No more loans with tricks & traps

Elizabeth Warren
Two years ago, Elizabeth Warren proposed the creation of a "financial product safety commission." Its mission: Review financial products "to eliminate the hidden tricks and traps that make some of them far more dangerous than others."

Even as the mortgage meltdown morphed into an economic crisis, Warren's idea didn't get a lot of traction. Then, in June, the Obama administration adopted it as part of a broad reform of financial regulations, renaming Warren's brainchild the Consumer Financial Protection Agency.

Warren is a professor at Harvard Law School and is an expert on debtor and bankruptcy law. She has written or co-written about 15 books, including "The Fragile Middle Class: Americans in Debt" and "The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke."

She is chairwoman of the Congressional Oversight Panel, which supervises Treasury's management of the Troubled Asset Relief Program, or TARP, and reviews financial regulations. In recent weeks she has talked with legislators and sat for interviews to push for financial regulatory reform. asked Warren which parts of regulatory reform are more important, why she thinks tighter banking rules can yield greater innovation, and why shopping for a mortgage is like shopping for a car.

q_v2.gif What parts of the Consumer Financial Protection Agency are dearest to you? If Congress enacts only part of what you suggested, what parts do you most want to keep?

a_v2.gifHere's the heart of it, what I think this thing does. The form of regulation we have now is a do's and don'ts approach -- a complex regulatory structure with many layers. Some of the rules apply differently depending on whether a lender is a federally chartered bank or a state-chartered thrift or a nonregulated business group.

Changes needed for the market to work again
  • All products of the same kind have the same rules.
  • Make the language of the deal easy to understand.

The point behind the CFPA is to replace the do's and don'ts approach with two key shifts:

First, all products of the same kind shall face the same set of rules.

For example, all mortgages, regardless of who issues them, have to meet certain minimum standards. That would be true whether these are from an unlicensed institution or they're from a nationally chartered bank. That would level the playing field. It's important to shift regulation into a product orientation -- that is, all products within a category are treated alike.

“There will be a lot of two-page credit card agreements and two-page mortgages and one-page checking account overdraft arrangements.”

The second part is to move toward leveling the playing field by making the products easy to understand. Disclosure has come to mean six more paragraphs of unreadable text back on page 91, which doesn't change consumer behavior and doesn't make markets competitive.

This agency will have the capacity to reach across all similar instruments and the ability to push toward revealing the key information and not hiding it in incomprehensible language or long disclosures that discourage consumers from reading them. Those changes will make big differences in how the markets function.

Ultimately, if this agency works the way it ought to, there will be a lot of two-page credit card agreements and two-page mortgages and one-page checking account overdraft arrangements. When that happens, there will be real competition and markets can work again.

That's the heart of it for me. If that's lost, there's not much point.

q_v2.gifYou describe the industry's definition of financial innovation as six new paragraphs of boilerplate to discuss something new. Where do you disagree with the industry's definition of financial innovation and what kind of innovation would you like to see?

a_v2.gifInnovation works for consumers only in a truly competitive market. Right now, partly because of the regulatory structure and partly because of the gaps in regulation, the business model for selling financial products to consumers has changed dramatically.

“The market became wildly profitable through innovations that were oriented toward tricks and traps.”

The old model was to sell a fairly straightforward product to people that the lender was pretty sure would they'd be able to repay. Lenders priced the product by figuring out what's the risk of nonpayment, what's the inflation risk, and what costs the business needs to recover.

The new pricing model shifted away from that, so that a handful of features are pushed out in front of the consumer that appear very attractive, like the monthly payment and no money down, while the cost and risks are buried in fine print that are often not well described. A lot of mortgage issuers made a lot of money over the past 10 years by selling products that many consumers barely understood or didn't understand at all. More importantly, the capacity to compare directly from product to product fell apart.


I shopped for mortgages in the 1990s, when we were buying a house, and 45 minutes on the phone pretty much told me how that market worked. I knew I was comparing apples to apples, because I got the prices and that was it. I made a decision. That's not how that market works anymore. The market became wildly profitable through innovations that were oriented toward tricks and traps.

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