Skepticism Runs High Toward Federal Consumer Watchdog Plan

Published December 1, 2009

Citing the downfalls of Fannie Mae and Freddie Mac, pundits and banking lobbyists warn separating consumer protection from safety and soundness through a Consumer Financial Protection Agency could be a calamity waiting to happen.

Before the subprime mortgage meltdown, the Office of Federal Housing Enterprise Oversight (OFHEO) regulated Fannie and Freddie regarding the prudence of their policies, and the Department of Housing and Urban Development (HUD) oversaw consumer protection issues.

One theory holds that this split led HUD to force Fannie and Freddie, which were government-sponsored entities with an implied federal backstop, to buy too many pools of excessively risky loans. Adherents of this theory say this trumped OFHEO’s safety-and-soundness instincts, and they worry the past could become prologue if the Consumer Financial Protection Agency (CFPA) is enacted as proposed.

Experts disagree over whether the warning is valid, but they generally agree the analogy is not precise.

Neither Regulator Nor Watchdog

For one thing, Brookings Institution Senior Economics Studies Fellow Robert Litan said, HUD was not fully a consumer regulator—mission regulation is the term generally applied to its former role—and OFHEO was not a true safety-and-soundness watchdog in the mold of federal banking regulators.

Litan says Congress heavily constrained OFHEO’s safety-and-soundness power by refusing to let it impose bank-equivalent capital standards on the government-sponsored entities (GSEs). Banking agencies are best when they focus on safety and soundness, he said, and they are unlikely to have the expertise and interest to give consumer protection the attention it deserves.

Like Litan, Bill Shear, director of Financial Markets and Community Investment at the Government Accountability Office, says the GSEs were put at risk because OFHEO did not have the full range of bank regulatory tools for prudential supervision. But overall, Shear has a slightly different take than Litan.

“A single regulator should consider mission and safety and soundness,” Shear said. “A balance should be created.”

GAO Recommendations Ignored

Shear said the GAO recommended a single regulator for housing GSEs for well over a decade before it finally happened last year with the establishment of the Federal Housing Finance Agency (FHFA) shortly before the government took over the two lenders.

Shear noted the GAO analyzed how best to oversee both the safety and soundness and the missions of the housing GSEs, but he emphasized the GAO has not applied this analysis to the regulation of other financial institutions.

‘An Obvious Problem’

American Enterprise Institute Resident Fellow Alex Pollock, a former president and chief executive officer of the Federal Home Loan Bank of Chicago, said in principle it appears the proposed CFPA could be dangerous to banks.

“With one group of people [in the organization] promoting risky credits and investments and a completely different group of people responsible for safety and soundness,” Pollock said, “you would have an obvious problem.”

Jim Lockhart, outgoing director of the FHFA, who served for the prior two years in the same post at OFHEO, said the key linchpin that broke in the GSEs’ collapse is they were allowed to leverage themselves 100 to one. Applying the analogy to the CFPA does not work because Fannie and Freddie were not dealing directly with consumers, he said.

The lesson is that fragmented regulation does not work, Lockhart said, adding, “You need to strengthen the coordination of regulators in key products such as mortgages.”

Lockhart said coordination is essential for improving consumer protection, but this mission should not be divorced from safety and soundness. His suggested solution would be to create a college of regulators, similar to a model being discussed to oversee systemic risk, with staff that can develop rules that would be enforced by the member agencies.

Ted Knutson ([email protected]) is Complinet’s Washington, DC correspondent. Reprinted with permission from Complinet, Inc.,, provider of compliance solutions for the global financial services industry.