By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in India and other parts of Asia researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as writes occasional travel pieces for The National.
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Whenever I read the words “financial innovation”, I tend to break out in hives. So imagine my distress when yesterday, the Consumer Financial Protection Bureau– which is supposed to be one of the good guys in the financial regulation story– yesterday issued its Project Catalyst report: Promoting consumer-friendly innovation. (I have embedded the full report below). I quote from CFPB director Richard Cordray’s message introducing the report:
The Bureau’s Project Catalyst initiative, which we launched in 2012, is another example of our commitment to innovation. This office was a novelty at the time for a financial regulator, being solely dedicated to promoting consumer-friendly innovation in the marketplace. From the start, we viewed an emphasis on consumer-friendly innovation as a key component of the Bureau’s mission of making financial markets work for consumers. Project Catalyst works toward this goal through outreach to and collaboration with a variety of institutions, including financial companies (both large and small and both banks and non-banks), startups, and non-profits. We believe that innovative developments hold great promise for making markets work better both for consumers and for providers of financial services.
Through Project Catalyst, we engage with innovators in a number of ways. Project Catalyst’s Office Hours program brings us face-to-face with innovators to exchange information about how they are developing new products and services. Project Catalyst also has established policies and programs to collaborate with innovators to help advance consumer-friendly innovation…. (Project Catalyst report p. 2)
Okay, perhaps I exaggerate a bit. Maybe I don’t actually break out in hives but my fingers certainly start to itch and the only sure cure is to sit down and draft a Naked Capitalism post explaining the grift du jour. Because innovation in this context is almost always a synonym for looting, or for otherwise engaging in financial legerdemain. After all, the whole mortgage backed securities racket was a textbook example of financial innovation– and look where that got us. Or, as Lambert has written here:
Readers will recall that I have often flagged “innovative,” along with “disruptive,” “startup,” “founder”, and (in the business context) “ecosystem” as bullshit tells, and recommended that if you hear such con artist’s patter in a crowd, you should put your hand on your wallet or clutch your purse more tightly.
Financial innovation usually provides an excuse to skim off rich fees, which are particularly problematic in the consumer financial products sphere, where the consumers targeted for some of the sparkliest innovations are precisely those who can’t afford to pay such fees: the un- and under-banked.
At this point, it’s worth reviewing just how many US households lack access to basic financial services. Quite conveniently, the Federal Deposit Insurance Corporation (FDIC), last week issued the annual FDIC National Survey of Unbanked and Underbanked Households, which summarises the latest numbers on these phenomena (as of 2015). Take a look at this report, or, if you’re short of time, at least the executive summary.
More than a quarter of US households are either unbanked and underbanked, according to FDIC definitions, and are therefore forced to rely on alternative financial services (AFS) to address basic banking, financial, and credit needs.
In 2015, 7.0 percent of U.S. households were “unbanked,” meaning that no one in the household had a checking or savings account. At 7 percent, the unbanked rate was lower in 2015 than in any of the past years of the survey, but only fell by 0.6 percentage points from the first year the FDIC survey was conducted, 2009 (from 7.6 percent). In number terms, this translates to approximately 9.0 million U.S. households and includes 15.6 million adults and 7.6 million children (FDIC executive summary p. 1).
An additional 19.9 percent of U.S. households in 2015 were “underbanked”, which the FDIC defines as a household in which someone had a checking or savings account at an insured institution but also obtained in the past year financial services or products outside of the banking system from an AFS provider. AFS products include auto title loans, check cashing, international remittances, money orders, pawn shop loans, payday loans, refund anticipation loans, or rent-to-own services. The 2015 US underbanked rate was 20 percent, unchanged from 2013. In number terms, this translates into approximately 24.5 million U.S. households and includes 51.1 million adults and 16.3 million children (FDIC executive summary p. 1).
The FDIC survey revealed that unbanked and underbanked rates were higher among black and Hispanic households, less-educated households,lower-income households, working-age disabled households, and younger households (FDIC executive summary p. 2).
What reasons do unbanked survey respondents give for not having bank accounts? The most common was “Do not have enough money to keep in an account,” with 57.4 percent of unbanked households identifying this as one reason, while 37.8 percent cited this as the main reason. Other cited reasons were: “Avoiding a bank gives more privacy” (28.5 percent), “Don’t trust banks”(28 percent), “Bank account fees are too high”(27.7 percent), and “Bank account fees are unpredictable”(24.0) (FDIC executive summary p. 3).
Obvious Solution Ignored
The obvious solution to the unbanked and underbanked problem would be for the federal government to set up a Post Office Bank. Many countries have post office banks, which offer various types of basic financial products at reasonable rates. I’ve little to add here to Lambert’s excellent summary of the rationale for a Post Office Bank and to what Yves has also written about the report the Inspector General of the Postal Service wrote boosting the concept.
Another helpful change would be to reinstate usury laws– so that the sky would no longer be the limit for the fees that purveyors of both AFS and ordinary financial services (e.g., credit cards) could charge consumers for their products. Since the unbanked themselves identify high and unpredictable fees as reasons for not opening bank accounts and consuming traditional banking services, perhaps by offering basic products, at lower cost, they could be drawn into the system. Just a thought– albeit another rather obvious one.
Why: Because Markets
But in the US, neither solution is on the potential policy table. Why? The answer: Because markets. As regular Naked Capitalism readers well know, the standard neoliberal solution follows that template. So not altogether surprisingly, this area– access to basic financial products at a reasonable price– is yet another where the Obamamometer and his minions have underperformed, needlessly complicating the issue by chasing private market solutions and thereby not making much of a dent in the problem.
