Topic: Finance, Banking & Monetary Policy

Yes, Your Honor, the CFPB Is Indeed Unconstitutional

I wrote only yesterday about the Consumer Financial Protection Bureau’s (CFPB’s) regulatory overreach with regard to payday loans, and it seems the D.C. Circuit Court was on the same wavelength.  Judge Brett Kavanaugh, writing for the court, handed down a stinging condemnation of the Bureau’s structure, labeling the single-director model unconstitutional.  Although the court’s remedy is somewhat limited – changing the agency from independent to one within the executive branch, with the director serving at the pleasure of the President – the opinion itself is a full-throated indictment of the CFPB’s structure and repeated overreach.  Even given its limited application, it is a win for those who have long questioned the many defects in the CFPB’s design.

The case before the court arose out of an enforcement action brought by the CFPB against the mortgage lender PHH Mortgage.  The action was initially brought before one of the agency’s own in-house adjudicators, who imposed a fine on the company.  (Although not explicitly addressed in this case, these internal administrative proceedings, led by administrative law judges or ALJs, present their own issues, similar to those at the SEC that I have discussed here and here.)  Director Richard Cordray apparently thought the $6.4 million fine imposed by the ALJ was insufficient and added another $102.6 million to the bill.  PHH Mortgage appealed the Director Cordray’s decision to the D.C. Circuit.

The court’s decision turns principally on the magnitude of the director’s power.  Unlike the heads of agencies such as the Department of Justice or Department of the Treasury, the director of the CFPB can be removed by the President only for cause.  That is, the President could remove Cordray only for inefficiency, neglect of duty, or malfeasance.  In fact, the court called the Bureau’s director the “single most powerful official in the entire United States Government, at least when measured in terms of unilateral power” after the President himself.  And the President is at least accountable to the people through the democratic process.  Other powerful positions within the federal government – Speaker of the House, Senate Majority Leader, heads of other independent agencies – have greater checks on their power.  The Speaker cannot act without persuading and cajoling a large number of colleagues.  Independent agencies such as the SEC and FTC are comprised of multi-seat commissions, and no one commissioner can act alone, making the commissioners themselves the checks on each other’s power.  The director of the CFPB faces no such constraints.

Money Laundering Laws: Ineffective and Expensive

Beginning in the 1970s and 1980s, the federal government (as well as other governments around the world) began to adopt policies based on the idea that crime could be reduced if you somehow could make it very difficult for criminals to use the money they illegally obtain. So we now have a bunch of laws and regulations that require financial institutions to spy on their customers in hopes that this will inhibit money laundering.

But while the underlying theory may sound reasonable, such laws in practice have been a failure. There’s no evidence that these laws, which impose heavy costs on business and consumers, have produced a reduction in criminal activity.

Instead, the only tangible result seems to be more power for government and reduced access to financial services for poor people.

And now we have even more evidence that these laws don’t make sense. In a thorough study for the Heritage Foundation, David Burton and Norbert Michel put a price tag on the ridiculous laws, regulations, and mandates that are ostensibly designed to make it hard for crooks to launder cash, but in practice simply undermine legitimate commerce and make it hard for poor people to use banks.

Oh, and these rules also are inconsistent with a free society. Here are the principles they say should guide the discussion.

The United States Constitution’s Bill of Rights, particularly the Fourth, Fifth, and Ninth Amendments, together with structural federalism and separation of powers protections, is designed to…protect…individual rights. The current financial regulatory framework is inconsistent with these principles. …Financial privacy can allow people to protect their life savings when a government tries to confiscate its citizens’ wealth, whether for political, ethnic, religious, or “merely” economic reasons. Businesses need to protect their private financial information, intellectual property, and trade secrets from competitors in order to remain profitable. Financial privacy is of deep and abiding importance to freedom, and many governments have shown themselves willing to routinely abuse private financial information.

And here are the key findings about America’s current regulatory morass, which violates the above principles.

The current U.S. framework is overly complex and burdensome… Reform efforts also need to focus on costs versus benefits. The current framework, particularly the anti-money laundering (AML) rules, is clearly not cost-effective. As demonstrated below, the AML regime costs an estimated $4.8 billion to $8 billion annually. Yet, this AML system results in fewer than 700 convictions annually, a proportion of which are simply additional counts against persons charged with other predicate crimes. Thus, each conviction costs approximately $7 million, potentially much more.

