The Senate Banking, Housing and Urban Affairs Committee held a hearing today on the importance of restructuring the regulation of the financial service industry to include additional consumer protection. Chairman Christopher Dodd (D-CT) noted that any increase in regulatory oversight must be balanced with the need to provide the industry with the flexibility to provide new financial products and services. Ranking member Richard Shelby (R-AL) noted that increased regulations should not create additional loopholes and should not create an environment that fosters a false sense of consumer security with respect to financial products.

Witnesses on the panel were:

  • Steve Bartlett, President and CEO, Financial Services Roundtable. In his testimony, Mr. Bartlett noted that the current crisis illustrates nexus between consumer protection regulation and the current regulations regarding the safe and sound operations of financial institutions. He suggested a system-wide overhaul of the regulatory process is necessary to ensure that consumer protection would be emphasized as part of regulatory examinations of financial institutions.
  • Ellen Seidman, Senior Fellow of New America Foundation, Executive Vice President of ShoreBank Corporation. Ms. Seidman, a former director of the Office of Thrift Supervision, suggested that the primary federal banking regulators, with proper guidance and authority from Congress, are capable of enforcing consumer protection as part of the financial institution’s safety and soundness examinations. Ms. Seidman’s proposal noted that products similar in function should be regulated similarly, regardless of the form or type of entity offering them. She also advocated elevating consumer protection considerations to the same level of regulatory oversight and examination as that of the safety and soundness of the financial institution’s operations.
  • Patricia A. McCoy, George J. & Helen M. England Professor of Law, University of Connecticut School of Law. Professor McCoy identified disparities among state and federal regulation and regulation of depository and non-depository institutions. She suggested that consumer protection enforcement authority should be centralized in a single regulatory agency, as opposed to scattered among federal and state regulators.

Questions from the Committee centered on whether a single federal regulator should be tasked with ensuring that consumer protection regulation, or whether the current regulatory system could be altered to address consumer protection concerns. Discussions also centered on whether funding for a centralized federal regulatory agency should be through assessment-based fees or by appropriation. Each of the witnesses had somewhat differing views on the first issue, but seemed to share a common stance on the issue of funding: assessment-based funding would be a workable option. A concern was voiced, however, that if the authority was given to state and federal banking regulators and funding was based on the assessments paid by member institutions, forum or charter shopping might become more prevalent leading regulators to a “race to the bottom” approach with respect to consumer protection measures.

With respect to mortgage lending practices, specific questions were posed to the panel regarding the use of mortgage brokers, yield-spread premiums, prepayment penalties, and teaser rates as they relate to consumer protection. Witness testimony suggested various strategies including (i) placing a fiduciary duty on mortgage brokers with respect to the consumers on behalf of whom they find originators, (ii) deferring broker compensation until later in the life of the mortgage to determine whether the loan was a “good” or “bad” asset, and (iii) eliminating the practice of paying brokers yield-spread premiums.

An additional point addressed by the Committee and witnesses was the role of securitizations in the current financial market crisis. Witness testimony consistently indicated that all parties involved in the securitization process, from originators to investment banks, maintain some “skin in the game” and bear a portion of the risk associated with the underlying assets. Additionally, the witnesses noted that federally regulated financial institutions were permitted to hold investment-grade mortgage backed securities on their balance sheet, even in instances where they would not be permitted to hold the underlying asset itself. This latter point was suggested as an example of an area in which the current regulatory framework has created loopholes for financial institutions that have exacerbated the current crisis and reduced the participant accountability.