February 5-7, 2013 | St. Louis Mo.
February 7, 2013
Breakfast Keynote Address
Introduction: James Bullard (3:30)
Keynote: Governor Jeremy Stein (46:29)
Keynote Q&A (11:22)
Session Four – Household Balance Sheets: Deleveraging and Economic Growth
- What's Driving Deleveraging? Evidence from the 2007-2009 Survey of Consumer Finances
Karen Dynan and Wendy Edelberg (22:08)
Session Four, Part 1 Discussant: John Krainer (20:16)
Session Four, Part 1 Q&A (14:47)
- Household Balance Sheets, Consumption, and the Economic Slump
Atif R. Mian, Kamalesh Rao and Amir Sufi (21:57)
Session Four, Part 2 Discussant: Brian Melzer (18:51)
Session Four, Part 2 Q&A (15:44)
Session Four Moderator: Daniel Davis (2:14)
Closing Plenary – Facilitated Panel Discussion: Household Balance Sheets and Economic Growth
Panelist: David Buchholz (10:24)
Panelist: Steven Fazzari (11:41)
Panelist: Deniz Igan (12:13)
Discussant: Barry Cynamon (20:03)
Panel Discussion Q&A (27:29)
Ray Boshara (2:09)
Michael Barr: Thank you, Ray. Usually I go to conferences where the introductions are not quite so sweet and nice. So I’m thankful for that. The last time I talked on this topic I was speaking to the National Lawyers’ Convention of the Federalist Society and I had a different introduction. I said, “Thank you.”
Ray asked me to challenge you and take you a little bit outside your comfort zone and I’m going to try and do that. I’m going to give formal, prepared remarks, and I also have a handful of slides to distract you with on your screen so that you have something to look at other than your Blackberry during my talk. If you’ve kept your Blackberry.
The topic of my talk is The Financial Crisis and Household Balance Sheets, but I’m going to roam a little bit broader than that.
When you think back four years ago President Obama was coming into office. Our financial markets as a whole were frozen. Our economy was shrinking dramatically. We were facing the worst economic crisis since the crisis that confronted Franklin Roosevelt when he came into office facing the Great Depression. And at the end of 2008 and the beginning of 2009 the economy was losing more than 800,000 jobs a month. And small businesses, businesses really of all sizes were closing their doors. Home prices were in a dramatic freefall. Families, as we’ve learned and heard about more this morning, were over-leveraged and over-concentrated in their leverage in the housing sector. And the financial crisis really crushed household balance sheets.
The President stepped in and in my view did a terrific job, a hard job, saving the economy, and beginning to restart growth. As we all know, the economy has to some extent been stabilized, but in many ways is still not growing fast enough. Businesses are hiring again, but the economy as a whole is not growing rapidly enough. And millions of Americans are still out of work. We face considerable economic challenges and risks, both domestically and globally still today.
When I was back in government in 2009 and 2010, we were trying to grapple with those financial circumstances, those deep difficulties for our economy. We were trying to focus on repairing those issues, but we were also focused on the urgent obligation to try and make the financial system failures that had triggered this economic crisis, this financial system that had cost American families and small businesses so dearly, we were trying to focus on repair and reform of that financial system as well.
The failures that led to the 2008 crisis had a number of causes. Regulators did not protect consumers or investors. Households and firms took on risks that they did not fully understand. Legal loopholes and regulatory gaps allowed large parts of the financial system to operate without sufficient oversight, without sufficient transparency and without sufficient restraint. Capital in the system, the buffer in the system to protect the system from collapse had become increasingly inadequate over time to deal with these growing risks in the system.
And in my view, although it is far from perfect, the passage of the Dodd-Frank Act does provide a strong foundation on which we can now build a more resilient system, a system that does a better job protecting consumers and investors that rewards innovation and that is better able to evolve with changes in financial markets.
The Act provides for supervision of major firms based on what they do rather than their corporate form. Shadow banking is brought into the regulatory daylight. The largest financial firms will be required to build up capital buffers and stronger liquidity buffers to constrain their relative size and to reduce their riskiest financial activities.
The Act comprehensively regulates derivatives for the first time, with new rules for exchange trading, central clearing, transparency, capital and margin. The Act provides for data collection and transparency so that in no corner of the financial system can markets go completely unnoticed in building up risk.
The Act requires and creates an essential mechanism for the government to wind down a failing financial firm without putting taxpayers at risk. And as you know, the Act creates a new Consumer Financial Protection Bureau to look out for the interests of American households.
