Case Tests Federal Supremacy Over Banks
Supreme Court to Hear Arguments Next Week in States' Challenge to 'Preemption' of Regulation

By Kirstin Downey
Washington Post Staff Writer
Saturday, November 25, 2006

The federal government and the banking industry will square off next week in the Supreme Court against all 50 states and the District of Columbia in a mortgage-lending case that could have broad implications for business regulation.

The case, Watters v. Wachovia Bank, focuses on the lending industry. But the broader question it addresses is whether federal regulators can essentially tell state regulators to go away. It's a debate over what is called "preemption." How the court resolves the dispute could affect many other industries.

For more than two decades, states have regulated the mortgage-lending practices of state-chartered subsidiaries of national banks. The parent national banks are regulated by a federal agency, the Office of the Comptroller of the Currency. In 2001, the OCC ruled that state regulation was improper, saying that under federal law those lenders should be overseen by the federal government.

Some states regulate lending matters not covered by OCC rules. For example, Maryland is among the states that set limits on mortgage prepayment penalties.

In 2003, Charlotte-based Wachovia Bank decided that it wanted to be regulated solely by the OCC. It told the states where it runs mortgage lending companies that those firms would no longer register with state officials or abide by local rules.

Many national banks have criticized the patchwork of local regulation intended to stop predatory lending. Other banks have also announced their intention to seek regulation by the OCC alone. They say the proliferation of state and local regulations makes it almost impossible to standardize business practices to maximize efficiency, driving up the cost of mortgage loans and making the banks wary of entering communities with strict lending rules.

Linda A. Watters, Michigan's insurance and financial services commissioner, protested Wachovia's decision. Michigan and the other states say they provide consumers with better protection against predatory home mortgage practices than does the OCC. They say the banks prefer OCC regulation because it is friendlier to them and because the federal agency focuses on whether the banks are protecting investors and depositors instead of borrowers.

Wachovia sued Michigan, asserting that the National Banking Act of 1864 gives federal regulators supremacy over state laws. Wachovia won on the District and Circuit Court levels. Other banks similarly prevailed against state regulators in lower and appellate courts. Michigan appealed.

The Supreme Court took the unusual step of agreeing to hear the case, although the lower courts had agreed to grant control to the OCC. The high court seldom hears cases in which lower-court judges have been unanimous in their rulings. Now both sides wonder what the justices' decision to take the case may mean: Will they approve the preemption practice or overturn it?

The first clues are likely to emerge Wednesday, when oral arguments in the case are scheduled. Both sides have mustered support for their viewpoints.

The brief on behalf of all the major banking trade groups, including the American Bankers Association and the Mortgage Bankers Association, was co-written by John D. Hawke Jr., who was comptroller of the currency when the 2001 rules were drafted, and Theodore B. Olson, U.S. solicitor general from 2001 to 2004.

"We hope it's a signal to the court that the banking industry is unified in where we think this case should come out," said Gregory F. Taylor, associate general counsel for the American Bankers Association.

Other businesses say the issue affects them, too. "The power of Congress (either directly or through administrative agencies) to preempt state and local law is vitally important to business and to the national economy," the U.S. Chamber of Commerce wrote in its brief. "Accordingly, the Chamber and its members have a substantial interest in ensuring that this Court properly resolves the issues raised in this case."

Another brief in Wachovia's support, co-written by libertarian law professor Richard A. Epstein, asserts that tighter rules on mortgage lending can make loans more expensive and less available, as lenders leave markets or adjust rates to reflect higher costs.

The preemption issue has attracted the attention of many prominent jurists and legal scholars. At an American Enterprise Institute conference in April attended by former special prosecutor Kenneth W. Starr and appellate court judges Douglas H. Ginsburg and Stephen F. Williams, Epstein and other scholars proposed that other industries could also eek federal preemption from state and local laws.

Many states set their own rules on such issues as auto emissions and safety, workplace standards and product safety.

Michigan's side also has many supporters. Michelle Aronowitz, deputy solicitor general in the office of New York State Attorney General Eliot L. Spitzer, wrote the brief that was co-sponsored by the 49 other states, the District and Puerto Rico. It is rare for so many states to support a particular legal position, but they were eager to do so, said Dan Schweitzer, Supreme Court counsel of the National Association of Attorneys General.

"One of the roles of state AGs is protecting their consumers, and what the OCC has been trying to do is prevent state AGs from doing that with respect to a very important [group] -- state-chartered mortgage lenders that happen to be owned by banks," Schweitzer said.

The OCC "has a long history of siding with the industry," said John Ryan, executive vice president of the Conference of State Bank Supervisors, which supports Michigan. Sharing that view are a dozen consumer advocacy groups, which wrote in their brief that the banks are seeking to shelter themselves under the OCC, which they say "has shown little interest in ensuring fairness to consumers." Lenders say the OCC handles consumer complaints quietly, without prosecution, often solving the problems more quickly.

The case comes to a head in a changed political landscape. Last year, a three-judge panel of the U.S. Court of Appeals for the 6th Circuit ruled in Wachovia's favor. Judge Boyce F. Martin Jr. wrote for the unanimous panel that federal law gave the OCC power to regulate banks, but he noted that "Congress has not spoken precisely to the issue."

The Democratic victories in the midterm elections, however, may bring the issue to the fore in Congress. Rep. Barney Frank (D-Mass.), who is expected to become chairman of the House Financial Services Committee, which oversees banks, has sponsored legislation that would limit the OCC's reach over state consumer protections.