Every Halloween, there exists the temptation for commentators to describe routine events in the news with adjectives like “scary” and “frightening.” Sensitive to sounding clichéd or inflammatory, I try usually to avoid using such terminology in my descriptions of the policy process.
Yet around Halloween 2018, after reading through new documents introduced into a lawsuit stemming from the Obama administration’s “Operation Choke Point,” I found that “scary” and “frightening” actually fit. These documents show that powerful bank regulatory agencies engaged in an effort of intimidation and threats to put legal industries they dislike out of business by denying them access to the banking system.
While I am often outraged about things the government does, this October I became truly scared and frightened about the ability of government bureaucrats to shut down arbitrarily whole classes of businesses they deem to be “politically incorrect.” As one who champions the fintech sector and the benefits it can bring, I also worry that such powers may be uses to shut down innovative new industries, such as cryptocurrency, that carry some perceived or real risks.
Choke Point was a multi-agency operation in which several entities engaged in a campaign of threats and intimidation to get the banks that they regulate cut off financial services—from providing credit to maintaining deposit accounts—to certain industries that regulators deemed harmful to a bank’s “reputation management.” The newly released documents—introduced in two court filings in a lawsuit against Choke Point—show that the genesis of Choke Point actually predated Barack Obama’s presidency, and began when President George W. Bush was in power.
It was then, in 2008, that the Federal Deposit Insurance Corporation (FDIC) greatly expanded the definition of “reputation risk.” Before this time, the term referred to a bank’s own practices that resulted in negative publicity serious enough to harm the bank’s financial strength. That, of course, included a bank having a relationship with a customer or third party who the bank knew was performing an illegal activity.
But in June 2008, an FDIC “guidance document” on third parties performing functions on banks’ behalf began to stretch the term. According to this document, “any negative publicity involving the third party, whether or not the publicity is related to the institution’s use of the third party, could result in reputation risk.”
When the Obama administration came into power, the FDIC would expand the definition of “reputation risk” even further, and other federal agencies, bureaus, and departments would soon jump on the proverbial bandwagon. Much of Operation Choke point would again be accomplished by “guidance documents,” which my Competitive Enterprise Institute colleague Wayne Crews refers to as “regulatory dark matter,” since they have legal force but allow regulators to bypass the sunlight of the notice-and-comment process of a formal rule.
In 2011, an FDIC guidance document featured a chart of business categories engaged in what it called “high-risk activity.” These included “dating services,” “escort services,” “drug paraphernalia,” “Ponzi schemes,” “racist materials,” “coin dealers,” “firearm sales,” and “payday loans.” The FDIC would post this and similar lists in other guidance documents and on its website.
A staff report of the House Government Reform and Oversight Committee puzzled over many of these categories. “FDIC provided no explanation or warrant for the designation of particular merchants as ‘high-risk,’” the report observed. “Furthermore, there is no explanation for the implicit equation of legitimate activities such as coin dealers and firearm sales with such patently illegal or offensive activities as Ponzi schemes, racist materials, and drug paraphernalia.”
Intentionally or not, it was the legal businesses that appeared to bear the brunt of being labeled “high-risk” by bank regulators. In 2014, the Washington Times reported that a number of gun shops had their bank accounts abruptly frozen or terminated. One shop owner received a note from his bank stating that “while this letter in no way reflects any derogatory reasons for such action on your behalf, [your] line of business is not commensurate with the industries we work with.”
But those hit hardest by Choke Point were providers of small-dollar loans, also known as “payday loans,” which have higher interest rates than conventional loans. Politicians and other critics have long railed against payday loans, arguing that they exploit the poor. But as my CEI colleague Daniel Press has argued that “for financially strapped consumers, small-dollar loans are often a better option than the available alternatives, such as overdrawing a bank account or defaulting on a different loan.”
Regardless of the merits of a product, until Congress acts, agencies of the federal government have no authority to shut down payday lenders, gun shops, dating services, or any industry by means such as cutting off their access to the banking system. Yet the new documents included in the court filings paint a picture of regulatory agencies seemingly unconcerned with any limits on their authority.
In 2013, according to the court filings, the Department of Justice shared with the FDIC the names of fifteen banks believed to have relationships with payday lenders. With this new backing from the nation’s top law enforcement officials, the FDIC began acting more aggressively and started requesting even more forcefully that banks terminate their relationships with payday lending firms. In an email cited in the court filings, an FDIC official says to colleagues, “I think we got our message across” after a bank terminated its relationships with payday lenders soon after a visit from the FDIC.
Banks across the nation got the message and rapidly stopped holding bank accounts and performing other services for payday and small-dollar lenders. Advance America, the payday lending and cash advance firm that is the main plaintiff in the lawsuit, received termination notices from twenty-one banks. Its banking-related expenses have soared 37 percent. In some cases, it had to hire an armored courier service to store and transport its money. The costs of regulation almost always get passed on to consumers, which in this case are low-income borrowers.
In August 2017, following diligent investigatory work by the House Financial Services Subcommittee on Financial Institutions and Consumer Credit, chaired by Rep. Blain Luetkemeyer (R-MO), the Trump Justice Department announced that Operation Choke Point “is no longer in effect and will not be undertaken again.” But to really ensure something like Choke Point isn’t taken up by future administrations or rogue regulators, the U.S. Senate must follow the House and pass the bipartisan H.R. 2706, the Financial Institution Customer Protection Act. This bill, which passed the House overwhelmingly in late 2017 by 395-2, states that a financial regulatory agency “may not formally or informally request or order” a bank to terminate a relationship with a customer unless “the agency has a valid reason for such request or order, and such reason is not based solely on reputation risk.”
Some unfortunately may see it as a “treat” when the government uses extralegal means to punish industries they disfavor. But the “trick” may be on them when that precedent is turned around and used to go after their allies. As George Mason University law professor Todd Zywicki noted in the Washington Post, “Notably absent from the FDIC’s hit list, for example, are abortion clinics [and] radical environmental groups.” To end a potential arms race of using bank regulators to go after industries disfavored by one political side, Zywicki called for curtailing “the expansive use of the vague and subjective standard of reputation risk.’”
So let’s resolve in 2019—if not this month during the Congressional lame duck session—to permanently drive a stake through the scary Operation Choke Point so that financial regulatory agencies never again carry out ideological vendettas through the banking system.