Meanwhile, for the one in seven Americans who live in poverty, or the millions of Americans who fear falling out of the middle class, these times have, as we’ve heard this morning, been particularly devastating. As I explore in my new book, No Slack: The Financial Lives of Low-Income Americans, these families were the least prepared to handle the shock of the deep recession. They had little or no savings to fall back on and stood one medical emergency or one major unexpected car malfunction away from a personal economic crisis. They had no financial slack.
When the crisis hit in 2008 these families found themselves over-leveraged and under-resourced. The Federal Reserve’s Survey of Consumer Finance confirms that American households’ net worth was hammered by the financial crisis. And recent research by Karen Dynan and her coauthors shows that household income volatility has gone way up in recent decades. Federal government policies have helped to cushion the impact, but these households still faced huge set-backs in both their labor income and in their transfer payments.
What these families now seek and what they now need is some measure of financial stability. Going forward American families will undoubtedly need to try and save a larger portion of their income and to borrow more responsibly. They will need to build up emergency savings to weather disruptions in income, and in emergencies or simply variable expenditure needs.
Today many American families are rediscovering the importance of living within their means. They are saving more and reducing debt. And they are growing more careful about how they borrow and how they invest. These changes are necessary and they’re healthy. Ultimately, they will help to build economic security for American families and make our economy stronger and more resilient.
But in my view, households should not be left on their own to navigate a financial system that has become increasingly detached from their everyday needs. They should not be left on their own to get through this system.
One of the critical ways that we can help promote economic security is by making consumer financial markets work better for American families. Low- and moderate-income individuals often lack access to the basic financial services that could help them cope better with these kinds of emergencies with the lack of financial slack in their lives. Facing serious economic and structural constraints, these households turn to a variety of formal and informal means to access their financial services needs, to receive their income, to pay bills, to borrow and to save. But the way our financial system is structured often makes transacting, saving and borrowing more expensive in both monetary and non-monetary terms, and less useful for families who need it the most.
To improve the financial lives of low- and moderate-income households we need to rely on a kind of three-legged stool; financial education, access to financial products, and consumer financial protections. And in each area it’s my view, we could make significant strides by using insights from behavioral economics.
Now policymakers typically approach human behavior through the perspective of the rational agent model, which contrary to its positivist claims relies on normative apriority analysis. The model assumes that people make insightful, well-planned, highly controlled and perfectly calculating decisions guided by considerations of personal utility. This perspective is promoted in the social sciences and in professional schools and has come to dominate much of the formulation and conduct of policy.
An alternative view, developed mostly through empirical behavioral research provides a substantially different perspective on individual behavior and its policy implications. And according to this empirical perspective, behavior is more an amalgam of human perceptions, impulses, judgments and decision processes. The availability and dissemination of data do not always lead to effective communication and knowledge. Understanding does not always lead to intention. Intention does not necessarily lead to the desired action. And individuals often misperceive the relevant choices, exhibit temporal biases or mis-forecast their own behavior.
Too many choices in this context can lead not to better outcomes but to decisional conflict and error. Attention constraints, local focus, and information overload can all swamp supposedly strong apriority preferences. And purportedly inconsequential contextual nuances, whether intentional or not, can alter choices and shape behavior, often in ways that people themselves agree diminish their well-being in unintended ways.
At the same time, a behavioral policy perspective that focuses only on the individual is incomplete. Policy also needs to account for market context and the incentives and behaviors of firms. In some contexts firms have strong incentives to exploit and in other contexts to overcome these consumer biases. Moreover, firms will shape their conduct not only in response to the behavior of individuals, but also to the action of regulators.
The evidence on this consumer fallibility and in how firms behave in light of this fallibility suggests a framework for which types of mechanisms will work best in particular markets. And it is helpful to divide consumer financial markets into two categories: those in which firms are neutral toward or have incentives for overcoming consumer fallibility and those frameworks in which firms have incentives to exacerbate consumer biases. For example, let’s take the case of consumers misunderstanding the importance of compounding of interest. Providers of bank accounts have incentives to help individuals overcome this behavioral barrier to saving. Lenders on the other hand may have incentives to exploit this biases that leads consumers to over-borrow.
Particular market context may exacerbate the incentives for financial firms to exploit these consumer biases. Once one introduces a behavioral agent into models of industrial organization, one can see that providers sometimes have incentives, for example, to shroud fees that are less salient to consumers, or to use contingent payments to exploit consumers’ errors for predicting their own future product usage, such as late fees, over limit fees, or overdraft fees. Or to use the presence of high switching costs to lock in consumers, to sub-optimal or higher cost products, or perhaps to bundle purchases and loans to reduce debt discipline and lead to over-borrowing.