By the way, the authors note that their calculations represent “a significant underestimate of the actual burden” because they didn’t include foregone economic activity, higher consumer prices for financial services, lower returns for shareholders of financial institutions, higher financial expenses for unbanked individuals, and other direct and indirect costs.

And what are the offsetting benefits? Can all these costs be justified?

The CFPB Should Learn That No Means No

Despite professing a desire for “financial inclusion,” usually understood as better access to financial products for lower income people, the Consumer Financial Protection Bureau (CFPB) has taken aim at a product used extensively by low- and moderate income Americans: the short-term, low value loans known as “payday” loans.  What is even more striking about the proposed rule, however, is the fact that it works as an end-run around an express limit on the CFPB’s power.  The CFPB has spent its short life pushing the bounds of its authority in numerous directions, going so far as to incur a slap from a federal court when it trod on the toes of another agency.  The CFPB could be excused for thinking that at least some members of Congress desired such expansion, given the broad and amorphous authority the Dodd-Frank Act grants the new agency.  But it is hard to justify evading an express prohibition.

Although the CFPB is given the authority to proscribe unfair, deceptive, and abusive practices, the Dodd-Frank Act explicitly withholds from the CFPB the authority to “establish a usury limit.”  The proposed rule does not set a rate cap, but it does make lending at any rate above 36 percent so onerous as to be infeasible.  In fact, it is not clear that it would be even be possible to comply with the rule.

On Friday, I submitted a letter to the CFPB, expressing concern over the agency’s authority to enact the rule as proposed.  In particular, the letter notes that the underwriting process required for loans with an effective annual interest rate higher than 36 percent are not only onerous but require the lender to make determinations that may be impossible to make.  For example, under the proposed rule a lender would be required to “forecast a reasonable amount of basic living expenses for the consumer – expenditures (other than debt obligations and housing costs) necessary for a consumer to maintain the consumer’s health, welfare, and ability to produce income[.]”  This amount can be difficult for individuals to determine for their own households.  My husband and I have an estimate we use to help us save for an emergency, but I couldn’t swear to its accuracy given the vagaries of life with small children.  I couldn’t guess what the right number might be for any other household in my acquaintance.  If I am uncertain what my own family might need, it is difficult to see how a storefront lender could make this determination for a prospective borrower who walks in off the street.  Certainly this level of underwriting, which surpasses even what is required for most mortgages, is not cost-effective for a loan of only a few hundred dollars.

The Wealthy Are Not All the Same: A Recent Study Finds Key Differences

Inequality and the “one percent” have generated an inordinate amount of media coverage recently, despite the fact that these topics barely register when people are asked to name the country’s most important problem. The rhetoric often portrays the wealthy as a homogenous group that inherited its wealth, and those that do work operate almost exclusively in the financial sector. A recent study published in Intelligence this year that was highlighted by Tyler Cowen delved into the characteristics of wealthy individuals. The findings run contrary to the commonly held perception that this is a stagnant, homogeneous group. There is a significant amount of diversity when it comes to which industries these people work in, and a much higher share of the wealthy Americans in this sample are self-made compared to some European peers.

In their study, David Lincoln from Wealth-X and Jonathan Wai from Duke University use the Wealth-X database to analyze a sample of more than 18,000 ultra high net worth (UHNW) people, which they define as having a net worth greater than $30 million. Their findings help us get beyond the rhetoric to see how the wealthy got to that position.

Compared to some of the European countries most-often cited as models of equity, the United States has a significantly higher share of UHNW people whose wealth is primarily self-made: 75 percent in the United States compared to just 31.3 percent in Sweden, 42.5 percent in Norway, or 43.6 percent in Denmark.

In fact, only 12.6 of the American individuals analyzed derived most of their wealth from inheritance, a lower share than any European country in the sample besides Finland (9.1 percent, but with a much higher share with their primary source of wealth being a mix between inheritance and self-made) and the United Kingdom (12.5 percent).

