Consumer Compliance Outlook: Second Quarter 2009

Interview with Sandra Braunstein

Consumer Compliance Outlook celebrated its one-year anniversary in May 2009, and what an interesting and challenging year it has been. When we published our first issue in May 2008, we were beginning to witness the fallout from problems in the subprime mortgage market. Delinquencies were rising, and the debate about foreclosure and foreclosure-prevention activities was intensifying while various stakeholders, such as Congress and community groups, were focusing on how consumer protection failures contributed to the subprime crisis. Apropos of this debate, Outlook's inaugural issue included an article on foreclosure-prevention activities and the Community Reinvestment Act.

Since then, we have lived through a tumultuous year that included the failures of Bear Stearns, Fannie Mae, Freddie Mac, and Lehman Brothers and an alphabet soup of government initiatives to respond to the crisis, including AMLF, CPFF, MMIFF, PDCF, TAF, TALF, TARP, and TSLF.1

To mark this one-year anniversary, the Outlook Advisory Board recently conducted an interview with Sandra Braunstein, director of the Division of Consumer and Community Affairs at the Board of Governors in Washington, D.C., to discuss the effects of the financial crisis on consumer protection issues.

Advisory Board (AB): Given the events of the past year, what has surprised you the most with respect to consumer protection?

Sandra Braunstein (SB): What surprised me the most was that in many ways the crisis with respect to consumer protection began a full year before the impact was felt in other areas. Consumer groups will tell you that the problems began before 2006. Even though we knew it was serious by the middle of 2006, and the downward trend accelerated through 2007, the extent to which the crisis has worsened has surprised me. Another issue that we have discussed over the years but has come into full focus now is the strong intersection between consumer protection problems in financial institutions and prudential supervision. We now understand that problems in the consumer protection realm often serve as a bell-wether or leading indicator for financial problems that will surface later.

In 2006 it seemed as if subprime lending was an isolated problem. People thought the economy was strong, and it would only impact a small part of the market. As we know, that's not what happened, and it became very widespread. What I hope we have learned is the importance of being diligent with respect to consumer protection issues — even when the market is strong and banks are profitable.

AB: In light of what we have already experienced, what currently concerns you most?

SB: When consumer protection issues initially started to surface, the market was functioning quite well. What keeps me awake is the optimum point of intervention — when do we go in and write stronger regulations, even though there is the potential to negatively impact the market or tighten credit availability. I am not sure we have the answer. I do not know if we will ever get it exactly right, but I am confident that the next time we will do it better.

AB: Would we be willing to take action sooner?

SB: I think from what we have learned we would intervene sooner but people have short memories. When markets become "normal" again, in whatever form that may take, it will be interesting to see if there is support for early intervention even though there may be unintended consequences with respect to profitability.

From the beginning of the economic downturn, a debate emerged over how or if weaknesses in our approach to consumer protection contributed to the crisis. The Federal Reserve, along with other agencies, has been very busy as a result. In the past year we have had new mortgage lending rules, new credit card rules, proposals for new substantive overdraft protection rules along with enhanced overdraft program disclosures, and proposed student loan rules, to name just a few. Even with these new and enhanced consumer protections, the House Financial Services Committee and the Senate Banking Committee continue to conduct hearings and draft bills with further consumer protection for these and other products and services.

— Advisory Board —

AB: Can you tell us what went into the new rules and how the Board's focus and processes have changed?

SB: We have learned several things with respect to the rule-writing process. Up until recently, rules written by the Federal Reserve relative to consumer protection centered on disclosure: making sure the public had good, accurate information about financial products and services in order to make informed decisions. The attorneys would write the regulations along with sample disclosures using the applicable statute as a guide. But over time we discovered that the information contained in these disclosures was not always well understood by consumers.

Actually, even before the crisis began we had already started to incorporate consumer testing into our rule-writing process. We have hired professionals to conduct consumer interviews and run consumer focus group meetings, and this input from the public has made a tremendous difference in the clarity of our disclosures. In fact, we have been so pleased with this approach that the Board has made a pledge not to issue new disclosures unless they have been consumer-tested. Our new Regulation Z credit card disclosures are a good example of the success of this new approach. Certainly, this process is more time-consuming, but the quality of the final product is well worth the additional effort.

Another thing we have learned from consumer testing is that certain characteristics of financial products in today's market are so complex that it is very difficult to use disclosures to adequately explain these concepts. Due to the complexity of these products or product features, disclosure alone may even confuse consumers such that they cannot reasonably avoid the harm from these products. As a result, rules need to be written to address unfair or deceptive practices in order to adequately protect consumers, which is why we developed the recent credit card rules.

AB: In April the "Today" show did a segment on overdraft protection services, which concluded with an announcement of the Board's proposed rulemaking and information on how to comment on the proposal. What's your reaction to this type of publicity with respect to the Board's rulemaking function?

SB: I think it's terrific! Anything that raises the visibility of consumer protection issues with the public is very positive, whether it's the "Today" show or another venue. In fact, I have recently seen a number of stories on local and national news programs on consumer protection issues, particularly on credit cards, and in my opinion a well-informed consumer will ultimately make better decisions.

AB: Is there anything else on your radar screen that you can share with us regarding potential policy or regulatory changes?