In other contexts brokers with conflicted interests can take advantage of consumers’ misplaced trust. And disclosures can make the problem worse as consumers let down their guard and brokers ease up on themselves. The implications for policy making in these two types of cases are different. Where firms are neutral to or have incentives to overcome consumer biases, changing the starting point or default may be highly effective on its own. The success, for example, in promoting retirement savings through the use of defaults is a well-known example. In this case employers were at worst indifferent to, and at best inclined to, increase employee participation in defining contribution plans. Where firms have incentives to exacerbate biases, changing the rules may not be enough. In these cases, firms will have incentives to work around the rules and render them less effective.
For example, firms may comply with a Letter of Disclosure Law but act to undermine them by discouraging consumers from focusing on and understanding the content. In such cases it may be necessary to change the way the game is scored to make a real difference for consumers.
This behavioral framework has profound implications as we think about how best to promote financial access. Defaults in the defined contribution plan would serve as a prominent example of how behaviorally-informed innovation can have a significant impact on the lives of everyday Americans. But there is a need for a lot more innovation that is informed by the interplay of consumer psychology and firm incentives in market-specific context.
To come back to the larger point, I think we can help families seeking financial stability in primarily three ways. Through enhancing individuals’ core competencies in financial education and financial capability; in promoting access to innovative financial products and services that meet consumer needs; and in establishing and enforcing strong protections for consumers. Basic financial literacy is the necessary foundation for informed consumer decision-making. But it is not enough. To be effective, financial literacy must be combined with improved access to suitable financial products and strong consumer protections. Efforts in all three areas, as I have mentioned, must be driven by evidence on how consumers and firms behave in the real world.
Let me first turn to the topic of financial education. Financial education needs to be more firmly rooted in the ways in which individuals actually make financial decisions in particular contexts, in particular markets. And I think there are three promising approaches in this regard. First, financial education providers can set core financial competencies and rigorously evaluate different approaches to conveying these competencies. We still know much less than we should about whether, when and how financial education might actually matter for financial outcomes.
Second, rather than attempting to teach these competencies divorced from institutional context, financial education providers, financial institutions in the public sector can seek ways to improve consumer understanding in the context of particular financial choices the individual is faced with at particular moments in time. The choice to save for retirement at the moment of hiring perhaps, or the decision to save at the time of filing for a tax refund.
Third, policymakers and financial providers need to view disclosures as a useful moment to increase financial understanding rather than a moment to increase the amount of financial information provided, which I’ll say more about a little bit later. But just as one example, in the Credit Card Accountability Responsibility and Disclosure Act, or the CCARD Act, credit card monthly disclosures must now inform consumers of the financial consequences of the decision only to make a minimum payment, and indicate the amounts needed to pay off the balance in a shorter time.
Second, let me turn to access issues. One area where more innovation is sorely needed is in an expanding access to financial services that meet the needs of low- and moderate-income Americans. A particular need is for a low-cost way of receiving income, paying bills and putting aside a bit each pay period for emergency savings. One challenge and opportunity in expanding financial access for low and moderate income Americans is harnessing low cost electronic payment mechanisms such as debit cards. Evidence suggests a strong interest among low- and moderate-income households in a payment card. While cost is an important determinant in preference among survey respondents in my study, for example, so too were non-pecuniary factors. For example, households were especially concerned with whether the card had strong consumer protections and whether it had national branding.
As to the government’s role, there may be ways that the government could help accelerate changes in the payment system that help benefit low- and moderate-income households in the market as a whole. Default arrangements, changing the rules, may help in this context, because the providers of savings and transaction accounts have incentives to alleviate consumer biases. For example, with respect to procrastination bias, in order to gather their deposits. However, defaults on their own may be less effective in banking than they are in the retirement context, and the reason is that the cost to serve individuals with small balances can discourage firms from serving low- and moderate-income populations. And in this context a combination approach might be needed. It may be necessary to change the scoring as well as the rules. For example, by designing creative solutions that help firms serve these populations with sustainable product economics.
One example in this area is from the Treasury Department’s work. The Treasury Department has taken an innovative approach to direct federal benefit payment recipients that relate to these insights. The Department is responsible for making ongoing payments to 70 million individuals for Social Security, Supplemental Security Income and Veterans Railroad Retirement and OPM Benefit Payments. Fifteen percent of these individuals receive their benefits by paper check. Individuals who have access to accounts can use direct deposit, but individuals who are unbanked or prefer not to use direct deposit receive their payments on a Direct Express card. Direct Express is a debit card account offered by a bank according to requirements established by the Treasury Department. More than 1-1/2 million federal benefit recipients have opted into receiving benefits on Direct Express, which was launched at the end of 2008. Consumers report 95 percent satisfaction with the card’s features. And Direct Express is an example of how government can help making serving low- and moderate-income consumers more sustainable for providers.
