Will Reforming Consumer Finance Regulation Cause a Recession?

Will reforming consumer finance regulation cause a recession? That is the claim of a recent article in The Hill by two former Washington Post business reporters. In particular, the article claims that an array of Trump administration actions represent “a scenario eerily reminiscent of events that drove the U.S. into a ditch in the Great Depression of the 1930s and the Great Recession 10 years ago.”

That’s a bold claim. And yet for such a prediction, the article provides little evidence to back it up. At best, it is a confused mix of hyperbole and fear mongering. In response to some particular claims regarding consumer protection (there are too many for one blog post), I’ve provided some brief responses below.

1. “Trump’s undoing of the Dodd-Frank Act, which Congress passed in 2010 to end the unsustainable consumer debt that triggered the mortgage crisis and plunged the country into the worst downturn since the Great Depression —produces a toxic mix: rising consumer debt and decreasing oversight of lenders.”

The “undoing” of Dodd-Frank presumably refers to S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act, a bipartisan piece of legislation passed in 2018. Yet that legislation merely tinkered around the edges of Dodd-Frank, predominantly raising certain restrictions placed on community banks under $10 billion is assets, which were far from the troubles of Wall Street. The vast majority of Dodd-Frank, let alone the enormous of amount regulation that preceded it, remains solidly intact.

No evidence is cited—and it is far from clear—how S. 2155 has led to rising consumer debt. Most of the regulatory changes from the legislation are yet to be implemented by agencies. As it currently stands, the household consumer debt service ratio remains virtually unchanged since S. 2155’s passage.

Furthermore, Dodd-Frank actually did little to “end the unsustainable consumer debt that triggered the mortgage crisis.” In fact, it left in place the government housing policies that pushed millions of people into homes they couldn’t afford. The one major housing finance reform that was instituted, the Qualified Mortgage Rule, has been rendered ineffective, as it exempts any loans eligible to be purchased by the Government Sponsored Enterprises, Fannie Mae and Freddie Mac, and the Federal Housing Administration, under an exemption known as the QM “patch.” As a recent economic analysis found, this has allowed the federal government to once again expand the market for loans to borrowers with high debt-to-income ratios and dangerously low down payments and credit scores.

2. According to the article, the fact that “household debt reached $13.54 trillion in 2018, higher than the previous peak of $12.68 trillion in 2008 when the mortgage crisis was in full swing,” is a sign of trouble in the financial system.

Looking at aggregate numbers regarding consumer debt tells you very little about the real burden or risk to households. It shouldn’t be a surprise that household debt is higher a decade on from the financial crisis—the ability to service that debt is also much greater.

The concern that households misuse consumer credit is nothing new. As George Mason Law School Professor Todd Zywicki has highlighted, these concerns have been repeated year after year in the popular press for more than a century. And yet, when looking at different measures of the household debt servicing ratio—how difficult it is for households to meet their debt obligations—the ratio is much lower today than in 2008, and even lower than it was in 1980.

3. “Trump appointees have turned the Consumer Financial Protection Bureau (CFPB), created by Dodd-Frank, from an office enforcing safeguards against such abuses into one that merely offers information.”

As I wrote recently for OpenMarket, this is not the case. Despite the rhetoric from critics of a Republican CFPB, the Bureau is still pursuing lawsuits and writing regulations. The Bureau has merely been reformed to focus on bread-and-butter consumer protection issues, such as unfair or deceptive acts or practices, rather than dubious enforcement actions and command-and-control style regulation.

4. The article then proceeds to list a number of Trump administration reforms that are allegedly increasing the likelihood of a financial crisis, including the CFPB’s rescission of the payday loan rule, Congress’ killing of the CFPB arbitration rule, the axing of the Department of Labor’s fiduciary rule, and the Office of the Comptroller of the Currency (OCC) establishing a national charter for FinTech lenders.

It is unclear how any of these regulatory changes would contribute to a financial crisis. To start with, the final payday, arbitration, and fiduciary rules came out during 2016 and 2017—long after the financial crisis—and none were ever claimed to have been designed to enhance financial stability.

Second, the claim that payday loans and arbitration agreements in consumer credit contracts are a threat to financial stability is nothing short of absurd. Small dollar loans account for an infinitesimally small amount of the total debt burden, and a particular dispute resolution mechanism does not have a tangible impact on household debt. If anything, the payday loan rule would have meant more consumers defaulting on other kinds of credit and the arbitration rule would have resulted in a slower process that recovered less money for consumers.

Further, while both of these regulations have been targeted for elimination by the Trump administration, neither was done so through the veto power of the Financial Stability Oversight Council (FSOC)—a council of 10 regulators that hold broad authorities to identify and monitor excessive risks to the financial system. The FSOC is able to vote to overturn CFPB regulations or actions, but only if it threatens the “safety and soundness” of the U.S. financial system.

Both the payday and arbitration rules were designed and promulgated by the Obama administration. It is certain that the Trump administration did not agree with these—indeed, the Trump CFPB is now in the process of rewriting the payday rule and the president signed a Congressional Review Act resolution to repeal the arbitration rule. Nevertheless, neither of these rules were ever suggested to be eligible to be overturned by FSOC veto, because regulating arbitration agreements and payday loans do not come close to endangering the entire financial system.

Lastly, it is similarly unclear how the Office of the Comptroller of the Currency’s FinTech charter would lead to a financial crisis. The OCC’s charter would allow eligible nonbank FinTech companies to abide by a uniform set of national banking rules, including preemption of state laws. This has the benefit of providing a single regulator, single licensing process, and single rule book compared to a patchwork of 50 state regimes that has proved to be a costly barrier to entry. The federal charter is no “deregulation” of FinTech companies. Instead, the tradeoff for companies seeking a federal charter is that they will also be subject to many of the same standards as similarly situated national banks, including capital, liquidity, consumer protection, and financial inclusion require­ments. These are burdensome for any institution. As of late February, no firms had applied for the charter, likely because it still includes heavy regulatory requirements.

In sum, the Trump administration’s reform of certain consumer protection regulations will not lead to a financial crisis. Instead of worrying about reforms at regulatory agencies such as the CFPB, those worried about financial stability should look to the federal government’s meddling in the mortgage markets, which is arguably contributing to another unsustainable house price boom.