Citing some of the historic difficulties that have plagued federal banking agencies, Consumer Financial Protection Bureau (CFPB) acting deputy director Brian Johnson suggested that the best regulator for the financial industry may be the marketplace itself, according to prepared remarks from a speech at the George Mason University Law & Economics Center’s Ninth Annual Financial Services Symposium.
The emphasis Johnson placed on “market-reinforcing” regulations during his speech underscores a stark divergence from the bureau’s priorities spelled out by former CFPB deputy director Steve Antonakes in a 2013 speech at the American Bankers Association’s Government Relations Summit in which he championed market accountability.
“Financial regulators must certainly be prepared to adapt and respond to changing circumstances,” Johnson said. “However, to have any sense of where financial regulation should be going, perhaps it is best to spend a little time thinking about where it has been going.”
Contrary to Johnson’s view that the bureau should be more willing to allow the market to regulate itself, Antonakes believed the agency’s role should be much more hands on, and he spent much more time speaking to the importance of examining the bureau’s supervisory and enforcement approaches to ensure efficiency. However, Antonakes also touched on a priority Kraninger recently said should be a greater focus for the bureau going forward – education.
“Our work is centered upon a belief that an educated consumer is a more capable and effective consumer,” Antonakes said. “We also hold that banks and non-banks should be treated alike and receive similar oversight if they offer the same types of financial products and services. Accordingly, we want responsible businesses playing by the rules to succeed, free of unfair pressure from predatory competitors.”
Johnson argued that in their efforts to control the activities of financial institutions, regulators often do more harm than good to the market and, by extension, consumers. He asserted that regulators, such as the CFPB, would be well-advised to keep that perspective in mind as they review regulations already on the books and consider approaches to regulating new technology innovations.
“Competitive enterprises have to treat their customers well or pay the price, and their need to satisfy customer demand drives technological innovation,” Johnson said. “New technologies have always influenced and shaped financial products and services, and they will continue to alter the relationship between customers and their financial service providers.”
Citing takeaways from the CFPB’s “Call for Evidence,” initiated under former acting director Mick Mulvaney, Johnson stated that the bureau has recognized unintended consequences associated with some of its regulations that it has a statutory responsibility to address. He suggested that a more forward-thinking and less “prescriptive” approach to future rulemaking could lessen the number of such negative side effects associated with new rules.
Johnson indicated that he believes regulators erred by electing to layer on more and more regulation to try to control the market and may have focused on the wrong risk factors.
He drew a distinction between complicated and complex systems, arguing that complicated systems usually are designed to achieve a specific end, such as a problem. He criticized regulators for treating a complex system such as financial services with a solution for a complicated system.
“Those attempting to manage a complex adaptive system must accept the uncertainty and ambiguity inherent in its spontaneous and emergent behavior, and accept the reality that markets do not serve a specific end or policy goal,” Johnson said.
And yet a specific end or policy goal is exactly what the CFPB championed under Cordray, according to Antonakes.
“A specific charge of the bureau is to attempt to level the playing field between banks and non-bank entities relative to compliance with federal consumer financial laws,” he said, speaking shortly after the bureau had released its initial set of Ability-to-Repay mortgage rules. “We recognize that compliance management will be managed differently by large, complex banking organizations at one end of the spectrum and small entities that offer a narrow range of financial products and services at the other end. While the characteristics and implementation will vary from entity to entity, we believe compliance management activities, including implementing new regulatory requirements, must be a priority. … It is in the best interests of the consumer for industry to understand and properly implement these rules.”
Although differing from Antonakes and the CFPB’s previous stance, Johnson clarified that he was not suggesting the end of financial regulations.
“To the contrary, last fall at a national meeting of consumer advocates, I expressly acknowledged the utility of market-reinforcing regulation. I want to recapitulate the main points of that discussion briefly,” he said. “In my remarks, I argued that the CFPB’s guiding regulatory principle should be animated by a concept I defined as a presumption in favor of consumer choice.”
To his point about reinforcing market activity, Johnson offered three detailed reasons supporting this claim, comparing them to the legs supporting a three-legged stool that is the U.S. market:
- “First, market activity is a product of competition. Firms competing over consumer dollars must offer products that offer a better value, better quality or both. And, consumers can derive information about products through this process, especially as it relates to quality. Indeed, Adam Smith’s ‘invisible hand’ of the market is itself a form of consumer protection.
- Second, the general framework of contract, property, and courts of law allow market participants to coordinate and plan their lives, what is known as private ordering. This general framework allows our large and often impersonal commercial society to flourish by providing means of redress for injury. And it gives market actors who take entrepreneurial risk peace of mind courts will enforce the legal promises on which they relied.
- Finally, the third leg of our stool is public agencies like the CFPB. While contract and property rights offer tremendous benefit, sometimes they are not enough to address nation-wide scams or large organizations that engage in fraudulent or deceptive practices. In the area of consumer protection, that is one of the primary reasons for the CFPB’s existence, to prevent and deter fraud and other conduct that undermines the ability of consumers to make decisions for themselves in the marketplace where neither competition nor private legal remedies adequately address the conduct.”
Antonakes, when it came to the financial marketplace, was less concerned with reinforcement and more focused on ensuring that consumers were protected from harm resulting from a lack of proper consumer protection mechanisms within a given entity. To that end, he asserted that the bureau should focus its supervisory activity on the following factors:
- “The size of the overall market in which a regulated entity’s product line operates;
- The potential for consumer risk related to a particular product market;
- A regulated entity’s level of activity in the marketplace, or more specifically, its market share; and
- Field and market intelligence that encompasses a range of issues including, but not limited to, the quality of a regulated entity’s management, the existence of other regulatory actions, default rates, and consumer complaints.”
Whereas there are some industry stakeholders that believe financial regulators, such as the CFPB, should engage in more prescriptive “command-and-control or market-replacing regulation,” and that government intervention is needed in the marketplace because consumers are not well-educated enough to make the best decisions for themselves, Johnson disagrees.
“All else being equal, regulatory rules should be as simple as possible,” he said. “Simple rules are easier for a greater proportion of actors operating within institutions to understand and adapt to, making the system more resilient overall. Simple rules also promote compliance.”
In addition to being simple, Johnson said rules should encourage decentralized decision-making, erring against attempts to centralize risk-management or dictate specific outcomes.
“When regulators attempt to maximize specific parameters, relating for example to centralized risk-management, or make certain products more attractive than others, they proceed as if markets are a means to produce the regulators’ ends,” Johnson said. “This is the wrong approach in my view. Financial regulators should recognize that complex market systems are not a means to accomplish their specific goals.”
He added that the bureau has a statutory obligation to regularly identify and address outdated, unnecessary or unduly burdensome regulations in order to reduce unwarranted regulatory burdens. To that point, he said that prescriptive rules that are “ill-suited to complex markets” should be among the first to come up for review by the CFPB.
Interestingly, both the current and former acting deputy director mentioned the need to ensure that the marketplace works for consumers and the industry.
“Our mission at the bureau is fundamentally designed to improve the markets for consumer financial products and services for both consumers and businesses operating within the law,” Antonakes said. “A renewed and appropriate focus on consumer protection will go a long way toward preventing the problems that gave rise to the financial crisis. Our goal is that this will allow substantial opportunities for all companies to innovate and compete in the marketplace.”
Johnson concluded by saying that regulators should, in essence, learn to accept that certain developments in the financial marketplace are out of their hands and will be determined by market conditions.
“We should strive to promote the adaptive attributes that make complex systems like markets so beneficial to society,” he said. “And if we take these lessons to heart, perhaps the future of financial services regulation in the United States will be brighter.”