In this case the government is changing the rules of the game, or changing the scoring of the game by bundling many customers’ accounts together, allowing for a more favorable scale of operations for the provider. States have key programs too. For example, many states make their benefit payments through Electronic Benefit Transfer cards that could be used in much more productive ways, much more efficient ways, ways that are better from a consumer protection standpoint for low- and moderate-income consumers.
Treasury has also established rules that better protect federal benefit payments from bank account garnishment and has enhanced requirements on the type of payment cards that are eligible to receive benefit payments, including prohibiting benefits from being deposited into accounts set up for payday loan type arrangements.
The Treasury Department is simultaneously undertaking other efforts. For example, in the 2011 tax season, the Treasury piloted an initiative to improve tax administration by offering selected low- and moderate-income households an opportunity to receive their tax refund on a debit card. And I know that many of you in this room are conducting experimental work to make improvements in this area as we speak today.
There has been enormous progress and there is an enormous opportunity to improve financial outcomes for low income households by setting up an automatic way for these households to receive their tax refunds through direct deposit to a bank account or prepaid card. And in the coming years, in my view, Treasury must focus on bringing these tax refund accounts to scale at the national level.
Let me turn to the third major area of concern and that is consumer financial protection. While education and access are critical, so too is consumer protection. In an environment of weak and ineffective regulation, the tendency in many consumer financial markets is to end up in races to the bottom, as we saw brutally in the housing market. And these are not likely to be overcome solely by consumer education or improved access. In the United States there have been a number of strides taken in recent years to improve consumer protection, and let me describe two or three of these.
First, with respect to the CCARD Act, the President signed, which the President signed into law in May 2009. The CCARD Act is an example of regulation written for a market and for a set of products in which providers had often had a strong incentive to usher consumers into sub-optimal choices, to rack up lots of late fees, to make only the minimum payment each month. And millions of American families racked up enormous fees before passage of the Credit Card Act.
The CCARD Act combines common sense disclosures with protections from practices designed to make use of consumer fallibility for the benefit of the credit card issuer and to the detriment of the consumer. For example, the act bans certain unfair rate increases, including rate increases on existing balances, owing to universal default clauses, and severely restricts retroactive rate increases owing to late payment. It bans certain unfair fee traps, including weekend due dates, due dates that change each month, and payment deadlines in the middle of the day. And it ends the confusing practice of so-called double-cycle billing.
The CCARD Act also uses a de-biasing approach by requiring minimum balance warnings that help to inform consumers of the consequences of their own actions by displaying how long it would take to pay off an existing balance if the consumer paid only the minimum payment each month. And the amount the consumer would need to pay each period to pay off the balance in a short period of time.
Credit card companies know the impact of compound interest on credit balances, is not intuitive to most consumers. And consumers may incorrectly assume that the credit card issuers has their primary interest at heart in paying down the balance sooner rather than later, and therefore has set the minimum payment amount to the optimal amount in line with that objective.
So imagine the shock that consumers might have had when she learns that paying a minimum payment of $150 each month on a $7,000 credit card balance would take 22 years to pay off in full. Or the relief in learning on that same page that an extra $60 payment each month would reduce the time it took to pay off that balance from 22 years to 3 years and save more than $5,000 in interest payments along the way. That is a form of meaningful disclosure. It’s a disclosure that empowers consumers to make choices that are right for them.
Now undoubtedly we are and will learn more from these sets of disclosures. Many consumers will be helped by the minimum payment disclosure, but some consumers will end up paying off more slowly or in ways that are less useful to them. And these disclosures will need to be and must be over time improved and changed. And that’s the kind of approach I think we need to consumer protection, an evidence-based openness to change.
The CCARD Act changes to the credit card market were followed, as most of you know, the next year by the Dodd-Frank Act with significant changes to the mortgage market and consumer protection more broadly. Consumer protection failings in the mortgage market quite likely contributed significantly to the abuse of practices that fed the housing boom and its bust.
The act directly takes on these past failings. For example, it bans yield spread premiums to brokers for getting borrowers to take on higher cost loans and brokers steering practices that often accompanied high-cost lending. It requires creditors to assess and document the borrower’s ability to pay rather than making no doc loans to those who cannot afford them. And it makes reforms to escrow practices so that it is harder for creditors to hide the all-in monthly costs of a loan, including taxes and insurance. And it requires key changes to make disclosures simpler, reducing the paperwork burden on creditors while giving households more of a fighting chance to understand the terms of their home mortgage loans.
