The CFPB: A Five Year Retrospective
University of Wisconsin – Madison – Department of Finance, Investment and Banking
December 18, 2015
This paper provides a 5 year review of the Consumer Financial Protection Bureau which is part (title X) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The CFPB is one of the most controversial parts of the Dodd-Frank Act. It has been argued (mostly by the banking industry) that the CFPB imposes a regulatory burden on banks without any measurable benefits for those it is designed to protect. It is also one of the first regulatory policies that embraces elements of Behavioral Economics. It does this with a regulatory framework that discourages the supply of certain financial products that are potentially toxic to the financial health of less than fully rational households. We find that CFPB as a regulatory policy conflicts with other government policies designed to encourage home ownership and access to financial products among the poor. One possible solution to this contradiction in conflicting government policies is to carry out the social goal of housing for the poor within a government sponsored enterprise much like the Federal Farm Credit System.
The CFPB: A Five Year Retrospective – Introduction
July 21, 2015 marked the 5th anniversary of the passing into law of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act is a roughly 2300 page document and its complicated rules and regulations are still in the process of being formulated and implemented. In this paper I will primarily concern myself with title X of the Act, namely, The Consumer Financial Protection Bureau (CFPB) focusing attention on certain aspects of the home mortgage market. More particularly we want to know whether the Dodd-Frank Act and the CFPB has furthered the goals of government policy. Unfortunately the answer must be: No. The answer is No because there is a stark contradiction between the goals of the CFPB and the other parts of the Dodd-Frank Act. Superimposed on both is a social policy whose goal is to promote home ownership and access to financial products for all income groups including low income households. The goal of the CFPB is to protect consumers while the rest of the Dodd-Frank Act is designed to stabilize the financial system. Both are in conflict with each other and the social goal of subsidizing housing and access to financial products for low income families. What makes this a contradiction is that all three goals are designed to be attained within the private financial sector. In section IV we sketch out how the government might possibly side-step this contradiction.
In evaluating the Consumer Financial Protection Bureau we begin in Section II by briefly describing the economic events that gave rise to the Dodd-Frank Wall Street Reform and Consumer Protection Act. That economic background was the Great Financial and Economic Crisis that began in 2007. This crisis was different. It was more severe than any recession since the Great Depression. It also illustrated some of the most egregious practices that characterizes the financial system in a competitive capitalist system. In Section III we describe the salient features of the regulatory response to the Great Crisis focusing mainly on the CFPB regulation of home mortgages. We then present a 5 year evaluation of the CFPB in Section IV. Section V concludes with a brief summary and a suggestion for a different approach to achieving financial stability along with a government program encouraging home ownership for all income classes.
The Great Crisis
The Economic Background
The financial and subsequent economic crisis that started in 2007 was the worst experienced by the U.S. since the Great Depression in the 1930’s. Figure 1 compares the 2007-2009 recession to the previous five recessions.1 It can be seen in the figure that the 2007-2009 recession was both deeper and of a longer duration than any of the five previous recessions. According to Treasury Department estimates, 8.8 million jobs were lost as of 2012. The unemployment rate reached 10 percent in 2009 and the civilian labor force participation rate fell from 64.4 percent in 2000 to 58.4 percent in 2011. People gave up looking for jobs. The cumulative cost from Figure 2 in terms of lost real GDP ranged from $6 trillion to $14 trillion (so far) or $50,000 to $120,000 per household depending on assumptions regarding the long-run trend in real GDP after the crisis.2 Over the 2007-2011 period household net worth in housing assets fell 33 percent and stock market valuations fell 40 percent between October 2007 and June 2009. According to U.S. Department of Treasury estimates total household wealth fell $19.2 trillion over this period.3 Finally the Great Crisis was not limited to the U.S. As Figure 3 indicates world output declined and as of 2012 had not returned to its previous trend level.
What were the causes of this calamitous event? It is generally agreed that overinvestment, especially in housing assets, was the principal initiating cause of the Great Crisis. Several factors came together to cause the overinvestment in housing. One was the government’s social policy towards housing. A second was the absence of regulation of banks and shadow banks partly the result of the deregulation of the financial system completed in the Gramm-Leach-Bliley Act of November of 1999. With regard to social policy Agarwal et al. (2012) offer evidence that the Community Reinvestment Act of 1977 pushed banks in the direction of providing riskier mortgage financing for low income and minority groups especially in and around regulatory conformance exam dates. The Housing and Community Development Act of 1992 and subsequent political pressure from the Clinton administration required the mortgage purchasers Fannie Mae and Freddy Mac to invest a substantial proportion of their portfolio in affordable housing mortgages. Both of these acts of Congress facilitated an expansion in housing demand (especially by those income groups least able to service their mortgage debt) and contributed to the increased but unsustainable price appreciation of real estate assets in the run-up to the crisis.
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