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Debunking Three De-regulatory Myths in Consumer Financial Protection

By Stephen Hall, Legal Director and Securities Specialist, 
with research assistance by Michael Hughes, Research and Program Assistant
 
Introduction: False Narratives Undermine Consumer Protection
As the Biden administration settles in and installs new leadership at the regulatory agencies, it’s a good time to expose and debunk some of the myths that gained ground over the last few years. In short, as we move forward, it’s time to remember what not to do when it comes to protecting investors and consumers in our financial markets. Part of that exercise is piercing through the myths advanced again and again by the regulated industry and its allies in policymaking positions to justify de-regulation and weak regulation.
 
A number of those myths have had a particularly powerful influence on the Consumer Financial Protection Bureau (CFPB), a vitally important agency that stands on the threshold of a new and more positive era. In its first five years, the CFPB served as one of the most effective consumer protection agencies in modern history, issuing strong rules, vigorously enforcing the law, and providing over $11 billion in relief to everyday Americans ripped off by financial firms. Yet beginning in 2017, it retreated from its role as a consumer champion and began rolling back important rules, gutting its enforcement program, and downsizing its personnel and budget. For example, the CFPB removed important restrictions on payday lenders,[1] afforded predatory debt collectors ample room to continuing harassing those struggling with debt,[2] and refused to prosecute firms that preyed on vulnerable consumers.[3]
 
This deregulatory agenda was aimed at catering to, not policing, the financial services industry. And it rested on a number of myths seeking to legitimize deregulatory policies that leave millions of Americans exposed to predatory tactics.They included the misguided notions that lax regulation is necessary to promote access to credit, that regulation should invariably foster “innovation,” and that state law protections should be broadly preempted.[4] Each one of these misconceptions is wrong in principle and in practice.The CFPB—along with the SEC and other agencies as well—faces an important opportunity to reject these myths, undo the damage they caused, and re-commit the agency to strong regulation and enforcement for the benefit of all American consumers in the financial markets.
 

Debunking Myth #1:
In fact, regulation protects consumers without depriving them of access to credit.

Deregulators advance the myth that paring back regulation is necessary to provide consumers with access to credit.  In reality, strong regulation doesn’t hinder access to credit. Rather, it protects consumers from a wide variety of toxic credit products and practices that can undermine or even destroy a family’s financial well-being. Moreover, additional regulation is necessary to finally ensure that low and moderate income communities have full and fair access to credit and to the economic opportunities such access brings.[5]
 
Fair and affordable credit helps almost all Americans accomplish their financial goals, from starting a small business to buying a house to funding a college education. But as the 2008 financial crisis showed, generally beneficial financial products like mortgages can easily become toxic when they are offered with hidden and onerous terms involving interest rates, fees, repayment requirements, collateral repossession rights, and other undisclosed or misrepresented features. The same is true of auto loans, student loans, and short-term credit products such as payday loans.
 
Consider payday loans. The industry and their allies insist that these are helpful products designed to enable consumers to meet short-term financial needs. Yet data from the CFPB shows that many consumers find themselves trapped in an endless cycle of payday loans, with more than two-thirds of borrowers taking out more than seven loans a year.[6]  And the financial burdens can be crushing as annualized interest rates climb as high as 391% and fees accumulate relentlessly, often totaling many multiples of the principal amount of the initial loan.[7]
 
Affirmative regulatory prohibitions and obligations on lenders are necessary to protect consumers from these abusive forms of credit. Among them are caps on interest rates and the duty of a payday lender to underwrite all of their loans to ensure that borrowers can actually afford to repay them—an obligation that the CFPB imposed in 2017 but then rescinded under the Trump administration.[8] Past experience with federal[9] and state law[10] confirms that  regulatory safeguards do not impair access to credit and actually tend to lower credit costs.
 
As we work to restore strong financial regulation in the public interest, we must realize that the claimed trade-off between consumer protection and access to well-functioning credit markets is a pro-industry myth.
 
Debunking Myth #2:
In fact, technology in finance must be accompanied by strong guardrails to ensure that it doesn’t upend markets and harm investors.
 
Another myth frequently advanced by deregulators is that technological innovation in finance is always a positive force that should be given wide regulatory leeway. This too is misleading because while innovation in finance can sometimes improve the financial markets for the benefit of consumers, it can also wreak havoc in our markets and facilitate predatory behavior when it is not adequately controlled through regulation.
 
More and more consumers are relying on FinTech financial companies and applications to access credit and interact with the financial system. While some of these innovations are proving to be beneficial, the risks associated with new technology in finance are also very real, and it is crucial that we acknowledge and address those risks when developing policy.[11] We’ve known this for years, as a technological error triggered a historic and potentially catastrophic slide in the equity markets during the May 2010 “Flash Crash.” Just a few months ago, the FinTech trading app offered by “Robinhood” helped generate chaotic volatility in the prices of certain meme stocks, including most prominently “GameStop.”
 
