The Obama Administration began talking up its proposals for regulatory reform Wednesday afternoon, and consumer protection is an important part of the plans that will be presented to Congress for approval.  Despite recent speculation that the Administration was cool to the idea of a stand-alone consumer financial protection regulatory body, such an agency is being proposed, a Financial Consumer Protection Agency. 

The few details available now describe a powerful agency much like the Federal Trade Commission with authority to decide which financial products and terms for those products can be provided to consumers.  Perhaps revealing is the requirement that financial institutions offer "plain vanilla" credit cards, mortgages and other financial products, and obtain approval of the Agency for any more sophisticated versions of those products.  Does this reflect a bias towards commoditization of those products?  I have seen reports that the proposal will require in some cases that a consumer be given the opportunity to "opt out" of the standard product before a more sophisticated product could be offered to the consumer.  Other details include an emphasis on clear disclosure and simple explanation of terms of financial products, which may be further pressure towards simple, commoditized products, since, frankly, the more complicated a financial product is, the less comprehensible any attempt to explain it in writing becomes. 

The  Agency would assume from existing regulatory agencies their current consumer protection responsibilities, making it the primary federal regulator for consumer financial protection, with authority to impose fines and penalties for violations.  However, states would be permitted to enact more stringent consumer protections than adopted by the Agency.

Business interests, not surprisingly, oppose the proposal for an independent consumer protection agency. Their arguments include the concerns that the new regulator will not know the financial institutions as well as the existing regulators do, and that the effect of the creation of the Agency will be to make the existing regulators less concerned with consumer protection.  Advocates for the Agency argue that the existing regulators have not placed a high enough emphasis on consumer protection and were subject to "regulatory capture" by the financial institutions they regulated. 

As is the case with these kinds of debates, both sides have good points, and some say that the fight in Congress against the proposal will be intense.  My guess is that the proposal will pass, since the need of our leaders to appear to be doing something, anything, in response to the carnage in consumers' (read voters) lives is overwhelming.  After that, time will tell if there is a big change in consumer financial protection enforcement.  Maybe the biggest benefit of the requirement for approval of new products will be that the more egregious practices that have occurred in the past will simply never get off the drawing boards of the financial institutions.

The industry is predicting less availability of credit to some segments of society if the legislation passes, but may secretly be thankful that the included "reforms" are not fundamental to the credit card business model. << MORE >>

The New York Times reports that the gun lobby has persuaded Senators to attach an amendment to the credit card reform legislation permitting carrying of firearms in national parks.  Perhaps bankers opposing the credit card legislation should adapt the old NRA marching cry: "credit cards don't kill people, people do."  Well, probably not, but the point should be a part of the debate over credit cards.

Popeye cartoons feature a character named Wimpy who is always proposing that he would gladly pay Popeye Tuesday for a hamburger today, and a whole industry has been built on that impulse.  Barbara Kiviat writes in Time Magazine about findings from studies of credit card behavior. "They [show] a systematic psychological breakdown — as a species we're just really bad at understanding costs that come later on."  She describes proposals that would make future costs more salient to consumers, essentially better disclosure methods.  Whether better disclosure will thwart the human impulse towards immediate gratification is not clear.

Another amendment that Senator Durbin would like to attach to the credit card legislation would create a Financial Products Safety Commission.  A separate bill already in the hopper that would do so is alive and attracting interest in the Senate (S. 566).

The proposed Financial Products Safety Commission would have the authority to prohibit certain credit card practices that cause financial difficulty for consumers.  Professor Elizabeth Warren, who originally proposed the idea, has stated with respect to the purview of the Commission "[i]t’s not the role of government to say someone can’t go to the mall and charge too much or that a credit card company can’t ding them for being late on payments. The point is focused on the tricks and traps and that this should not be about hiding things."

