Consequences of the Crisis

Assessing the Legacy of the Great Financial Tempest
   Monday: Banking   |   Tuesday: Housing   |   Weds: Wall St.   |   Thursday: The Fed   |   Friday: Consumers

The Financial Crisis and Consumer Protection

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Elizabeth Warren
Professor of Law, Harvard University
Friday, September 18, 2009; 10:30 AM

On Monday, Sept. 15, 2008, investment banking firm Lehman Brothers filed for bankruptcy protection, kicking off a week of massive shifts on Wall Street that was the beginning of the largest financial crisis in recent memory.

Harvard University Law Professor Elizabeth Warren was online Friday, Sept. 18 at 10:30 a.m. ET to discuss the effect the the steps the government has taken to protect consumers and her efforts to reform the industry's credit and mortgage practices.

How has the recession changed your spending habits? Are you saving more and spending less? What do you think of the proposed consumer protection agency? And do you think the new credit card reform legislation will be effective? We want to hear from you.

A transcript follows.

Professor Warren is the Leo Gottlieb Professor of Law at Harvard University. She currently serves as the Chair of the Congressional Oversight Panel of the Emergency Economic Stabilization Act for TARP and TALF funds. Warren has written nine books and more than a hundred scholarly articles dealing with credit and economic stress. Her latest two books, "The Two-Income Trap" and "All Your Worth," were both on national best seller lists.

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Elizabeth Warren: Hello. This is Elizabeth Warren. Thanks for joining me. I've never done an online chat before, so go easy on me. I'm looking forward to answering your questions.

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Portsmouth, N.H.: Professor Warren, I greatly respect the wisdom you've offered in your book, "The Two-Income Trap" and on your TV appearances. I trust your advice. It just makes sense. So, do you think health-care reform will help the average person's economic picture? With wages stagnant, pensions gone, a decade of 401(k) growth essentially wiped out, and businesses looking to employees to cover more health-care costs, it seems like consumers are never going to get to a point where they can actually save money for the future.

Elizabeth Warren: I'm glad you liked the book (great place to start).

The problems that got families into financial trouble came from many directions: stagnant wages, medical costs, higher ed, housing. That's the bad news, but it is also the good news in terms of remedies. If we can reduce the burden on families when they hit serious medical problems, their overall financial security will improve.

People in Washington often talk about health care and economic security as if they were entirely separate issues. The pieces are all tied together.

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Chicago: What will prevent the banks from manipulating a new consumer finance agency in the same way they manipulate the existing agencies that were supposed to be watching over them?

Elizabeth Warren: Currently the banks get to choose their regulators. If they don't like the way they are treated by the OCC, for example, they can change their charter to the OTS or to a state charter. That creates regulatory arbitrage--playing off one regulator against another. And the regulators really care--their budgets come from the banks they regulate. As a result, regulators compete to attract business by offering to be very FRIENDLY regulators. And serious regulation came unraveled.

The CFPA is a single regulator. Anyone that wants to issue a mortgage, for example, will have to follow the same set of rules. Anyone wanting to do a credit card will face the same regulations. There is no competition among the regulators to regulate least, and that takes away the power the banks have to control the process.

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New York: Aren't many of the economic problems of our times due to the fact that the stakes have never been higher because things (e.g. banks) have never been bigger?

Elizabeth Warren: Too-big-to-fail is one of the biggest problems we face right now. Until we can say with real credibility to a big financial institution: "You blew it, and now you die" then we've lost the discipline that markets were supposed to provide.

I think dealing with systemic risk regulation is less about whether one person or five people have oversight to monitor risk and more about whether bankruptcy is a meaningful risk for the big players.

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Delray Beach, Fla.: Is there any way I can re-coup my $10,000 in Fannie Mae...and my $20,000 in GM. Bondholders were supposed to be paid first. I'm 85 years old and really need this money. Thank you.

Elizabeth Warren: I can't help you, but your story makes it clear how deeply unfair the current system is. If you had been holding credit default swaps from AIG, you would have been repaid in full, using taxpayer dollars. But because you hold GM bonds, you got pennies on the dollar. Both companies were insolvent, both had secured creditors (CDS or bonds), and both got TARP money to restructure. But only one paid its creditors in full.

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Muskogee, Okla.: What is your opinion of huge banks who lessen consumers credit ratings by lowering credit limits on those people who have absolutely nothing negative in their credit reports, i.e., have no late payments, no minimum payments only, are not overburdened by total debt beyond their means to repay, etc., and who are very unlikely to be affected by the current job losses? Is this not extremely unfair to that segment of the population who is doing everything right? And isn't it also destroying the ability of small businesses owned by those same people to finance growth and recovery of our economy?

Elizabeth Warren: I think the whole credit rating system needs a serious overhaul. First, though, the practice that the banks have engaged in--driving up costs for people who have performed in full under their contracts--is wrong.

I don't want to sound like a broken record, but this is another reason why we need a consumer agency. Someone has to ride herd over these banking practices.

PS I spent all my teenage summers in Muskogee working in my aunt's Mexican restaurant. I love that place.

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Annapolis, Md.: I believe that Credit Scoring (using Beacon and FICO scores as a benchmark to determine whether to lend to consumers) will cause the recession to be prolonged. Has anyone looked at the role credit scoring will play on the outcome of this recession?