Many important questions have been raised about the entire episode in Congressional hearings and elsewhere, but it seems clear that Robinhood’s technology and design choices, including the intense gamification of trading, induced or amplified the trading frenzy, to the detriment of many retail investors.[12] And the world of crypto currency cries out for more oversight to prevent huge market gyrations and predatory investment schemes.[13]
 
There is ample cause for concern based on empirical data as well. A recent study has found that trading apps drive investors towards high-risk “lottery stocks,” thereby reducing their expected returns compared to traditional trading strategies.[14] Similarly, the use of FinTech “marketplace lending” programs is associated with the assumption of more debt and a higher likelihood of default than traditional credit sources, particularly for consumers with sub-prime credit scores.[15]
 
Congressional hearings following the GameStop turmoil revealed yet another and even more profound set of questions about the value of technology in finance: Do high-speed trading algorithms, when coupled with preferential access to market data, really improve pricing and liquidity for the benefit of everyday Americans invested in the market, or are they fundamentally nothing more than sophisticated tools used by a few high-frequency trading firms to fleece millions of investors in small but collectively massive increments? The evidence clearly indicates it’s the latter.[16]
 
Policymakers must reign in the deregulatory proponents who seek to dominate the conversation when it comes to new technologies in finance. The CFPB and other financial regulators must carefully assess the risks posed by new technologies in finance and adopt necessary guardrails to help protect our financial markets and the consumers who rely on them.[17]
 
Debunking Myth # 3:
In fact, state regulation has a vital role to play in consumer protection and it should not be subject to sweeping preemption.
 
Finally, many in the financial services industry—at times supported by regulators—have pushed the myth that state laws should be preempted, even where those laws seek to protect consumers in the financial markets.  In reality, state laws have a vital role to play in consumer protection, and the strongest state standards should be embraced by federal regulators as benchmarks, not nullified in the name of “efficient” national markets. 
 
For example, certain companies, most notably federally chartered banks, are granted the right to operate in any state while adhering only to the state laws as written in their home state. The result is that many state consumer protections, including caps on exorbitant interest rates, are sidelined in the interest of preserving an autonomous network of federal or national banks. One of the many deregulatory priorities of the Trump administration was to further expand the scope of this preemption for the benefit not only of national banks but also nonbank financial companies that covet the ability to evade state limits on their activities. In 2020, two key banking regulators, the FDIC and OCC, issued rules that would make it easier for payday lenders to partner with federally chartered banks to circumvent interest rate limits and other consumer protections through federal preemption.[18]
 
The CFPB’s Taskforce on Federal Consumer Financial Law[19] advocated for an even more sweeping approach, recommending that the CFPB should have the authority to issue licenses to a broader array of non-depository institutions that would enjoy similar preemption of state law.[20] This model amounts to “competitive federalism” in which states vie for business through lax regulation that makes them attractive “home states” for financial companies.  Past experience with this approach tells us that far from creating the best possible rules, it will simply incentivize states to undercut each other’s regulations to attract corporate domiciliaries. We know from the national bank model that this “race-to-the-bottom” fosters weak home state rules, coupled with the preemption of all other state laws. 
 
Further expanding the scope of state preemption will end badly for countless consumers. And as we argue, there is no legitimate reason for following this course because strong regulation—both federal and state—can protect consumers without stifling innovation or depriving consumers of access to the financial products they need.
 
Conclusion
Debunking myths about regulation is not merely an intellectual exercise. Policymakers guided by these theories cause real-world harm to vulnerable consumers by repealing important protections, adopting weak new rules that cater to industry, and undermining enforcement programs. We must therefore constantly expose and oppose these flawed notions about the role of financial regulation.
 

[3] A 2019 report on CFPB enforcement actions found that under President Trump’s CFPB directors, the number of new enforcement cases brought by the agency declined by 80% and that the CFPB consistently failed to demand restitution for victims in the few enforcement actions it carried out. See Dormant: The Consumer Financial Protection Bureau’s Law Enforcement Program in Decline, The Consumer Federation of America (Mar. 12, 2019).

[4] These myths figured prominently in a recent report published by the CFPB’s “Taskforce on Consumer Financial Law,” which amounted to little more than a deregulatory polemic advancing robust versions of these myths about consumer financial regulation. See Taskforce on Federal Consumer Financial Law, Report Volumes I and II, Consumer Financial Protection Bureau (Jan. 2021) (Taskforce Report). Other myths abound, of course.  Among them is the debunked claim that regulation imposes crushing burdens on companies (even though the financial services industry consistently ranks among the most profitable sectors).  See, e.g., Better Markets Comment Letter on Request for Comment on Potential Money Market Fund Reform Measures in President’s Working Group Report (Apr. 12, 2021) 7-9. Another pillar of de-regulatory thought has been the insistence that every agency rule should be subject to an exhaustive and quantitative cost-benefit analysis (even though cost-benefit analysis is biased in favor of industry, unduly burdens and slows the rulemaking process, and finds no place in most laws). See Cost-benefit Analysis in Consumer and Investor Protection Regulation: An Overview and Update Better Markets (Dec. 8, 2020); see also Setting The Record Straight On Cost-Benefit Analysis And Financial Reform At The SEC Better Markets, (July 30, 2012). 