This sounds good, I guess, but let's try to apply the distinction between hidden tricks and traps on the one hand and on the other hand areas the government should not be concerned with. Some common characteristics of credit card products that bankruptcy theorists believe increase the risk of consumer financial distress and bankruptcy include teaser introductory rates, no annual fees or introductory waiver of these fees, low monthly minimum payment requirements, and rewards for use of the credit card, and once the cardholder is carrying a balance, penalty fees and interest rate increases for late payments and overlimit charges.  To these I would add widespread availability of credit cards to most economic levels of society, high credit limits, and transfer of the transactional costs of credit cards to merchants.

Some of these practices are already the subject of credit card regulatory changes and the reform legislation in Congress requiring more transparency and restricting unilateral changes to credit card terms. What additional tricks and traps lie in credit cards that the proposed Financial Products Safety Commission would concern itself with?  Credit cards can be risky in the wrong hands, and to the extent that the features of credit cards encourage usage and accumulation of debt, it becomes difficult to separate tricks and traps from personal responsibility.

I believe that a Financial Products Safety Commission would quickly find itself wrestling with issues of public policy that are beyond the competence of government bureaucracy and that, in my opinion, should be left to the legislative process. 

Start-up companies building innovative businesses on prepaid card platforms will therefore want to seek the uniformity of product terms and other compliance obligations they can achieve by finding an issuer that is nationally chartered.  ...<< MORE >>

The latest example of the reduced, if not lacking, confidence in U.S. regulators in these times is the apparent Congressional intent to legislate restrictions on targeting of advertising to users of the Internet utilizing information gleaned from analysis of that usage.  Last week the House Subcommittee on Communications, Technology and the Internet held another round of hearings on the subject.  This is an area in which the Federal Trade Commission (FTC) has been active for some time, adopting final Principles in February 2009 for use by the industry in self-regulation. 

The four Principles governing behavioral advertising, discussed  in detail in the FTC's Report,require (i) notice of data gathering and consumer ability to opt out, (ii) reasonable security protections for collected data and limited term retention, (iii) express consent to a change to the use and protection of data already gathered, and (iv) express consent to the use of sensitive personal data.

The FTC has been monitoring behavioral advertising for the last decade and the Principles are the culmination of efforts that included Town Hall Meetings and a round of comments before finalizing the Principles.  Although compliance with the Principles is voluntary, the FTC indicated that in the coming year it would investigate and monitor self-regulatory programs of industry participants and bring enforcement actions under Section 5 of the FTC Act for unfair and deceptive practices where appropriate.

The industry has embraced self regulation but apparently both the House and the Senate have not.  There will be more hearings and possibly a bill or two later this Summer.

The United States has always been a laggard in personal privacy regulation compared to certain other regions, in particular the European Union.   Behavioral advertising in the UK has also been in the news, with the European Commission threatening to sue the UK government if it does not modify its data protection laws to address new technologies such as behavioral advertising.  BT (formerly British Telecom) conducted tests in 2008 of its "Phorm" covert behavioral advertising technology without notifying consumers or obtaining their consent, which is a violation of the EU Data Protection Directive.  The EU Telecommunications Commissioner also separately expressed concern about use of RFID technology to monitor consumer behavior without their consent. 

European privacy legislation is likely to continue to be more stringent than anything adopted in the U.S., since the U.S. model generally favors "opt out" protection, which is much less onerous than European "opt-in" requirements.  For many years European data protection laws have imposed restrictions on the cross-border transfer of personal information to a jurisdiction without legal protections equivalent to the "home country" protection.  Since personal data originating in the EU has been transported across borders for processing for years, often to the U.S., there has for years been the question whether European law was being complied with, along with questions of extra-territorial jurisdiction.  These questions are simply amplified with the Internet, although probably with no change in the general ignorance of the potential issues.   As a practical matter, though, this will continue to be an area where the law is aspirational, but not enforceable.

The Credit Cardholders Bill of Rights Act (HR 627) passed out of the House Financial Services Committee after markup on a vote of 48-19.  Several amendments that would have made the bill less stringent than the regulations already adopted by the federal regulatory agencies were defeated on smaller margins.  The full House next takes up the bill and when passed, as it surely will be, will be reconciled with the companion, but tougher, Senate bill (S 414), assuming that bill passes, which is apparently more problematic, at least in its current form.  Today credit card executives meet with the Obama administration, which strongly supports the Senate version of the bill, as it implements promises made by Obama during his election campaign.  The Senate Bill also includes a requirement for a study by the OMB of interchange practices that seems a ringer if it ends up being part of any enacted law. 