Elizabeth Warren: I understand the need for risk-based pricing. People who have bad payment histories deserve to pay more. But our current credit scoring has expanded beyond that purpose. Credit scores are now used by some companies to determine what people pay for homeowner's insurance or whether they can get a job.

Credit scoring can also create a snowball effect--a credit ding increases the cost of credit, and as costs go up, people fall further behind. The snowball can work in other ways too: If a company lowers your line of credit and that lowers your credit score, the company now has an excuse to raise your interest rate. The credit card bill got rid of some of the worst practices in this area, but there is still lots of room for manipulation.

So far as I know, no one is doing the research on the role credit scoring will likely play on the outcome of the recession or who gets hit the hardest. I think this is an important issue.

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Arlington, Va.: Do you think our economy is based on consumer spending? And do you think that's a sustainable model? Should we be encouraging people to spend more or save more?

Elizabeth Warren: Yes, about two-thirds of our economy has been based on consumer spending. I think this is unsustainable. In fact, I KNOW it is unsustainable.

I think we have to produce more. The President has pushed this point, and I agree with him on this.

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Baltimore: What does a term like "recovery" mean to the average person when unemployment is still so high?

Elizabeth Warren: I wonder the same thing.

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Arlington, Va.: Liz,

At the last TARPCOP hearing, you were asking Treasury Secretary Geithner for the details about how they conducted their stress tests. You have also said that there should be ongoing stress tests on the nation's banks. If the Treasury does give you that information are you intending to conduct your own stress tests? Do you realize the potential for that to cause runs on the bank?

Elizabeth Warren: I'll never get enough information to run a stress test myself. The bank examiners keep all of those data private. But COP can 1) evaluate those tests to see if they are robust, and 2) ask that they be repeated (perhaps in stronger form).

I don't think that knowing the results of stress tests will cause runs on the bank. Depositors are fully insured. Commercial debt and shareholders should already be monitoring their banks. In fact, I think the reasoning works the other way: If investors don't have confidence in whether these banks have been adequately tested, then many of them will continue to sit on the sidelines.

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Woodbridge, Va.: Instead of holding votes on the financial regulatory reform legislation this month, Chairman Frank has announced another round of hearings to go over issues that have been discussed at dozens of House and Senate hearings this year. The proponents of increased regulation seem to be in retreat. Will anything meaningful be enacted or has Wall Street won?

Elizabeth Warren: The bank lobbyists are out in full force. They are calling, writing, paying personal visits every single day. The message may be worded differently, but it is always the same: We don't need real change, just trust us. Of course, that's what they said a year ago, two years ago, and three years ago. "Everything is fine."

Banks have won nearly every battle in the past, but I genuinely think the people are going to win this time. My reasoning is simple: We can't afford business-as-usual any longer, and people understand that. I can't imagine that anyone in Congress thinks they can go home to their voters next year and say "We gave $700 billion to the banks to deal with this crisis, and we changed nothing."

I think people are looking at this backwards. Creating a new agency and getting real reform done in a few months in Washington is moving at the speed of light.

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Las Cruces, N.M.: Noticed your name as the "Anti-Czar" list as "The T.R.A.P. Czar"

Since Czars haven't been this much in the news since 1917 with the Romanovs, I was just curious how you respond to this latest sideshow?

Elizabeth Warren: My brother called me to ask how I got to be a Czar. I said I didn't know since I was appointed during the Bush administration and given this job by Congress. He was disappointed, but, on the bright side, he thought my picture looked good.

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Philadelphia: What do you recommend for someone who paid credit cards off every month, which I thought made me a good customer, but I guess the credit card companies thus weren't making any money off me, and I now see my credit limit drastically reduced. It has been possible for me to exceed that limit in a month's spending. Now I will be hit with penalties and this will wind up costing me more.

Elizabeth Warren: What can you do? So long as the credit card companies are in charge, without real oversight, doing your part of the contract is no guarantee that you are protected. Somewhere in the 30-page contract they reserved the right to change the terms of the deal whenever they want.

I'll say it again: We need a consumer agency.

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Columbia, Md.: As the former administrator of a small but active regulatory agency to protect consumers I am a true believer in good regulation makes a good marketplace. That has not been the thinking in Washington since the Reagan Administration. What makes you believe that a political appointee in this administration would actually attempt regulation? Right now there have been few perp walks by the people that brought us this recession and the same people are in power in the financial marketplace.

Elizabeth Warren: We complain about our agencies, and they have failed us in significant ways. But before we decide that nothing can ever get better, take a deep breath.

For all their faults, do we think that the FDA has had no impact? Do we want to go back to a world in which anyone with a bathtub and a bunch of chemicals could be a pharmaceutical company? How about the Consumer Product Safety Commission? How many people are alive today because infant car seats don't collapse? How many people have two eyes instead of one because their older brother didn't shoot them with his BB gun? And the list goes on: OSHA, EPA, SEC.

No, regulation isn't perfect. And sometimes the failures are monumental (thank you, Bernie Madoff). But I'd take an imperfect FDA, CPSC, or even SEC over no FDA, CPSC or SEC any day.

The key is that we need to hold people accountable. I want to see a real face at the front of each agency. No more hiding out. I want someone to be responsible directly to the American people, responsible for explaining how his or her agency is meeting its public obligations and taking the blame if they fail.

We may never be perfect, but we can do a lot better.

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Elizabeth Warren: Thanks for doing this with me. I'm sorry I couldn't answer all the questions (there were some really good ones), but I'm headed off to another meeting.

Ask me back sometime.

ew

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