Earlier this month, the California Legislature passed the California Consumer Financial Protection Law (CCFPL) to create a new state-based regulatory agency modeled after the federal Consumer Financial Protection Bureau (CFPB). If the legislation is signed by Governor Gavin Newsom (D), he would be approving of a bill that picks winners and losers in the financial services sector and implementing a law which would hurt consumers.
Specifically, the bill would replace the state’s existing Department of Business Oversight (DBO) with a Department of Financial Protection and Innovation (DFPI). Under the CCFPL, the DFPI would have significantly more power than the DBO and would be able to bring forth both administrative and civil actions against financial firms.
However, thanks to last minute lobbying by certain trade associations, previously licensed financial services providers like banks and auto lenders would be exempted from the new stringent enforcement authority granted to the DFPI. Because of that, these firms would enjoy the benefit of dealing with the same regulatory regime they were subjected to while under the supervision of the DBO, all while other financial services firms, including competitors such as innovative FinTech startups, are forced to comply with enhanced regulations. Notably, these carveouts were not extended to certain previously licensed financial services providers, including payday lenders and student loan servicers.
Banking trade associations were also able to include an amendment in the final version of the bill for their members to be exempt from one of the CCFPL’s most onerous provisions—the authority of the DFPI to go after businesses for unfair, deceptive, or abusive acts or practices (UDAAP) violations. The UDAAP designation originated in the Dodd-Frank Act, and made it unlawful for any provider of consumer financial products or services to engage in unfair, deceptive, or abusive acts or practices.
Beyond departing from traditional anti-fraud consumer protection standards, UDAAP was not clearly explained by Dodd-Frank, especially in describing the differences between unfair, deceptive, or abusive acts or practices—leading to much confusion in the financial services industry over the past decade. In practice, the CFPB has often relied upon the poorly defined and broad UDAAP standard as its primary enforcement tool, contributing to UDAAP being labeled “the most feared word in Dodd-Frank.” Fortunately, under the leadership of CFPB Director Kathy Kraninger, the bureau has worked to end this kind of “regulation by enforcement” by issuing a policy statement earlier this year that helps to clarify what constitutes an abusive practice and outline how regulators will handle UDAAP supervision and enforcement actions.
While it remains to be seen how California will define UDAAP, considering the CCFPL is a Dodd-Frank lookalike, it is likely that it will mirror the federal UDAAP standard. Further, although banks may still be punished under the federal UDAAP standard, they were able to secure language in the bill exempting them from the future California UDAAP standard, all the while other financial services providers in California would be subjected to both federal and state regulations.
Rather than try to use the power of the state to squeeze competition, the financial services industry should have put forth a unified effort to combat Newsom’s plan to bring about a “mini-CFPB” in the state of California. This certainly would have been the best way to defeat the proposal, especially since the open-ended language of the bill seems to put few restrictions on the DFPI and its regulatory purview. Once regulators are given this expansive power, they may find a way to expand it to all businesses.
Besides being cronyist, the bill is also ill-conceived for trying to implement a state-based version of the CFPB to advance consumer protection.
The CFPB was created under Title X of Dodd-Frank and is the brainchild of Sen. Elizabeth Warren (D-MA). According to Warren, her consumer protection convictions go back to the 1970s—one morning in particular where she was preparing breakfast and almost burned down the house because of her misuse of a toaster. In later years, during her time as a law professor, Warren thought back to that moment and realized that while the Consumer Product Safety Commission exists to ensure basic safety in the consumer products marketplace, there is no equivalent regulatory body to regulate the financial services industry and protect consumers from predatory practices.
While progressives love Warren’s story and regard the CFPB as the be-all and end-all of consumer protection, experience has shown the bureau is an unaccountable regulatory behemoth that ultimately hurts the consumers it was designed to protect.
Although Congress is supposed to have the power of the purse, the CFPB is outside of the traditional appropriations process and therefore lacks proper legislative oversight. Similarly, the DFPI would also lack oversight, since it is designed to be funded through annual registration fees from covered financial institutions, rather than through state-allocated monies.
Further, the CCFPL would create a Financial Protection Fund, similar to the CFPB’s Civil Penalty Fund, that would allow the department to collect fees, fines, and penalties to compensate consumers harmed by bad actors. That is all well and good, though the CFPB’s Civil Penalty Fund has routinely been used by the bureau as a slush fund to increase its budget. In 2013, only 16 percent of money collected in the Civil Penalty Fund actually went to affected consumers. As noted by current Securities and Exchange Commission member Hester Pierce, formerly of the Mercatus Center, the bureau’s enforcement policies can be perceived to be “driven by its own interest in increasing the size of its civil penalty fund,” thus “[compromising] the bureau’s legitimacy.” Taking that into account, is this really the consumer protection model that states should adopt?
Beyond that, time and time again CFPB enforcement and regulation has negatively impacted consumer welfare. Take, for example, the bureau’s aggressive enforcement of the Equal Credit Opportunity Act, which has led to fewer credit options for working and middle class consumers. And do not forget the bureau’s payday loan rule, which would have all but stripped consumers of this vital source of credit.
Given the bulk of evidence that shows the CFPB has done more to hurt consumers than help them, coupled with the cronyism built into the bill, it’s concerning that California legislators and Governor Newsom seem set on passing this legislation. Discussing the bill, former CFPB Director Richard Corday said that the “DFPI is going to be a game changer,” and that it “could be a model for the country.” Given how the federal CFPB has raised consumer costs and harmed consumer choice, those who truly wish to advance consumer interests should fight to ensure this doesn’t happen.