There are also important structural changes brought about by the Dodd-Frank Act. Before Dodd-Frank our system was largely incapable of supporting a successful regulatory structure for consumer protection. Fragmentation of rule writing, supervision and enforcement made it impossible to create a comprehensive and well-calibrated consumer regulatory system. Jurisdiction and authority for consumer protection was spread over many federal regulators which had higher priorities than protecting consumers. Banks could choose the least restrictive supervisor among several different banking agencies, and a large number of non-bank providers, from home mortgage originators to payday lenders, escaped any meaningful federal supervision at all.
Now with the Dodd-Frank Act’s creation of a Consumer Financial Protection Bureau, we have a chance to do more than play catch-up in regulating consumer financial markets. The bureau provides a historic opportunity to build a more successful regulatory structure for consumer protection, one that is designed to promote financial inclusion, preserve consumer choice, and provide for more efficient and innovative markets for consumer financial products and services, markets that can operate on a competitive basis of price and of quality rather than on hidden fees.
The Consumer Financial Protection Bureau provides for the first time a consumer agency with necessary mission focus, with market-wide coverage, and with consolidated authority. It is an agency that can focus not simply on more regulation but on smarter regulation, more coherent and more effective regulation. Regulation that is designed and implemented with an understanding for and respect of classical models, but is not blind to the compelling insights into consumer decisions derived from behavioral economics. Regulation that can empower consumers to find more suitable financial products from among many seemingly indistinguishable choices. And to provide a level playing field to the financial sector as well.
What I find most curious about the voices of opposition to the Consumer Financial Protection Bureau, an agency whose primary mission is accountability, transparency, fairness and access, is that their logic rests on a premise that empowering consumers is somehow antithetical to free markets. Opponents appear to be stuck in a debate that presumes that regulation and innovative markets are necessarily at odds. In fact, in my view, the opposite is true. Markets rely on good faith and on trust and on fair dealing. Markets require transparency that reflects economic reality rather than distortions caused by misleading sales pitches. And the discipline of the market requires clear rules.
The financial crisis that led to fundamental reforms of our financial system, but the process of reform is not over. The Consumer Financial Protection Bureau has gotten started on its work, and has grown to be, I think, quite a significant presence in the consumer financial market place.
But many in Congress have been trying to hamstring reform by starving the Consumer Financial Protection Bureau of a director or of funding by blocking nominees at the CFPB and other agencies, or by seeking to repeal key parts of the act.
For the low- and moderate-income families that we interviewed for my book these reforms are not an abstraction. The families that we talked to can ill afford a financial system that imposes unnecessary costs, confusion and complication on their daily lives.
In my view, our nation needs to take, must take the steps necessary so that the financial system works better for everybody. That means, yes, improving financial education. But it also means expanding access to financial products that meet the needs of low- and moderate-income households. And it means laying the foundations with strong consumer protections. Thank you very much.
So I would be happy to take any questions and really on any and all topics are fair game. Including my theory of what really caused the blackout at the Super Bowl. Yes?
John Sabelhaus: Hi, I’m John Sabelhaus with the Federal Reserve. So I am not a member of the Federalist Society, but, not to let you completely off the hook. So I think obviously disclosure makes a lot of sense, informing people, but I guess what some people on the other side would worry about is that you might be actually constraining the supply of certain types of products to low- and middle-income families. And I’ll pick one example that you use, which is the sort of small car dealer on the side of Route 1 who has 20 cars on the lot and charges what appear to be really high interest rates, implicit interest rates. And that in a sense what some people would believe is that there’s a free market, a competitive market to supply cars, used cars to people, and that you’d have to believe there’s some sort of restraint on competition from the supply side, or somebody else could come in and provide these cars. So it’s really, you know, being very careful. How is it that in the new world we’re going to be careful to make sure that we’re not constraining supply of these sorts of products to low- and middle-income families?
Michael Barr: So the first thing to know about the Consumer Financial Protection Bureau is that it may not set usury caps, so it cannot adjust, control the interest rate that is charged on a product or service. So if the only thing going on is a question about whether the price being offered for a product is too high, I don’t think the CFPB would have a lot to say about it, and frankly I wouldn’t have a lot to say about it. But I do think that there is some context in which, the particular context you mentioned may raise additional concerns about whether the pricing is being done in a transparent way and whether the normal mechanisms that people think of as being the context in which they operate are operating. So I’ll give you an example from that context.
So normally a process of inducing a debt discipline into a relationship occurs on both sides of the equation from the borrower and the lender that tend to limit the extent to which individuals end up over-borrowing. But in some contexts that debt discipline is weakened. And one of the contexts in which that discipline is weakened are in circumstances like rent-to-own facilities and buy-here, pay-here car lots. And those are circumstances in which you might want to be more careful about ensuring that the disclosures about the costs and price of what’s going on are done in a way that consumers really understand.