SEC. 501. STUDY AND REPORT.

    (a) STUDY REQUIRED.—The Comptroller General (in this section referred to as the ‘‘Comptroller’’) shall conduct a study on interchange fees and their effects on consumers and merchants. The Comptroller shall review—

(1) the extent to which interchange fees are required to be disclosed to consumers and merchants, and how such fees are overseen by the Federal banking agencies or other regulators;
(2) the ways in which the interchange system affects the ability of merchants of varying size to negotiate    pricing with card associations and banks;
(3) the costs and factors incorporated into interchange fees, such as advertising, bonus miles, and rewards, how such costs and factors vary among cards; and
(4) the consequences of the undisclosed nature of interchange fees on merchants and consumers with regard to prices charged for goods and services.

(b) REPORT REQUIRED.—Not later than 180 days after the date of enactment of this Act, the Comptroller shall submit a report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives containing a detailed summary of the findings and conclusions of the study required by this section, together with such recommendations for legislative or administrative actions as may be appropriate.

Judge for yourself whether interchange fees in their current form will survive the current antipathy towards bank practices.

Scott Loftesness alerted me to CyberSource v. Retail Decisions, Inc. which may be the first use of last year's Bilski decision to invalidate a payments industry business method patent.  A petition for certiorari by Bilski is on file with the US Supreme Court, but there has not yet been a ruling.  There is quite a difference of opinion in the patent community whether Bilski is the right vehicle for the Supreme Court to review patentability of business methods, many feeling that the invention in Bilski suffers from obviousness, and as lawyers like to say, "bad facts make bad law."

The Court in the CyberSource decision took time at the end of its opinion to speculate on the future of business method patents.

"In analyzing Bilski, one is led to ponder whether the end has arrived for business method patents, whose numbers swelled following the decision in State Street Bank & Trust Co. v. Signature Fin. Group, Inc., 149 F.3d 1368 (Fed. Cir. 1998). Without expressly overruling State Street, the Bilski majority struck down its underpinnings. ... Although the majority declined say so explicitly, Bilski’s holding suggests a perilous future for most business method patents."

The Court further speculated on the possible interest of the US Supreme Court in reviewing Bilski.

"The observations of several Justices suggest that this issue may be expected to receive serious consideration by the Supreme Court. See eBay Inc. v. MercExhcange, LLC, 547 U.S. 388, 397 (2006) (Kennedy, J., concurring) (noting the “potential vagueness” and “suspect validity” of some business method patents); Lab. Corp. of Am. v. Metabolite Labs., 548 U.S. 124, 127, 136-137 (2006) (Breyer, J., dissenting from denial of certiorari) (questioning State Street’s adherence to Supreme Court precedent and observing, “Patent law seeks to avoid the dangers of overprotection just as surely as it seeks to avoid the diminished incentive to invent that underprotection can threaten. One way in which patent law seeks to sail between these opposing and risky shoals is through rules that bring certain types of invention and discovery within the scope of patentability while excluding others.”). The closing bell may be ringing for business method patents, and their patentees may find they have become bagholders."

The credit card industry has been receiving a lot of negative attention recently.  The antipathy towards credit card issuers due to long-standing practices is high and long-standing complaints of consumer advocates are finding a welcoming audience in Washington DC.    Despite the adoption in December 2008 of rules by the federal regulatory agencies that will prohibit or restrict the practices most complained about, Congress is proceeding with a bill (S. 3252) to accomplish the same thing because the new regulations do not take effect until July 2010. Most recently the Obama administration has signaled intent to pile into the issue as well.  Credit card issuers are scheduled to meet with Treasury Secretary Geithner in the White House on Thursday.

