Financial Literacy Jansen Cfphr Testimony

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Written testimony of J. Bradley Jansen Submitted for the record to the U.S. House Committee on Financial Services Subcommittee on Financial Institutions and Consumer Credit Hearing on Improving Consumer Financial Literacy Under the New Regulatory System June 25, 2009 Chairman Gutierrez, Ranking Member Hensarling, members of the subcommittee, thank you for allowing me the opportunity to submit testimony on this important question. My name is Brad Jansen, and I am the director of the Center for Financial Privacy and Human Rights. CFPHR was founded in 2005 to defend privacy, civil liberties and market economics and is part of the Liberty and Privacy Network, a Washington, DC-based 501(c)(3) organization. I would like to applaud the committee for recognizing the importance of private actors in the campaign for financial literacy. Unfortunately, the often counterproductive influence of the relevant government agencies is not explored. This statement aims to fill that void by exploring: Harmful leadership by federal regulators concerning consumer mortgages, • Problems associated with pre-empting state subprime lending laws, and • Importance of protecting independent consumer watchdog groupsʼ sites. • While some general principles of financial literacy are universal, the dynamic, changing capitalist system we have continues to develop ever more specialized and complex financial products to meet consumer demand. The benefits of this system can be limited if financial literacy lags. Governmental regulations generally react more slowly than the private actors. Such delays can retard consumer financial literacy. The first rule should follow the physiciansʼ Hippocratic Oath and “First, do no harm.”

Center for Financial Privacy and Human Rights [email protected] PO Box 2658 Washington, DC  20013-2658 Tel. 202-742-5949 ext. 101

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Policymakers need to establishing general rules (against fraud, reasonably understandable disclosures,1 etc.) and recognize that since private regulation moves faster to meet consumer concerns governmental regulation should augment and support that approach--not undermine it. Similarly, states, the “laboratories of democracy,” are closer to the people and often contribute to this discovery process. The Uniform Commercial Code could be encouraged to “harmonize” state leadership and simplify consumer protection regulations. In short, a “bottom up” approach is better than a bureaucratic “top down” one.2 As George Soros explains, “While markets are imperfect, regulators are even more so. Not only are they human, they are also bureaucratic and subject to political influences, therefore regulations should be kept to a minimum.”3 Soros also rightly cautions against excessive credit-induced financial bubbles. Relatedly, very few Americans understand that role that central bank monetizing of government debt plays in causing inflation and how that affects consumer financial products. The Fed's Follies In Regulation of Consumer Mortgage Products For about the last one and a half decades, the Federal Reserve had primary influence and, in some aspects, formal control over many consumer financial products in America. Now, as we are collectively going back and re-examining the structures and policies that led to the financial crisis, it is being realized that this arrangement may have been a key contributor to the mess. We are realizing now that, in fact, much of the prosperity at the time was just an illusion created as a direct consequence of policies that tended to encourage, if not inflate, economic bubbles. Everyone is familiar with the criticism that the Federal Reserve Board kept interest rates too low for too long after the NASDAQ bubble burst. Whatever degree to which this is true (complicated with foreign central bank purchases of US securities), what has received less attention are the comments of Federal Reserve Board Chairman Alan Greenspan regarding exotic mortgage products and the role they may have played in build up to the financial crisis. Greenspan told the 2004 Credit Union National Association conference, “American consumers might benefit if lenders provided greater mortgage product alter-

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See Privacy Rights Clearinghouse, “'Reasonably understandable' means clear and concise sentences, plain language, active voice.” http://www.privacyrights.org/ar/GLB-Reading.htm 2

Nobel prize winning economist F. A. Hayek explained these issues well in his “The Use of Knowledge in Society” essay. http://www.econlib.org/library/Essays/hykKnw1.html 3

George Soros, The three steps to financial reform, Financial Times, June 16, 2009 http:// www.georgesoros.com/articles-essays/entry/the_three_steps_to_financial_reform/

Center for Financial Privacy and Human Rights [email protected] PO Box 2658 Washington, DC  20013-2658 Tel. 202-742-5949 ext. 101