So in that particular market context your level of concern may go up, your scrutiny may go up, and you may want to be more intrusive about the kind of disclosure or understanding you’re trying to convey. So I think that while the price signal itself doesn’t tell you something, that particular market context might.
Chris: I have a question that is motivated by a particular experience, but I think it is something that the regulatory system will increasingly have to deal with over time. The particular experience is on a number of occasions I have discovered that businesses which I cannot identify have started charging me on a monthly basis for services which I cannot identify.
Michael Barr: I’ve had that happen to me too. Yeah.
Chris: I think it’s called innovation by people in the industrial organization literature that studies this. It’s fee innovation. But what I wonder, and I’ve recently kind of started taking, helping my mother who’s getting older sort of track her own finances, and I’ve discovered that there are companies that are charging her for things which she doesn’t know what—Well, in all of these cases I have, you know, when I’ve looked into it’s turned out that it’s basically sort of on the borderline of fraudulent activities. The company that claims that I signed up for some service, which I would never have signed up for, given my personality.
Michael Barr: Right. No rational human being.
Chris: No, yes.
Michael Barr: In which I include you.
Chris: Yes, that’s right. Things vague. Things like computer security protection. And so where—somebody’s got to do something about this. Is that something that is within the remit of the Consumer Financial Protection Bureau in its—For example, I could imagine them writing rules for credit card issuers saying, you know, you’ve got to, at a minimum make it easy for people to dispute and overturn these kinds of things. More generally, what you want to do, I think, is provide incentives for the credit card companies to root out the bad actors. And they are obviously not doing it now. So talk about that. I mean, is the FTC has to do this or…?
Michael Barr: So the key question is whether the activity in question is a consumer financial activity. And I have to say we wrote the statute really broadly. And it came up in lots of contexts in which different sectors of the economy did not want to be covered by the Consumer Financial Protection Bureau. And by that I mean every sector did not want to be covered. But they each came in separately to ask for exemptions.
And if you go back, those of you who are lawyers—How many of you are lawyers in the crowd? No lawyers in the crowd? Wow. Oh, one. Allen, okay.
Male: [Inaudible 00:38:18]
Michael Barr: Maybe. So those of who are lawyers in the crowd will have a delightful time going back and reading the statute. So the exemptions to the Consumer Financial Protection Bureau all take roughly the following form. You industry that you want to come in and have an exemption, you are exempt. You’re just exempt. Unless you offer a consumer financial product or service, in which case you’re not exempt. But we say that in lots of words.
So really in every example. So attorneys are exempt unless they are offering a consumer financial product or service. And in your case the big area this has come up in, I don’t know if this is your particular example, Chris, but the big area this has come up with that was heavily litigated in the act is with respect to telephone companies, with respect to wireless and landline, but big communications firms of all kinds really. And the whole telecom industry, which is not a small industry, came in to see me when I was at the Treasury Department with the following view. We do not offer a consumer financial product or services. And I said, “That’s great, so if you don’t offer them, you’re exempt.” And that’s what we did, we exempted them. But every time we tried to, we exempted them unless they offer a consumer financial product or service. But every time we told them what that was and we put that in the statute they wanted to come back and change a little word here or there.
And, again, the economists in the crowd want to understand this. But every little word in the statute actually matters. The law matters a lot to the outcome you’re asking about. And they did not get their word, the word they wanted. They got the word we wanted. And the word we wanted is translated into English as dumb pipes. So if you are a dumb pipe, if you are a telecom company and all you’re doing is offering a connection between people, don’t worry about it. But if you’re actually offering a service you’re covered. So the kind of scams that you’re describing, if they are a consumer financial scam, are covered. If they are not a consumer financial scam, but some other scam, a scam to consumers but not a financial scam, then you have to turn to other regulatory agencies, the FTC, the FCC, and others. And it’s spottier.
But could, if it is a consumer financial product or service the Consumer Bureau can get at it unless you are an automobile dealer. The one real exemption in the act.
Karen: When people talk about why mortgage lending hasn’t picked up more in the recovery, a really common narrative I hear is that it has to do with regulatory uncertainty, either directly or maybe with respect to the private label mortgage-backed security market not starting up again. You hear people say, you know, it’s uncertainty because Dodd-Frank hasn’t been fully implemented and we don’t know what’s in store. Or it’s about, you know, areas that Dodd-Frank didn’t cover. And I was just wondering if you had thoughts about that narrative?
Michael Barr: Sure. So I would maybe separate out the sort of two groups, the PLS market, the private label securitization market and the rest of the market. First of all, the private label securitization market was not a great market. Let’s be honest. So when we talk about reviving the PLS market, we ought to be thinking carefully about what we mean by that. There are parts of the PLS market that were, parts of the PLS market that should be revived that can function well with good rules. And there are parts of the PLS market that I hope don’t get revived. So ninja loans, loans to people without any income, without any documentation, without any job prospects, I hope we don’t go back and do those ever again. Or pick-a-pay loans where you get to decide each month how much you want to pay, that was a financial innovation that I don’t think for 99.9 percent of the people who had it was a good innovation.
