I suspect that big swings in policy tend to probably favor the big banks who have the resources and the ability to hire armies of lawyers and consultants and the like to be able to adjust to changes over time, whereas smaller firms and the like, I think, are disadvantaged potentially by that. And upper income consumers probably have the ability to buffer those changes more easily through just the resources that we have.
I think with respect to potential, assuming that Chopra, Rohit, is confirmed, Director Chopra, I think one thing that’ll be interesting to watch is coming from the FTC, how does that influence his experience? The CFPB, we note in the report, seems to be unique in the world, which is that it is a consumer protection agency that has what we can call five tools: supervision, enforcement, rulemaking, research, and consumer financial education.
The FTC obviously does not have supervision. It has limited rulemaking. It does have the other aspects of it. But it’ll be interesting to see how Director Chopra uses that combination of tools. And this is something we write a lot about, which is, for example, our view is that the relationship between supervision and enforcement at the CFPB isn’t clearly defined, or what the role of supervision should be relative to the prudential regulators. Should CFPB be supervising in a different way from the prudential regulators? So I think it’ll be interesting to see how he uses those tools.
The second thing that you alluded to, Brian, is that based on my experience at the FTC, the interface between competition and consumer protection is very deeply embedded in the fabric of the FTC of being aware of unintended consequences of competition from consumer protection ideas. And hopefully, that will be brought to the CFPB. Dodd-Frank makes it clear that competition is a relevant consideration for — it’s on par. It’s one of the core missions of the CFPB is to be concerned about competition, and so our goal, I think, or our hope for the taskforce would be that will create a higher elevation.
The last thing I’ll say is David mentioned that 40 years ago — or that 50 years ago, the NCCF recommended the creation of something like the CFPB. And when we did the taskforce, we were very aware that we were writing it in the year of an election, and we knew we were not just writing it for this year or the potential that Director Kraninger would continue. But we were writing with an idea of, like the NCCF, of looking 10 or 20 years into the future and creating a framework that would be more adaptable, a framework that would be easier to modernize, that would deal with the fact that the world is speeding up and it’s accelerating at an accelerating pace.
And so we tried to create a framework for how to think about developments over time as markets and consumer preferences change. And so it took 40 years for that recommendation of the NCCF to come to fruition, so hopefully some of our recommendations will take less than 40 years [laughter], and some might never end up coming in at all.
But we hope at least it will be a resource for Director Chopra, assuming he is confirmed, to get up to — to kind of get a sense of what we see, at least, as the strengths of the current consumer financial system and consumer protection framework, as well as areas, at least, that we thought that improvements and modernization could be done.
Brian Johnson: Thanks, Todd. David, you get the final word here.
Prof. David Silberman: Brian, to your question, I don’t think the pendulum swing serves anybody’s interest very well. I would say to Director Kraninger’s credit, I don’t think the pendulum swung that far. Certainly, on payday, it did, but on many things, it was a different bureau than it was under Director Cordray, but not 180 degrees different. I would hope that the bureau is not going to swing radically left and right with elections.
And I guess since this implicates in some ways the question of bureau structure, I came — before I entered into the world of consumer finance, I was a labor lawyer, a union lawyer. Natural Labor Elections Board has a commission structure, and that structure never has prevented it from swinging fairly dramatically from Republican to Democratic administration and back again. So I don’t have any reason to think that a commission structure would somehow temper in material ways the swings to the extent they occur. I think that, hopefully, regulators recognize that stability — there’s a value to stability and people being able to predict what the rules will be and adjust their behavior accordingly.
Brian Johnson: Thank you both to David and Todd for your participation today. This has been illuminating. Like I said, I wish we had more time to discuss, but nonetheless, this was a great start to the conversation. So with that, I will wrap things and turn them back over to Colton. Thank you very much.
Colton Graub: I just want to echo Brian. We’re very grateful to David and Todd for their time today and for the insightful discussion. We welcome listener feedback by email at [email protected]. Thank you for joining us. This concludes today’s call.
Conclusion: On behalf of The Federalist Society’s Regulatory Transparency Project, thanks for tuning in to the Fourth Branch podcast. To catch every new episode when it’s released, you can subscribe on Apple Podcasts, Google Play, and Spreaker. For the latest from RTP, please visit our website at www.regproject.org.
This has been a FedSoc audio production.
Lecturer on Law
Harvard Law School
George Mason University Foundation Professor of Law
Antonin Scalia Law School, George Mason University
Managing Director, Banking Supervision and Regulation Group
Patomak Global Partners