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natives to the traditional fixed-rate mortgage.”4 As USA Today reported, “While borrowers can refinance fixed-rate mortgages, Greenspan said homeowners were paying as much as 0.5 to 1.2 percentage points for that right and the protection against a potential rate rise, which could increase annual after-tax payments by several thousand dollars . . . He said a Fed study suggested many homeowners could have saved tens of thousands of dollars in the last decade if they had ARMs. Those savings would not have been realized, however, had interest rates shot up.” Note that Mr. Greenspan expressly endorsed adjustable mortgages over traditional, safe fixed mortgages--this is going further than simply suggesting them as an additional possibility. This is all the more puzzling given that the Federal Reserve was still holding interest rates at historical lows--exactly the environment in which consumers should be picking fixed mortgages, not adjustable ones. As it turns out, “0.5 to 1.2 percentage points” was a pretty reasonable amount to pay for the right not to have one's mortgage payment shoot up by 30-200% on them. So this was not only extremely bad advice, but diametrically opposed to the option most consumers should have picked--and coming from the nation's top financial authority. These comments, while expressing no specific policy, clearly set the tone for industry and consumer behavior. At the time, Mr. Greenspan was considered the “Maestro” for past economic performance, and by some the “most influential man in the world”. People believed--perhaps rightly so--that the Greenspan Fed was responsible for making the 2000-2001 recession “short and shallow,” as well as expertly handling the post-9/11 environment. When such a person at such a powerful and influential institution voices a preference for one financial product over the other, it inevitably becomes de facto policy. More disconcerting is the above combined with another incident at the Federal Reserve. Consider Edward Gramlich, a Democrat who was one of seven Federal Reserve Board governors from 1997 to 2005, who reportedly proposed to Mr. Greenspan while predatory lending was a growing concern that the Fed ought to ensure its examiners look into the offices of consumer-finance lenders of the bank holding companies under its authority. In another example of government regulation failure, Mr. Greenspan dismissed the idea.5 As Chairman Frank has reiterated, giving the Federal Reserve additional statutory authority has not served consumers well, such as with subprime mortgages. The above episode illustrates another example of Hayekʼs caution against the

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Chairman Alan Greenspan, “Understanding household debt obligations,” Credit Union National Association 2004 Governmental Affairs Conference, February 23, 2004, Washington, D.C. http://www.federalreserve.gov/boarddocs/speeches/2004/20040223/default.htm 5

Greg Ip, “Did Greenspan Add to Subprime Woes?,” Wall Street Journal reported on June 9th, 2007, http://online.wsj.com/article/SB118134111823129555.html

Center for Financial Privacy and Human Rights [email protected] PO Box 2658 Washington, DC  20013-2658 Tel. 202-742-5949 ext. 101

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fatal conceit 6 that plagues central planners and possibly how regulators become captive agencies of the industries they regulate.7 Federal Regulators Destructively Pre-Empted Statesʼ Subprime Laws Beyond the Federal Reserve Board, Federal influence has at times ended up pre-empting state policy moves that would have protected consumers. However state governmental actors can also become captive of political influence-including the pernicious influence of the other Government Sponsored Agencies that often work against consumer interests. A series of examples involve what are known as “tangible net benefit” laws where states stepped in to address a legitimate concern. One such example is Georgiaʼs “Fair Lending Act” passed in in 2001 which required lenders to be able to prove that a refinancing of any home loan fewer than five years old would provide a “tangible net benefit” to the borrower. The subprime industry, lead by Ameriquest and in conjunction with other lenders and Fannie Mae, launched a campaign against the Fair Lending Actʼs “vague” provision. The Georgia Senate soon complied and removed the tangible-netbenefit requirement opposed by the industry for nearly all loans.8 The pressure of the Federal GSEs siding with national mortgage lending companies apparently overwhelmed the states and consumer interests. New Jersey also passed a law with similar characteristics called the “Home Ownership Security Act.” Ameriquest again complained and began channeling donations to legislators who would oppose these laws. Federal regulators then intervened with a series of orders protecting federally-chartered financial institutions from state consumer protection laws. The National Home Equity Mortgage Association pressured lawmakers not to hand an advantage to federal over statebased financial institutions and warned of reduced availability. In 2004, after the onslaught from Federal regulators, the Government Sponsored Enterprises which had their own special Federal regulator--the Office of Federal Housing Enterprise Oversight (OFHEO)9, and companies like Ameriquest, the tangible net benefit laws in both states were rolled back. Other states had similar experiences.

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F. A. Hayek, Fatal Conceit: The Errors of Socialism, http://www.press.uchicago.edu/presssite/ metadata.epl?mode=synopsis&bookkey=58673 Mark A. Calabria , “ Did Deregulation Cause the Financial Crisis? ,” Cato Policy Report, July/August 2009 http://www.cato.org/pubs/policy_report/v31n4/cpr31n4-1.html 7

Glenn R. Simpson, “Lender Lobbying Blitz Abetted Mortgage Mess: Ameriquest Pressed For Changes in Laws; The Wall Street Journal, Dec. 31, 2007. http://online.wsj.com/public/ article_print/SB119906606162358773.html 8

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Now part of the Federal Housing Finance Agency (FHFA) http://www.fhfa.gov/