One of the practices that has received much criticism recently is "universal default", in which experience of a cardholder with other creditors can be used by an issuer to raise interest rates and cut credit lines.  There have been a lot of interest rate increases and credit line cuts going on recently given the deteriorating finances of consumers, and the pained outcry of cardholders has  received widespread publicity.  There is irony in this in one sense, and that is that banks are being roundly lambasted for poor credit underwriting practices in connection with their mortgage and other lending activities, but universal default practices are an attempt to control risk with what is an unsecured loan of indefinite duration.  What the banks failed to realize, it seems, is that the credit card has become a consumer product rather than a loan product, and has thus become politicized.  "Don't mess with my credit card."

Current credit card regulation under the Truth in Lending Act (TILA) and Regulation Z is disclosure-based, with certain practices prohibited by separate regulation, as was done in December 2008 by the federal regulators.  Mortgage lending was similarly regulated until the adoption of amendments to Regulation Z prompted by passage of the Homeowners Equity Protection Act (HOEPA) in 2008.  In a survey of HOEPA-inspired changes to Regulation Z  by Jacqueline A. Parker, Jeffrey P. Naimon and Catherine M. Brennan published in the February 2009 edition of The Business Lawyer they noted that "[t]he final rules go a long way towards changing TILA, at least as it applies to residential mortgage loans secured by a consumer's principal dwelling, from a disclosure statute that relies on informed consumers to protect themselves to a source of substantive requirements and restrictions governing residential mortgage lending transactions."  In particular, with respect to subprime mortgage lending, creditors are prohibited from lending without verifying the income and assets relied upon to determine repayment ability.  Unsecured credit card lending is quite different in the sense that the cardholder cannot lose his or her house, at least directly, as a result of default, but the highly politicized nature of credit cards in the current climate conceivably could result in substantive restrictions on credit card lending that requires issuers to ensure that cardholders are able to repay the obligations incurred. Universal default tools would be unavailable, so that  would likely mean smaller credit limits and higher APR's and probably less availability of credit cards to some people.

The current outcry in Washington and on Main Street is the sound of a pendulum swinging with increasing momentum.  Prognostications are generally tricky since events are essentially unpredictable.  However, one thing that is predictable with some certainty is human social behavior. Human humors are fickle and swing one way then the other with some regularity. Once the pendulum reverses course it is pretty easy to predict that the status quo will suffer.

Amidst the current climate of recrimination and retribution against purveyors of financial products and services of all types, Senators Durbin, Kennedy and Schumer have introduced S. 566, “The Financial Product Safety Commission Act of 2009”. http://www.govtrack.us/congress/bill.xpd?bill=s111-566  This bill would create a new regulatory agency (“FPSC”) with the following objectives:

“1) to minimize unreasonable consumer risk associated with buying and using consumer financial products;
(2) to prevent and eliminate practices that lead consumers to incur unreasonable, inappropriate, or excessive debt, or make it difficult for consumers to repay existing debt, including practices or product features that are abusive, fraudulent, unfair, deceptive, predatory, anticompetitive, or otherwise inconsistent with consumer protection;
(3) to promote practices that assist and encourage consumers to use credit and consumer financial products responsibly, avoid excessive debt, and avoid unnecessary or excessive charges derived from or associated with consumer financial products;
(4) to ensure that providers of consumer financial products provide credit based on the ability of the consumer to repay the debt incurred;
. . . ; and
(9) to take such other steps as are reasonable to protect users of consumer financial products.”

To achieve this, the new agency would be required (among other things) to adopt consumer financial product safety rules that:

(A) ban abusive, fraudulent, unfair, deceptive, predatory, anticompetitive, or otherwise anti-consumer practices, products, or product features;
(B ) place reasonable restrictions on consumer financial products, practices, or product features to reduce the likelihood that they may be provided in a manner that is inconsistent with the objectives in (A); and
(C) establish requirements for clear and adequate warnings or other information that will advance the objectives in (A).

This new agency would be the supreme regulatory authority in these matters, superseding any other regulators, state or federal, although these other regulators would be able to investigate and enforce the regulations against violators if the FPSC lets them.  Violations of any of the regulations adopted by the FPSC would carry criminal and civil penalties and give rise to private causes of action.

