You may have never heard of preemption, but that one little word could have a big effect on whether state banking regulators can protect consumers when large national banks act badly.
Preemption is the idea that federal regulations should always supersede state ones when they conflict, even when federal regulations are weaker. During the run-up to the financial crisis, the Office of the Comptroller of the Currency used the doctrine of preemption to allow large national banks to avoid state financial regulations that went beyond federal law in regulating banks. According to the Financial Crisis Inquiry Commission, that helped banks make riskier loans than state regulations would otherwise have allowed.
For example, say National Hypothetical Bank sold me a mortgage that, in the fine print, gave the bank the right to use my front yard as a pasture for their sheep. Now, say that the state of Florida had a law that specifically forbids banks from inserting language into mortgage contracts that converts front yards to pasture land.
I could make a complaint to the Florida Office of Financial Regulation and they would help me get those darn sheep off my lawn once and for all, right? Wrong. The OCC would likely fight for NHB's right to keep those sheep on my lawn, saying that federal law doesn't ban the practice, and since NHB is a national bank, more permissive federal laws regarding mortgage and livestock would apply.
To keep those types of shenanigans from happening again and contributing to a future financial crisis, the Dodd-Frank financial reform law included a passage basically saying that the OCC can only preempt state regulations under extraordinary circumstances. The OCC response, in a nutshell: So what?
Citing a 1996 Supreme Court case, the OCC, in a pending proposal, said that while it would consult with the Consumer Financial Protection Bureau when deciding to overrule state consumer protection laws, the basic idea that it could routinely preempt state regulations regarding national banks would stay put.
Senate and House Democrats didn't much care for that interpretation, and neither did the Treasury. Last week, Treasury officials sent the OCC a sharply worded comment letter to the regulator criticizing the decision for what it says was basically ignoring the changes in Dodd-Frank. That's provoked a backlash against the Treasury from preemption advocates, who say the Treasury is interfering with the OCC's independence. From Kate Davidson at American Banker:
In the wake of a public disagreement over a pending proposal, a House panel is asking the Treasury Department to disclose the role it played in the Office of the Comptroller of the Currency's rulemaking on preemption.
"We seek assurances that the Treasury has permitted the OCC to act independently in the rulemaking for this and all provisions of the Dodd-Frank Act," wrote Randy Neugebauer, the chairman of the House Financial Services Subcommittee on Oversight.
While it's unlikely any kerfuffel over the Treasury's letter will amount to much, the preemption issue isn't going away. In fact, it may have been just the motivation the Obama administration needed to finally tap a new OCC head after a yearlong vacancy. Perhaps the Obama administration is hoping its nominee, Tom Curry, a former state financial regulator, will be a little more friendly to the idea that OCC preemption should be used sparingly.
What do you think? Should national regulators be able to brush away state financial laws at will?