[6] See Payday Loans and Deposit Advance Products, Consumer Financial Protection Bureau (Apr. 24, 2013).

[7]  See Payday Loan Facts and the CFPB’s Impact, The Pew Charitable Trust (May 2016); see also Payday and Car Title Lenders Drain $8 Billion in Fees Every Year, Center for Responsible Lending (Jan. 2017).

[8]   See Payday, Vehicle Title, and Certain High-Cost Installment Loans, 82 Fed. Reg. 54472 (Nov. 17, 2017), for the original payday lending rule issued by the CFPB; see also Payday, Vehicle Title, and Certain High-Cost Installment Loans, 85 Fed. Reg. 44382 (Sep. 22, 2020), revoking various provisions of the rule including the requirement that payday lenders confirm that borrowers can repay their loans before issuing them.

[9] See Agarwal et. al., Regulating Consumer Financial Products: Evidence From Credit Cards, 130 The Quarterly Journal of Economics 111 (Feb. 2015).

[10] See Amir Fekrazad, Impacts of interest rate caps on the payday loan market: Evidence from Rhode Island, 113 Journal of Banking & Finance (Apr. 2020).

[11] See Dan Cruz, Opportunities and Challenges in Online Marketplace Lending, Treasury Notes (May 10, 2016).

[12] See Dennis Kelleher and Joseph Cisewski, Select Issues Raised by the Speculative Frenzy in GameStop and Other Stocks, Better Markets White Paper (Mar. 26, 2021); see also SEC Chair Gary Gensler, Prepared Remarks at the Global Exchange and Fintech Conference (June 9, 2021) (discussing the need to “freshen up” regulations in light of new technologies and practices in finance).

[13] The SEC highlighted these risks in a recent staff statement warning investors that Bitcoin was a “highly speculative investment” and urging investors to consider “lack of regulation and potential for fraud or manipulation in the underlying Bitcoin market.” See Staff Statement on Funds Registered Under the Investment Company Act Investing in the Bitcoin Futures Market (May 11, 2021).

[15] See Sudheer Chava Nikhil Paradkar, Winners and Losers of Marketplace Lending: Evidence From Borrower Credit Dynamics, Georgia Tech Scheller College of Business Research Paper (Spt. 2017).

[16] See Better Markets Fact Sheet, Payment for Order Flow: How Wall Street Costs Main Street Investors Billions of Dollars through Kickbacks and Preferential Routing of Customer Orders (Feb. 16, 2021); see also Brief Amicus Curiae, by Consent, of Better Markets, Inc. in Support of Respondent and Intervenor, Citadel Securities LLC v. SEC, No. 20-1424 (D.C. Cir. filed Apr. 12, 2021).  Other recent tech innovations pose serious direct risks to the most vulnerable consumers, most prominently the use of machine-learning algorithms and non-traditional data to assess creditworthiness. See Rebecca Heilweil, Why algorithms can be racist and sexist, Vox (Feb.18, 2020); see also James A. Allen, The Color of Algorithms: An Analysis and Proposed Research Agenda for Deterring Algorithmic Redlining, 46 Fordham Urban Law Journal 219 (2019).

[17] Notably, the Taskforce Report devoted an inordinate amount of attention to the benefits of fintech and recommended only policy actions that would aid this sector. See e.g Taskforce Report Taskforce Report Volume I, at 466-475.

[18]  Permissible Interest on Loans That Are Sold, Assigned, or Otherwise Transferred, 85 Fed. Reg. 33530 (June 2, 2020) (OCC “Madden rule”); Federal Interest Rate Authority, 85 Fed. Reg. 44146 (July 22, 2020) (FDIC “Madden rule”),; National Banks and Federal Savings Associations as Lenders, 85 Fed. Reg. 68742 (Oct. 30, 2020) (OCC “True Lender rule”), . For analysis of these rules, see Better Markets Comment Letter on Permissible Interest on Loans that are Sold, Assigned, or Otherwise Transferred (Jan 21, 2020); Better Markets Comment Letter on National Banks and Federal Savings Associations as Lenders (Sep. 3, 2020); Better Markets Comment Letter on Federal Interest Rate Authority (Feb. 4, 2020).  On May 12, 2021, the Senate passed a resolution under the Congressional Review Act to nullify the OCC’s True Lender rule.  It is expected to pass the House as well.  Meanwhile, lawsuits have been filed challenging both the Madden rule and the True Lender rule in court.  See New York v. OCC, No 1:21-cv-00057 (S.D.N.Y. filed Jan. 5, 2021); Calif. v. OCC, No. 20-cv-5200 (N.D. Cal. Filed July 29, 2020).

[19] See note 4 supra.

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