CFPB Chugs Innovation Kool-Aid
In this Project Catalyst report, the CFPB has not just swallowed but chugged the innovation Kool-Aid. Although the agency has both authority and potential to reshape the consumer financial product universe, so far, its actual performance has underwhelmed. The jury’s very much still out as to the effectiveness of both its rule-making and enforcement initiatives. I’ll mention just a couple of signature examples on the rule-making side. We continue to await the long-promised payday lending rules– and these of course, apply almost exclusively to the un- and under-banked. And for what now seems an eternity, the agency has been dancing around the issue of restricting mandatory arbitration clauses— under which consumers “voluntarily” and in advance waive access to going to court in disputes over credit cards and common financial products in favour of arbitration processes heavily stacked against consumer interests. Expect to see final regulations issued sometime later this year or early next in both areas, and the shape of these two sets of rules will tell us how seriously the CFPB regards its consumer protection responsibilities.
The other place to assess the CFPB’s effectiveness is on the enforcement side, where its performance has been underwhelming– most recently in its settlement with Wells Fargo over its egregious cross-selling practices. In her first of several posts on the issue, Yves called out the CFPB as a “toothless tiger” for agreeing to a $100 million settlement with the bank:
This “record breaking fine” is a rounding error compared to Well’s Fargo’s second quarter profits of $5.6 billion. Not surprisingly, investors shrugged off the fines. The bank’s stock traded up by 13 cents on Thursday, closing at $49.90. In other words, to the extent bank execs do “think again” before permitting fraud to take place on their watch, the lack of any impact on sacrosanct share prices and on the officials personally says they should see if they can get away with it, since the downside is inconsequential.
This is only intended to be a short post, and I’d like to zero in on only two problematic aspects of the Project Catalyst report, each concerning consumer credit.
The CFPB is concerned to expand access to credit to consumers not included in the current system:
The Bureau estimates that 26 million Americans are “credit invisible,” meaning they have no credit history, and another 19 million have credit history that is either insufficient or too stale to generate a credit score. This problem disproportionately impacts Black consumers, Hispanic consumers, and those living in low-income neighbourhoods. Without a sufficient credit file, consumers face barriers to accessing credit, or are forced to pay higher costs for credit, which may prevent them from attaining meaningful opportunities.
Project Catalyst has met with a number of innovators seeking to expand access to credit or offer credit at lower interest rates to borrowers who may be excluded or mispriced by existing credit models. They see opportunities to expand access by incorporating non-traditional data sources and employing machine learning techniques in their underwriting methods. Other innovators report uncertainty about how to do this in a way that complies with the requirements of consumer protection laws. Project Catalyst recognizes that the use of non-traditional data and underwriting techniques may pose risks for consumers but remains interested in developments that would support expanded access to responsible credit while mitigating these risks (Project Catalyst report p. 22).
There are two problems here. First, is that the CFPB appears only willing to consider tinkering with the existing highly-defective and inaccurate credit reporting system. It wants more people to have credit reports, rather than recognizing the entire system is defective and that too much reliance is placed on it (not only for getting credit, but also for other purposes such as hiring decisions).
And a second problem is that overall, we need less household borrowing, period. Household borrowing is economically unproductive. The CFPB should be focusing on ways to reduce consumer indebtedness, rather than drawing more consumers into what will no doubt be “innovative” (aka high-interest, high-fee) debt traps.
Credit Reporting Accuracy and Transparency
The CFPB further tiptoes around the deficiencies in the current credit reporting system:
Consumers are often unaware of or confused about negative information in their credit files, such as items in collection. Project Catalyst has learned that a number of FinTech firms are developing tools and new approaches to improve consumer access and understanding of their credit score and history. For example, one approach being taken is to streamline the process for consumers to dispute errors on their credit reports directly. Increasingly, companies from large credit card companies to FinTech startups are also offering consumers more information about their credit scores and credit reports on a regular basis. Along with access to free scores, some companies also offer resources such as tools that model hypothetical scenarios and actions consumers might take to improve their credit standing. These insights may help consumers understand the impact of their behavior on their credit scores and prompt beneficial changes in their financial behaviour (Project Catalyst report p. 24).
Why is the CFPB leaving such important tasks to FinTech firms to address, especially “to streamline the process for consumers to dispute errors on their credit reports directly”? If the agency is concerned about accuracy in credit reports, why doesn’t it undertake to overhaul the credit reporting system, making it easy for consumers to challenge errors, requiring these to be corrected within a short, strictly defined time after the credit reporting service is informed of the error, ]and imposing large sanctions on firms that fail to correct mistakes?
The bottom line here: Why is Cordray cozying up to financial industry and start-ups, relying on them to correct real problems and deficiencies? As we all know, they’ve performed admirably in performing such functions in the past (irony alert). We don’t need another “business-friendly” regulator. Real regulators regulate. They don’t powwow and jolly about with the regulated.
I understand the CFPB faces hostility from the industry and from a significant number of members of Congress, and that anything it does will likely be challenged in courts. Some of these opponents are inherently hostile to the agency’s structure or mission (as I’ve recently written here).
Message to Richard Cordray: members of the financial industry aren’t your friends. No matter what you do, how many forums and seminars you conduct, and how reasoned and thorough your assessments are, this basic dynamic won’t change. You’re still going to get hauled into court. So please, accept that outcome as an inevitable. Start behaving like a regulator, and regulate, rather than relying on the innovation fairy to produce consumer-friendly financial products.