The Pentagon as Financial Regulator

When the Pentagon is sticking its nose in an area this far from its native (and very large) sphere of influence, you know something is up. From Reuters:

The Pentagon is writing a rule to keep the minds of U.S. troops on their missions by shielding them from debt, but the prospect of the Defense Department as a regulator frightens the financial industry.

“You’ve got soldiers writing financial regs and they don’t know what they’re doing,” said one bank lobbyist, speaking on condition of anonymity.

The rule will limit how much lenders can charge military personnel, and it could affect banks, credit unions, mortgage providers and payday lenders, among others.

The Pentagon is especially concerned about payday loans, which are typically two-week extensions of credit to cover quick cash needs between paychecks. They can have interest rates of 300 percent a year or more, pushing troops so deep into debt that they cannot focus on fighting.

Defense officials and some lawmakers argue that young, financially unsophisticated service members are particularly vulnerable to shady financial practices and deep debt, especially when lenders offering high rates and quick cash set up shop outside the gates of military bases.

The push against payday loans is part of a bigger effort to clamp down on financial practices the Pentagon sees as predatory. It follows efforts to boost standards for insurance sales after reports found the insurance industry had spent years offering unsuitable and expensive products to soldiers.

The limit on loan rates would be set at 36 percent — a number meant to drive the payday loan industry out of military lending.

But many in the financial industry say the provision was worded so poorly that it threatens other lending products, such as the cash advances on credit cards and overdraft protection on checking accounts.

It also may make the industry subject to penalties that include prison. That risk could stop many lenders from doing business with military personnel and their families.

“The effect of these sanctions is impossible to overstate,” banks will tell the Pentagon in a letter obtained by Reuters.


The broad wording would not worry the financial sector if Congress had told the industry’s usual regulators — the U.S. Federal Reserve in particular — to implement the law, lobbyists in Washington said.

Instead, the job went exclusively to the Department of Defense.

“DoD are experts in the defense of our nation and we obviously share their concerns for the well-being of our troops,” said Lyndsey Medsker, spokeswoman for a payday group, the Consumer Financial Services Association of America.

“But the oversight of financial services and credit products should probably be left to those who are experts in financial services.”

It’s appalling that anyone can attempt to defend loans at an annual interest rate of 300% (since when aren’t soldiers creditworthy? Their paychecks come from the US government, so they are a full faith and credit obligation of the US Treasury, and soldiers can’t even quit if they want to. They have to get a discharge. I’d say that’s about as good as it gets). But this isn’t really about the DOD’s alleged incompetence as a financial regulator (let’s face it, it isn’t hard to craft an interest rate ceiling, but any broadly worded provision will likely incorporate fees, which can drive de facto interest rates into the stratopshere). It’s that the Pentagon’s strike against overweening creditors, if permitted to stand, may lead Congress to take interest in the question of the fairness of lending practices, and perhaps even to overturn the federal exemption of national banks (ones chartered by the Fed), federally chartered savings and loans, installment sale sellers, and chartered loan companies from state usury laws.

A bit of background: federal usury laws were in place until the Great Depression, and states had usury laws of their own. In 1978, the Supreme Court ruled in Marquette versus First Omaha Services Corp. that a national bank could charge the highest interest rate permitted in its home state to customers living anywhere in the United States, irrespective of any state interest rate caps.

In 1980, short term funding rates were over 20% and Citibank was losing boatloads on its credit card portfolio. Unable to obtain legislative relief from a New York interest rate ceiling of 12%, Citibank went jurisdiction-shopping (this wasn’t as easy as it might sound, since in those days, federal banking regulations stipulated that before a national bank could set up operations outside its home state, it needed to be issued an invitation from the legislature of the state they wanted to enter).

Citi forged a deal with South Dakota that kept the local banking interests at bay and actually wrote the emergency legislation that permitted them to set up shop in 1981. Other states swiftly followed suit with credit-card-friendly laws.

Credit cards have gone from a loss leader to one of the most profitable, if not the most profitable, banking product. And it is due entirely to a change in the regulatory climate (another Supreme Court decision, in 1996, lifted limits on late fees, which in 2003 contributed $12 billion in revenues).

And let us not forget the new bankruptcy law, enacted in 2004, which severely limits consumer access to Chapter 7 bankruptcies (the kind that let you erase your debts) and imposed tough standards for payback plans under Chapter 13 (the version most consumers now must use). A relative who is a bankruptcy lawyer himself, and one would think would favor such a bill, has called it draconian, unfair, and a clear sop to the credit card industry.

So you can see the banks have every reason to fear a powerful organization like the Pentagon standing up against the God-given (well, Supreme Court given) right of financial services companies to engage in predatory pricing. Who knows where such a radical line of thinking might take us? But no one should be surprised that a lack of restraint could lead to a pushback, albeit from a very unexpected source.

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