There are some people for whom pick-a-pay is just fine. But they look like me and I don’t need a pick-a-pay loan. But it would work for me, because I’d pick a good payment. I’d pick a 30-year amortizing payment.
So parts of that market are not likely to come back and shouldn’t come back under anybody’s scenario. Parts of that market should come back and are fine. So private label jumbo market in 30-year fixed rate mortgages and in most adjustable rate mortgages for most people most of the time outside of the Alt-A and sub-prime sector was okay. So, in other words, mortgages that would be Fannie- or Freddie-eligible in the prime sector but for their loan size. So that market exists now and should be expanded, for example, by reducing the conforming limit for Fannie- and Freddie-eligible mortgages and for FHA eligible mortgages.
For everybody else, there are lots of mortgages that are being made by Fannie Mae, Freddie Mac and FHA today. They are 90 something plus percent of the market. The big critique on the Hill right now, if you’re watching the news today and yesterday, is that FHA is being too open in making mortgages, not too strict. That they are taking people with too low credit scores.
Fannie and Freddie are much tighter than they have been historically, and much tighter than their own internal guidelines would suggest. And part of that is that the originator of the mortgage is concerned that if they deliver a mortgage to Fannie Mae or Freddie Mac at a lower credit score, even if it’s acceptable to Fannie Mae and Freddie Mac, if the loan then goes into an early re-default it will be put back to the originator as being not properly made in the first instance. And the reason they’re worried about that is they made a lot of bad loans in the past that are being put back to them for many billions of dollars by Fannie Mae and Freddie Mac appropriately.
So there’s adjustment. There’s a big transition going on in the market for all those reasons. Now you layer on—I think that’s the basic dynamic right now. Then you layer on top of that, there are big changes coming in, they aren’t in place yet, but big changes coming in the regulatory space that will tend to reinforce the current situation, which is, tend to reinforce documentation of loans. Tend to reinforce making loans to individuals with better credit history, and the question is can we find some, going forward in the country, can we find some middle ground in the future between what we did 2003 to 2006 or 2001 to 2009, depending on how much you want to stretch it. Avoid doing that. But don’t go back to a system where basically you have to have 50 percent down and you can only get a 5-year balloon mortgage, which is the system we had before the Great Depression, which I think would be a mistake.
But there’s a big ground in between there, and we’re working on figuring out what the right level, we as a country are working on figuring out what we think the right level is.
Karen Pencil: Hi, I’m the other Karen. Karen Pencil. Actually, I met another Karen here today too. In your vision of the ideal mortgage market of the future, who would fund, what institutions would fund mortgages, which ones would bear credit risks, and does the regulatory infrastructure in place and in train support or take away from that vision?
Michael Barr: I’m sorry, say the last part of your question again?
Karen Pencil: I was thinking about the incentives…
Michael Barr: I got the first two.
Karen Pencil: I was thinking about the embedded incentives in the regulatory infrastructure, you know, the incentives to hold banks on balance sheet. The incentive to securitize. The incentive to sell things to the GSEs. So I’m curious both about what your vision is, about how the mortgage market should be originated and whether you think the upcoming regulatory changes would support or inhibit that vision?
Michael Barr: I think that there is going to be a continued need for government involvement in the home mortgage market. So I think that it would be a mistake to go to a system in which we had no government guarantees in mortgages. And I think that primarily for two quite separate reasons. One is although the evidence, I think, is somewhat mixed, I am reasonably convinced by the argument that the absence of a government guarantee would make it quite difficult to sustain a market for 30-year fixed-rate mortgages for the bulk of home borrowers. And I think fixed-rate mortgages, self-amortizing, 30-year, fixed-rate mortgages are an enormously important innovation from the Great Depression that we should not kill, from a homeowner stability perspective.
I think that whoever is the proper bearer of interest rate risk in our economy, it is unlikely to be the individual homeowner, to answer your balance sheet question.
The second reason that I think a government role in the housing market is important is a financial stability reason. So if every once in a while we’re going to blow up our housing markets it would be good to have a prepositioned, pre-paid-for insurance scheme for that, instead of what we just did. So we ended up having an insurance system for Fannie Mae and Freddie Mac after the fact that was not paid for by anybody other than taxpayers, ex-post. And I don’t think that’s a good way of running the system. So I would much rather see us having a pre-position insurance mechanism in the housing sector given how important it is for household balance sheets.
