Congress vs. Bernanke on Borrower Protection

A good old-fashioned showdown is set for this week between the Congress and the Fed. Congressmen are hoppin’ mad at the Fed’s failure not only to act to stem overheated and sometimes predatory subprime lending, but also its patent lack of enthusiasm in doing anything to keep this and other predatory practices from recurring. And they have some justification for their annoyance. While admittedly the Fed regulates only a portion of the institutions that were involved in subprime lending, it failed to use the tools it had available, most notably the Home Ownership and Equity Protection Act (by contrast, the Office of the Comptroller of the Currency, made use of HOEPA and had relatively few abuses among the banks it supervises).

There is a reason the Fed has been so tone deaf on this issue. It does not see borrower protection as part of its job (it isn’t part of the original Fed charter) and the little we’ve seen directly also suggests the Fed is a staunch believer in free market ideology (remember, Greenspan was an acolyte of Ayn Rand and Bernanke hasn’t had the time to put his own stamp on the institution).

Congress is threatening aggressive moves, namely, moving some of its regulatory authority to other agencies, if the Fed doesn’t fall into line. This should be a very interesting set of meetings.

From the Wall Street Journal:

The Federal Reserve, under fire on Capitol Hill for not protecting consumers more aggressively from dubious banking practices, will likely become more assertive toward the lending and marketing practices of the nation’s more than 35,000 banks, credit unions, finance companies and mortgage brokers.

In the wake of a meltdown in the market for subprime mortgages and increasing congressional scrutiny of practices in the credit-card industry, Democratic leaders have blasted the Fed’s regulatory performance.

The form that any changes in the Fed’s regulatory approach might take isn’t clear, but they could affect anything from credit-card payments to mortgage penalties.

The central bank has broad authority to prohibit banking practices it deems unfair and deceptive, an important role that receives far less attention than the setting of monetary policy.

This year’s political assault on the Fed’s consumer-protection record may reach a crescendo this week, with Fed Chairman Ben Bernanke set to face lawmakers during two days of congressional testimony starting tomorrow. Mr. Bernanke, entering his second year at the Fed’s helm, is still trying to cement his stature with lawmakers the way he did quickly with Wall Street.

“They had a job to do, and they didn’t do it,” said Senate Banking Committee Chairman Christopher Dodd, (D., Conn.), of the Fed’s performance. “A lot of people are hurt, and I’m angry about it,” added Mr. Dodd, who is seeking the Democratic presidential nomination.

The pressure on the Fed represents one of the most significant challenges to its authority in decades. House Financial Services Committee Chairman Barney Frank (D., Mass.) has threatened to give some of the Fed’s jurisdiction to other regulators if the central bank doesn’t begin making changes by the fall. Moreover, three nominees to the Fed’s seven-member board are awaiting confirmation by Mr. Dodd’s Senate committee.

“There is a deep level of anxiety and frustration in every [congressional] office, everyplace we go on this issue,” Alfred A. DelliBovi, president of the Federal Home Loan Bank of New York, told Fed governor Randall Kroszner during a recent meeting. “It seems to me that either the Fed is going to have to act on this or [its powers] will be moved somewhere else.”

It remains unclear whether the Fed’s regulatory woes will hurt Mr. Bernanke’s monetary-policy goals. But Mr. Frank dismissed the idea. “Are we resisting Bernanke’s monetary policy because of this? That’s ludicrous.”

Under former Chairman Alan Greenspan, who stepped down last year, the Fed successfully accumulated broader regulatory jurisdiction over banking and consumer protection, in part because of its reputation for independence.

The central bank now is the only government body that can write rules banning any practice it deems unfair and deceptive at the nation’s more than 7,000 banks. It is also the only agency that can prohibit any mortgage practice across the entire lending industry.

Instead of aggressively using these tools, the Fed has tried to take a market-based approach: encouraging fair disclosures and trying to root out bad actors quietly, rather than wielding a heavy hand that might deter innovation. This has allowed the financial-services industry to develop novel and flexible types of credit, such as interest-only mortgages. But critics allege that this approach has also allowed questionable practices to entrench themselves with little scrutiny.

Three of the five current Fed governors — Mr. Bernanke, Kevin Warsh, and Mr. Kroszner — have been economic-policy advisors to the White House, which has a similar market-based philosophy with regard to financial-services regulation.

Other federal agencies have moved faster to head off congressional criticism. Comptroller of the Currency John Dugan started a Web site last week to help consumers resolve issues with their banks. Federal Deposit Insurance Corp. Chairman Sheila Bair has pressed banks to move borrowers with expensive adjustable-rate mortgages into more affordable fixed-rate products. And the Office of Thrift Supervision has begun working on its own proposal to ban unfair and deceptive practices at more than 800 federally insured thrifts.

Faced with the possibility that some of its power might be scaled back, the Fed is changing its rhetoric.

In May, Mr. Bernanke said the central bank had the authority to prohibit certain mortgage practices. Mr. Dodd objected, saying the Fed was playing down its role. A month later, Mr. Bernanke shifted, saying the central bank “has the responsibility to prohibit mortgage lending practices that it finds to be unfair and deceptive.”

The Fed held a daylong public hearing last month to discuss different ways it could use its authority, and senior officials have begun speaking much more bluntly about the types of actions it could eventually take.

“We have not taken anything off the table,” said Sandra F. Braunstein, director of the Fed’s division of consumer and community affairs. “We are willing to use any of the tools available to us, that includes rule writing or banning practices or anything else we feel is necessary.”

As criticism of the Fed intensified last month, Mr. Bernanke held a closed-door meeting with roughly 40 members from the Association of Community Organizations for Reform Now, a consumer group that has asked for a moratorium on all foreclosures stemming from problems in the subprime mortgage market.

It is unclear what types of practices the Fed might try to abolish, but that hasn’t stopped consumer groups and Democrats from making suggestions. One of the most frequently criticized is a credit-card practice known as double-cycle billing, which allows companies to charge customers interest on almost all their credit-card balance even if the borrower pays off almost all of it by the due date. Another: Prepayment penalties on mortgages, particularly those that penalize a borrower for trying to pay off an adjustable-rate mortgage before it resets into a much higher monthly payment.

Last month, the Fed and other regulators warned banks away from such mortgage penalties, but it didn’t use its rule-writing authority to ban the practice across the industry.