Center for Financial Privacy and Human Rights [email protected] PO Box 2658 Washington, DC  20013-2658 Tel. 202-742-5949 ext. 101

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To complete the picture, one must note that during this period that Ameriquest was being pursued by virtually every state's attorney general for predatory lending practices. Finally, the company relented in 2006, paying approximately $400 million worth of settlements, and being essentially dismantled as a retail lending company. Then-New York Governor Elliot Spitzer has argued powerfully that the state regulators were “blocked” by the Office of the Comptroller of the Currency and other Federal regulators in reigning in Ameriquest and other companies engaging in similar “predatory” or deceptive practices.10 Government regulators--especially federal ones--protected companies engaging in questionable practices against consumers, their watchdogs, and state legislators close to the people. Independent Consumer Watchdog Sites Under Attack By Industry A further hazard lies in the difficulties independent consumer watchdog sites face in exposing fraud and other problems in the financial industry and stepping up providing consumer financial literacy. One example of this problem centers around the web site ML-Implode.com, known as the “Mortgage Lender Implode-o-Meter,” founded by finance and economic blogger Aaron Krowne at the end of 2006. The site warned of the mortgage crisis and predicted a broader banking crisis, and pointed to specific troubled and predatory lending companies, as well as connected banks on Wall Street. The site provides a forum for the public to report on the crisis, “blow the whistle” on malfeasance, and discuss its causes and policy and industry responses to it. However, the site has faced a series of expensive and frivolous lawsuits from mortgage-related companies displeased with being covered--or sometimes even mentioned--on the site. This is despite the fact that most of the material is posted on open forums, received as tips, or quoted from authoritative sources, typically in ways protected by the First Amendment, if not specific federal law (such as the Communications Decency Act). In one example, a Maryland company called Global Direct Sales, LLP, which (until recently, when the practice was outlawed by Congress) arranged for buyers to receive taxpayer-subsidized FHA loans without producing the required 3.5% downpayment, sued the Implode-o-Meter and a blogger on the site for a critical article which was almost entirely a compilation of material from reports and rulings of various federal agencies and respected financial publications such as Forbes Magazine. 10

“Predatory Lenders' Partner in Crime,” The Washington Post, February 14, 2008.

http://www.washingtonpost.com/wp-dyn/content/article/2008/02/13/AR2008021302783.html

Center for Financial Privacy and Human Rights [email protected] PO Box 2658 Washington, DC  20013-2658 Tel. 202-742-5949 ext. 101

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Suits such as these more often than not can quickly shut down such small, independent (but effective) watchdog sites. Krowne reports that the Implode-o-Meter “would have shut down in 2007” in the face of a lawsuit by Loan Center of California (which was later dropped), had the public not contributed enough in a fundraising drive for the site to stay afloat. He adds, “Unfortunately, economic conditions make this a difficult feat to reproduce today.” Krowne reports that current similar attacks by mortgage companies mean the site is continually in jeopardy of shutting down. Such abuses of the legal system to silence criticism are common. Recently, Mike Morgan was pursued by Goldman Sachs, which was displeased with his Goldman Sachs watchdog site “GoldmanSachs666.com”. Despite prominent disclaimers that the site was not commercial, not associated with the investment bank and contained only speculative opinion, Goldman Sachs pursued a trademark infringement argument against Morgan, obviously in hopes that he would have to turn over the domain name. Previously, Morgan ran a Lennar, Inc. watchdog site provocatively-named “LennarSucks.com” for consumers displeased with a variety of Lennar's practices. After an expensive and exhausting battle, Morgan relented and shut the site down in 2006. However, a substantial portion of the complaints against Lennar have been since substantiated, as the housing market downturn has exposed shoddy construction and other problematic practices that proliferated unchecked during the boom. In conclusion, since “when there is smoke, there is fire,” policymakers should: Examine the effectiveness of federal (and state) laws such as “anti• SLAPP” laws that ought to be protecting consumersʼ watchdogs, Strengthen whistleblower protection laws, and • Require financial regulator examinations to consider such companiesʼ • suspicious lawsuits to silence consumer watchdog groups and sites. These groups and sites play a key role in bellowing these important smoke signals. The cause of consumer financial literacy would be well served if governmental regulators reinforced rather than undermined private market regulation. Thank you for the opportunity to comment. If you have any questions or need additional information, please do not hesitate to contact me at 202-742-5949 ext. 101 or by email at [email protected]. Respectfully submitted,

J. Bradley Jansen, Director Center for Financial Privacy and Human Rights Center for Financial Privacy and Human Rights [email protected] PO Box 2658 Washington, DC  20013-2658 Tel. 202-742-5949 ext. 101