So for those two reasons I see an important role for the government.
Now that being said, I think there’s enormous room to reduce the role of the government from where it is today to something a lot smaller and still achieve those two objectives. And I think that should primarily be done by introducing mechanisms to expand the first loss position of the private sector in government-guaranteed mortgages. So what in that little world that people live in would call lowering the attachment point of the government guarantee so that more of the risk of first loss is taken by the private sector. And that can be done through securitizations of first lost positions, or it can be done through a private mortgage insurance or other mechanisms if those are well regulated.
We currently, I think, have a woefully inadequate system for regulating private mortgage insurance. I think that’s demonstrably the case. I think there’s no reason that that should be a, we should rely on a model where individual states set up the system for regulating PMI companies. And so I’d favor a system in which we have uniform federal regulation of whatever mechanisms are used to absorb the first loss position in mortgage securitizations, whether those are PMI or first loss securitizations or otherwise.
That was a long answer to your questions. Two minutes apparently. So my answers coming up will be short. Yes?
Male: You could group the questions.
Michael Barr: No, I’ll just be short.
John Duca: All right, John Duca of the Dallas Fed.
Michael Barr: Yes.
John Duca: Real quick, community banks complain that they’re being over-regulated, that they don’t pose as much systemic risk as the big banks. At the same time it seems like these auto title loan companies are showing up on corners in poor sections of town. And we still see these rent-to-own commercials where they say, “It’s not debt. You’re renting to own.” If you had to redo or refine, let’s put it this way, if you had to refine DFA to deal with some of these things what would you, what would your inclinations be?
Michael Barr: So I think as long as the CFPB is able to overcome the challenge to the recess appointment of its director it has more than adequate authority to deal with the non-bank sector. It has plenty of supervisory and enforcement power in that sector and will use it over time, I think. So I’m not worried about that at all, with the exception I mentioned of the auto dealers.
The community bank sector was not heavily regulated by the Dodd-Frank Act. I go out and I talk to community bankers all the time about this. The change of the Dodd-Frank Act predominantly make it more expensive to be a very large bank, and they make it somewhat more expensive to be a regional bank because of the compliance between $10 and $50 billion dollars.
If you were a community bank, you’re not getting more regulation because of Dodd-Frank. And when you dig under and you actually see what people are talking about, they’re not upset about the Dodd-Frank Act in their daily things, although they’ll frame it that way. They’re really upset about their, I’ll use some, I’ll insert expletive examiner is who they’re really upset about because in—No, it’s true. Because in any economic cycle, on the upside the examiner is too loose, everything is great, let it ride. And on the down side, examiners get too tight. And this was a bigger up and a bigger down. And so examiners were too loose, too loose or looser. And now they’re much stricter than they need to be. And there’s some variation across different regulatory agencies, which I will not say in public. But it’s a consistent pattern across the agencies, even if the variation is there. And that’s a problem.
The other big area that community banks are upset about is Bank Secrecy Act compliance, which is too burdensome and which is largely ineffectual in achieving its policy aims, and should be reduced. But politically to go and say we need less BSA compliance is really not a winning argument in the world that we live in. And so you better have a better argument than that for reducing the burden on community banks.
I promised to be short, but I was long.
Travis gets the last question, I guess.
Travis Plunkett: I’ll be quick. Travis Plunkett with the Pew Charitable Trust. Michael, balance for us a little on behavioral economics, one of the ideas that you’ve thrown out, tax time savings. On the one hand, a great opportunity. You’re receiving a windfall to save a little bit every year and build up savings. On the other hand, behavioral research shows us that through what they call mental accounting people plan for those windfalls and spend them in advance. So how do you sort of balance those two things to make tax time savings a real significant opportunity?
Michael Barr: Travis, I think that’s a great point. And one of the things that I found in my study, in No Slack is that many low- and moderate-income families want that pre-commitment device. They want to use excessive withholding, excessive tax withholding to save more. Many families when they get that refund the predominant use, 80 percent of families are using that to pay down past debt. Now maybe it’s for the specific purpose that you described, or maybe it’s for other things, so there is this tension between wanting to have a savings moment, a positive savings moment as opposed to a reduction indebtedness net savings increase moment. But if you’re trying to increase savings over time for this family it may be that it’s asking too much of a low- and moderate-income family to save that amount over the course of the year. And there may be a need for better strategies to either move some of that income into the month, as we had ineffectually with the advance EIC payment. It never took off. One percent take up. But if you have a way of spreading some of that and splitting some of it into a savings account at the end, that might be a better outcome than having the whole thing be a lump sum in February.
But I think that’s exactly the right tension to focus on and I think worth exploring.
Thank you very much.