Unlike the common portrayal, it is the European countries that has a more stagnant and stultified elite class, while the United States has one of the higher shares of self-made men and women in the study’s sample.

Ultra High Net Worth Individuals by Primary Source of Wealth, Select Countries

Source: Wai and Lincoln (2016), Appendix F. 

Bucking the Protectionist Trend

In September, the UK government gave the green light for the construction of the Hinkley Point power plant through a French-Chinese consortium. The project—which has received wide international attention after being very nearly relegated to the protectionist dustbin—has been agreed to after much hemming and hawing. It has been mired in controversy mainly over security concerns related to foreign ownership, viewed by some as smacking of protectionism.

It is no secret that there has been a worrying trend toward protectionism in the global markets. The appetite for international trade agreements and foreign investment has been consistently listless. In the United States, and globally, some politicians have been banking on this by flaunting protectionist rhetoric in an effort to garner support. But while protectionism may win votes in the short-term, domestic economic growth will lose out in the long-term. Ultimately, politicizing the global economic rut will only make matters worse.

Did the Gold Standard Fail? A Response to David Glasner

At the Mercatus / Cato CMFA conference a few weeks ago on “Monetary Rules for a Post-Crisis World,” David Laidler and David Glasner gave interesting and informative talks on the history (and history of economic thought) regarding the evolution of monetary rules during the first panel. Video of their talks, and that of co-panelist Mark Calabria, is available here. Ari Blask recaps the entire conference here.

I haven’t seen Glasner’s paper, but he has posted a summary of it on his blog. (All subsequent quotes are drawn from that source.) There he suggests that perhaps the earliest monetary rule, in the general sense of a binding pre-commitment for a money issuer, can be seen in the redemption obligations attached to banknotes. The obligation was contractual: A typical banknote pledged that the bank “will pay the bearer on demand” in specie. (Demand deposit contracts, which preceded banknotes historically, made the same pledge.) He rightly remarks that “convertibility was not originally undertaken as a policy rule; it was undertaken simply as a business expedient” without which the public would not have accepted demand deposits or banknotes.

I wouldn’t characterize the contract in quite the way Glasner does, however, as a “monetary rule to govern the operation of a monetary system.” In a system with many banks of issue, the redemption contract on any one bank’s notes was a commitment from that bank to the holders of those notes only, without anyone intending it as a device to govern the operation of the entire system. The commitment that governs a single bank ipso facto governs an entire monetary system only when that single bank is a central bank, the only bank allowed to issue currency and the repository of the gold reserves of ordinary commercial banks. Under a gold standard with competitive plural note-issuers (a free banking system) holding their own reserves, by contrast, the operation of the monetary system is governed by impersonal market forces rather than by any single agent. This is an important distinction between the properties of a gold standard with free banking and the properties of a gold standard managed by a central bank. The distinction is especially important when it comes to judging whether historical monetary crises and depressions can be accurately described as instances where “the gold standard failed” or instead where “central bank management of the monetary system failed.”

Capture and Ignorance in Financial Regulation

After spending some years in both legislative and regulatory policy roles, I’ve come to even more strongly believe that almost everything you really need to understand regulation can be found in Peltzman’s classic 1976 extension of Stigler’s original economic model of regulation. Almost everything. What I find lacking is recognition of the importance of both outright ignorance of the “correct” policy solution, along with cognitive biases on the part of policymakers. While I reach slightly different conclusions for the structure of policy implementation, I follow Rachlinski and Farina(2002) in framing the inquiry around two models of government error: Public Choice and Cognitive Failure.

While still largely ignored within mainstream academia, the central framework of Public Choice theory, that actors in the political realm pursue rational self-interest, appears to have been largely embraced by popular political commentators from Senator Elizabeth Warren to Presidential Candidate Donald Trump. The notion that “the system is rigged” clearly resonates with the public. For some the obvious solution has been to further insulate regulators from the political process: witness the structure of the Consumer Financial Protection Bureau (CFPB) created by the Dodd-Frank Act.

The “protecting” of regulators from the political process is, however, based upon the belief that the “correct” policy is obvious and is simply being blocked because regulators are “captured” by those they regulate. Insulate the regulators, and like magic, you get the right policy.