Obama's Consumer Protection Agency Explained

A key component of President Obama's plan to overhaul the financial regulatory system is the creation of a consumer protection agency. The agency would oversee consumer financial products, which have been regulated in the past, but whose oversight was exposed as lax.

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MICHELE NORRIS, host:

To help us make sense of all this, we turn now to Adam Davidson. He's a member of our Planet Money team. And Adam, this is big complicated stuff. So today we're going to try to take just one central piece of this and try to understand it, this Consumer Financial Protection Agency. We heard about this from Scott Horsley. But could you tell us a little bit more about why the administration has seen fit to create this new agency?

ADAM DAVIDSON: Well it's really interesting in the big white paper that the administration released today. They say that consumer financial products -we're talking about mortgages, credit cards, basically the stuff we get from banks and other financial services companies - have been regulated - in fact, have been regulated by many different regulators - but that we've learned that there were gaps, there were things that regulators weren't paying attention to.

And obviously lots and lots of Americans got mortgages that they didn't fully understand, mortgages that probably any reasonable financial advisor or someone looking at this objectively would say, boy, may be no one should have ever gotten an interest-only-balloon-option-arm mortgage. So this new agency would look at this, and, I guess sort of modeled on something like the Consumer Product Safety Commission, which says hey, you can't sell a toaster that burns down a house - would say you can't sell a mortgage that makes someone lose their house.

NORRIS: So this all sounds wonderful but how will this work?

DAVIDSON: Well that's the issue. Will it work at all? What the administration's own white paper shows is that these are not new powers. The government and a variety of regulators have had the power to make sure that the products that banks and other financial services companies sell to us are good and sound and reasonable. And for a variety of reasons, they clearly have fallen down on the job. And so creating a new agency, sure it's easy to imagine that for the first few years, or our first while, they will pay very close attention to more exotic financial products.

But it's pretty easy, and a lot of the people I talked to today say 10 years from now, 30 years from now, 50 years from now, is this really setting in place a fundamental change, or is this just one more layer of regulation in a regulatory system that fundamentally broke down? Objection number two actually comes from small banks. They say that this works to benefit the large banks that caused this crisis. And by imposing a huge burden on small banks, it actually penalizes the very banking institutions that weren't selling junk that defrauded customers.

NORRIS: So if the Consumer Financial Protection Agency lives up to its name and tries to protect consumers, what is an example of a burden? I guess that's what they call it that this new agency would impose on one of those small banks that's so worried about the new system?

DAVIDSON: The small banks say that this new system imposes huge regulations on them that will, for example, force them to hire more lawyers. If your entire profits are $300,000, you can't hire too many more lawyers before you run out of money. Whereas the large banks can spread the costs of this new regulation much more easily. So it penalizes the part of our system, this is the argument, that was the most stable and it effectively rewards the part of our system that was the most unstable.

NORRIS: And if it does that then it's the larger banks that would be more likely to survive. And wasn't that one of the lessons of the financial crisis, that big banks can sometimes - or big institutions - can sometimes, cause the biggest problems?

DAVIDSON: I have been talking all day long with behind-the-scenes folks in the government with economists and banking professionals, and I'd say the big disappointment that I have heard is that this plan does not, in an aggressive full-on way, say we will no longer in America have large - banking and other financial institutions - so large that we cannot allow them to fail. This proposal does say that we should eventually do something about it. But it doesn't have the kind of pointed, focused attention on that issue that an awful lot of people were hoping.

NORRIS: Thank you Adam.

DAVIDSON: Thank you.

NORRIS: That's Adam Davidson, from our Planet Money team. You can find a lot more at the Planet Money blog and the podcast. Just go to npr.org/money.

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Obama Unveils New Financial 'Rules Of The Road'

President Obama on Wednesday unveiled a multipronged plan that aims to protect the U.S. financial system from another meltdown by giving regulators broader involvement across the financial spectrum — from bank holding firms and big companies to individual borrowers.

Joined by Treasury Secretary Timothy Geithner and other top financial advisers at the White House, Obama proposed giving the Federal Reserve more authority to regulate bank holding companies and other large firms whose failure could endanger the U.S. economy. He also called for creation of a new agency that would oversee credit and lending practices, protecting borrowers from entering into the types of risky loans that resulted in the nationwide housing crisis.

"Financial institutions have an obligation to themselves and to the public to manage risks carefully. And as president, I have a responsibility to ensure that our financial system works for the economy as a whole," Obama said at a news conference later.

Obama said the financial overhaul is part of his plan to build a new foundation for growth and prosperity that includes changes in the country's education and health care systems, as well as credit card reforms.

In an 88-page document detailing the proposed changes, the White House said the country's post-Depression regulatory system was not sufficient to deal with the abuses and excesses that led to the unraveling of major financial institutions. It notes that the regulatory system was poorly equipped to handle today's complex financial instruments.

One of the key weaknesses of the current system, according to the document, is that agencies and regulators are responsible for overseeing individual companies, while no one has been charged with looking at the stability of the financial system as a whole.

"Regulators were charged with seeing the trees, not the forest," Obama said. "Even then, some firms that posed a so-called systemic risk were not regulated as strongly as others; they behaved like banks but chose to be regulated as insurance companies, or investment firms, or other entities under less scrutiny. As a result, the failure of one large firm threatened the viability of many others."

The president said he consulted lawmakers, business experts and consumer advocates in drafting the changes. He urged Congress to act quickly on his plan, while acknowledging that some will say he is proposing too much new regulation while others will complain it's not enough.

"We do not want to stifle innovation," Obama said. "But I'm convinced that by setting out clear rules of the road and ensuring transparency and fair dealings, we will actually promote a more vibrant market. This principle is at the heart of the changes we are proposing."

Key elements of Obama's proposal include:

• Establishing the Consumer Financial Protection Agency to review credit and lending practices, providing some protection for potential homeowners, students and credit card holders. Some powers would be ceded by the Federal Reserve and other government agencies.

• Requiring that all lenders be held to the same standards as banks, and that mortgage brokers provide clear and concise disclosures.

• Creating a pathway for regulators to dismantle troubled companies. The Federal Deposit Insurance Corp. would have a system to sell a company's assets if the Treasury Department and the Federal Reserve decide that its failure would pose a threat to the nation's economy.

• Requiring that lenders retain a 5 percent stake in all asset-backed securities in order to discourage risky loans and the practice of passing at-risk assets off to other investors.

• Eliminating the Office of Thrift Supervision, which oversaw institutions such as Washington Mutual and AIG that turned into some of the biggest failures of the economic crisis.

• Establishing the Financial Services Oversight Council to monitor the overall health of the U.S. financial system.

• Requiring that shareholders vote on compensation packages for executives in the financial industry.

• Promoting increased supervision and regulation of financial companies by bolstering the authority of the Federal Reserve, requiring increased capital commitments to offset loans and off-sheet commitments.

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