This new regulatory agency is similar to a proposal made in the U.S. Treasury’s “Blueprint for Financial Reform” which I have described in a previous post.   However, Professor Elizabeth Warren of Harvard first proposed the idea for this particular formulation in an article in the Summer 2007 Issue of Democracy entitled “Unsafe at Any Rate”  http://www.democracyjournal.org/article.php?ID=6528

She argued pretty persuasively that consumers need as much protection in connection with financial products as they get from the Consumer Product Safety Commission in connection with toasters.

Fortunately or unfortunately, depending on your predilections, this is probably an idea whose time has come, in some form or another.  There will be a House of Representatives counterpart to S. 566 from Representatives Delahunt (D, MA) and Miller (D, NC), although Barney Frank (D, MA) may have a different, yet unknown,  approach in mind.  

Ironically, a concern I have with an FPSC, if it is created, is the apparently limitless scope of its charter, and the possibility of “regulatory capture” by anti-business advocates.  I say ironically, because regulatory capture by the regulated has been one of the charges against the existing financial regulators the FPSC would supplant.  I fear regulatory capture of the proposed FSPC by its constituency due to the aforementioned pendulum and populist fervor that seems to be battering common sense out of many in Washington.

It is not unusual for Congress to delegate substantial and broad authority to regulatory agencies to create and enforce standards of safety and fairness.  The Federal Product Safety Commission and the Federal Trade Commission are just two examples.  However, as I read S. 566, the FPSC could decide to regulate pricing of financial products, and given the current climate and heavy lobbying by merchant associations (under the guise of consumer protection) might not payment card interchange and merchant discount rates be on the table?   Payments products are not toasters, and involve network economics that are not popular even if understood.  There is considerable antipathy towards credit cards in particular (see, for example, Charging Ahead, by Ronald J. Mann, Cambridge University Press 2007, in which he statistically links increases in consumer credit to consumer bankruptcy). If the payments industry is regulated into stagnation through pricing controls then we might as well just turn everything over to the Federal Reserve and let them run the payment system as a utility.  On the other hand, maybe the pendulum will again reverse course before the middle ground of common sense is left too far behind, as it seemed to be for the last 10 or 15 years.

When I was managing Visa's Washington legislative activities in the early 90's I was struck at how easy it was for politicians to make hay against the banks, and how hard it was to fend off or make unfriendly legislation more friendly.  It is not that the lobbying by banks was not first rate, but rather that too many legislators, or their friends, or staff, seemed to have some grudge against their bank, past or present.  I have observed much of the same problem facing GM in its recent contacts with Congress - apparently too many people have owned Vega's, or Nova's (which interestingly means "does not go" in Spanish).

In today's paper there was an Associated Press story that elicited from me an utterance that has escaped my lips too often recently - "what were they thinking (this time)?"  Apparently 30 states have agreements with the largest banks in this country to issue Visa or MasterCard prepaid cards to recipients of unemployment benefits, and in several states this is the only way that recipients can receive the benefits.   While it is possible to cash out the entire balance at a bank branch free of charge, many recipients use the card like a credit or debit card (many billions of dollars have been spent by the banks and associations to ingrain that habit) , but since it is a prepaid card, incur transaction fees, overdraft fees, ATM fees and balance inquiry fees.  Now I understand the nature of the prepaid card product and the economic rationale for these fees, but does anyone at these banks actually think ahead? The Associated Press article makes quite a bit of hay at the banks' expense over the gross unfairness of charging fees for unemployment recipients to use their benefits, and frankly there is nothing the banks (and don't forget the government agencies) can say that will refute this fundamental perception of unfairness.  No va.

Over on the newly relaunched Payments Views site (www.paymentsviews.com), another excellent payments industry service from Scott Loftensness and Glenbrook Partners, there has been interesting discussion about the need for "New Banks".  Should a banking institution be expected to make fairness, a non-quantifiable but very real part of the world, a business consideration?