SB: Right now we are working feverishly to address the regulatory changes required by the credit card reform legislation that President Obama signed into law in May. While the new law tracks with the credit card regulations that the Board approved last year in many respects, there are many differences, some of which will require amendments to those regulations. In addition, there are some new provisions that will require us to issue proposals for notice and comment. Finally, some of the provisions in the legislation go into effect this August, and the rest go into effect in February 2010 and August 2010. The Board's rules were to go into effect in July 2010. Consequently, this work is taking priority at the moment and will likely affect the timing of our final rules on overdraft protection, for example. With regard to our proposed overdraft protection rules, we received 18,000 comment letters on overdraft protection, which is far less than the 66,000 we received on our proposed credit card rules but is still quite high. Most of the letters came from individual consumers. The proposed rule offered two different approaches to overdraft protection services: opt out or opt in. Most consumers preferred the opt-in approach, in which they would have to ask to have this feature added to their account, while the industry preferred the opt-out approach.

We also hope to issue final student loan rules under Regulation Z by late summer. We are also conducting a significant amount of consumer testing on mortgage disclosures, both closed-end and HELOCs (home equity lines of credit). We hope to have proposed rules out for comment during the same time frame.

AB: Is there anything else you have learned from recent comment letters?

SB: The comment letters have been extremely helpful, and in addition to the impressive volume, the comment letters on credit cards have been particularly fascinating. In today's world, credit cards are such a ubiquitous product — almost everyone has at least one. What was so interesting was that the vast majority of these comment letters were written by individual consumers. They typically shared with us their actual experiences with their cards or card issuers. These letters provided significant anecdotal evidence, which we used to craft our UDAP (Unfair or Deceptive Acts or Practices) credit card rules.

AB: There has been some discussion regarding the possible role that the Community Reinvestment Act (CRA) played in the recent financial crisis. Where do you see the debate regarding the future of CRA headed?

SB: First, let me clearly state that the CRA was not to blame for the current financial crisis, and we are not in doubt on that point. However, because the CRA and its implementing regulation were enacted in 1977, it is not as relevant as it could be, since significant changes in the banking industry have occurred over the past 32 years.

The CRA is a priority for the House, and I believe (Representative) Barney Frank is interested in reviewing it from a legislative perspective. When I testified before Congress last year, he was interested in possibly expanding CRA coverage to include other entities, such as credit unions, insurance companies, and other financial services providers.

AB: What is your perspective on how or if the CRA should change given the evolution of the financial services industry?

SB: We have also been looking at the CRA from a regulatory perspective. While no decisions have been made, we have discussed issues such as the relevance of assessment areas for our largest institutions and whether race should be considered as part of the performance evaluation. The statute is very clear in that the CRA focuses on low- and moderate-income individuals and geographies and not race, but a number of community groups are proponents of this type of expansion. We have also discussed the possibility of additional enforcement tools for noncompliance as well as the issue of affiliate lending, and whether it should continue to be optional or should be included as a mandatory part of the performance evaluation process.

We are getting input from the industry as well as community groups, and these are just some of the issues currently being discussed.

AB: Moviegoers in select cities recently saw a public service advertisement sponsored by the Federal Reserve to raise awareness about mortgage foreclosure scams. Can you tell us more about these advertisements and why the Board chose this approach?

SB: I think it is fantastic. Our partner NeighborWorks and industry representatives have shared information with us about scams that are targeting homeowners who might be facing foreclosure. For instance, these individuals will slightly change the name of a legitimate organization such as HOPE Now and set up a copycat website that could easily fool unsuspecting consumers.

This is the worst type of fraudulent activity that preys on vulnerable people who are already facing rough financial times and are in danger of losing their homes. People are being asked to pay out large sums of money up front in order to receive a loan modification, but we know that no third party can promise that will happen if the borrower is not eligible. We have heard of fees that can range from $2,500 to $3,000, and in the best case scenario, some assistance may be provided; but in the worst case, the borrowers lose their money, receive no help, and are still facing foreclosure.

As an organization, we wanted to find a way to increase public awareness about these scams. People do not think of the Federal Reserve as a resource for consumers, but we have a great deal of information on our website 2 that can be very helpful, such as "5 Tips for Avoiding Foreclosure Scams."3

While we recognize that commercials are out of character for the Fed, we thought this would be an effective way to reach a broad segment of the population so we launched these advertisements in April in select cities with high foreclosure rates. We were very pleased with the final product and will continue to explore using various forms of media to deliver important messages for the public.

Over the past year we have seen financial institutions take steps to reduce their credit risk exposure (e.g., reducing limits on home equity credit lines) and/or move into new lines of business (e.g., reverse mortgages) now that subprime mortgage lending has virtually disappeared. Outlook has published articles on both of these topics. Since the inception of the publication in May 2008, our theme has been to remind our readers that consumer protection issues remain in the forefront of the crisis and that rules and expectations are rapidly changing. As a result, consumer protection and compliance need to be a part of all major business decisions.

— Advisory Board —

AB: If you had one piece of advice for bankers at this time — as it relates to consumer protection — what would it be?

SB: Right now, bankers are understandably focused on prudential supervision, the results of the stress tests, and capital requirements. But it is very important that bankers stay focused on consumer protection. Bankers need to continue to look for opportunities to make credit available for qualified borrowers. We have all seen the consequences when bankers are not focused on consumer issues, so bankers need to do what is necessary to mitigate that risk.

AB: And what would be your advice to examiners?

SB: I would give the same advice to examiners: Stay focused on consumer issues and use sound judgment in making your assessments. I would also add that now more than ever it is extremely important to keep the lines of communication open with our safety and soundness counterparts.

AB: Finally, given the division's many initiatives over the past year, which ones are you most proud of?

SB: I am most proud of the people who work at the Board who have continued to remain dedicated to our role in consumer protection during a time when it seemed we were being attacked from all sides. So many individuals rose to the challenge and were creative in terms of finding solutions for difficult problems.

I am also very proud of the new rules we have developed and the process we have used to develop those rules. We have made significant progress toward putting a better infrastructure in place to help consumers get responsible credit.