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Public Policy Analysis & Opinion Modernized chickens come home to roost Federal preemption in financial services without establishment of national rules invites trouble By Kevin P. Hennosy The English word “radical” comes from a Latin word radix, or root. A radical response attacks something at its roots. That little bit of etymology came to mind this summer when, in a moment of giddy frivolity, I found myself watching an online video archive of a House Financial Services Committee meeting. Just call me Captain Excitement. On June 13, 2007, Massachusetts Banking Commissioner Steven L. Antonakes observed, “The states have been innovators in the area of consumer protection. Nearly every consumer protection regulation that exists at the federal level, or that Congress is currently contemplating, has its roots at the state level.” The Congressional leadership’s view of financial services regulation has changed drastically since the Democrats took control of Congress in January 2007. Across the financial services sector, the Congress is building a case for more active government oversight. The Democrats are not seeking to undo the radical changes made to financial services oversight during Republican control of Congress, but they are trying to reinstitute consumer protections that, in some cases, were preempted out of existence by federal agencies. Even some influential Republicans on the House Financial Services Committee believe that deregulation through preemption went too far, particularly in the area of banking. The optional federal charter proposal threatened to do the same thing to insurance. Beginning in the mid-1990s, lobbyists representing the financial services sector launched a concerted effort to bring about radical change—not reform—to financial regulation. In most cases this effort meant securing or encouraging the use of existing preemption powers for federal agencies to push aside state consumer protection frameworks that Commissioner Antonakes referred to, while dissuading against the creation of federal frameworks. Banking lobbyists, aided by skillfully placed litigation and a generation of judicial appointments with a consumer-skeptical bias, achieved the greatest success. The Office of Comptroller of the Currency (OCC) took up the bankers’ cause by asserting preemption powers to negate state consumer protection efforts, including those related to bank sales of insurance. The proposal to create an optional federal charter for insurance companies would have extended the preemption effort to large swaths of the insurance sector. The entire effort was referred to as “modernization.” At the June 13 hearing, both Chairman Barney Frank (D-Mass.) and Ranking Member Spenser Bachus (R-Ala.) used their opening statements to decry the consumer abuses that followed the preemption campaign. A flock of modernized chickens has come home to roost. Both Representative Frank and Representative Bachus lamented the fact that preemption efforts could not be “unwound.” Frank explained that if Congress passed legislation that prohibited preemption, President Bush would veto the legislation. Again, according to Frank, by the time the Congress could send legislation to a new president, it would be too disruptive to business to undo what preemption has done. So, Representatives Frank and Bachus agreed that with banking and affiliated activities shielded from most state-based consumer protections, the federal consumer protection efforts had to be beefed-up. “We have bitten off 50 heads, and we do not have the brain power to replace them, “ said Representative Frank. The chairman praised the state-based consumer protection framework and opined that elected attorneys general and insurance commissioners were far more motivated to help consumers than appointees. He said that agencies on the federal level lacked funding, staffing and statutory frameworks for consumer protection. Some of the assembled lobbyists must have thought: “That is the point.” Chairman Frank then attempted a little preemption of his own. He told the federal agency officials who were about to testify that he would not accept the argument that “safety and soundness” standards provided federal officials with the only authority they needed to provide consumer protection. He explained that some abusive activity actually enhanced safety and soundness of financial institutions. He promised that the committee would look at providing federal agencies the legal authority and resources (including the ability or responsibility to work with state officials) to do the job. He also warned witnesses to keep their hands on the table and resist pointing fingers at one another. In addition to legal authority and resources, the chairman called for a change in attitude at federal agencies. He shared a story about former Federal Reserve Chairman Alan Greenspan, who once said that he showed concern for consumer protection because he “always followed the staff recommendation on that.” Chairman Frank pointed out that Chairman Greenspan would never merely follow “staff recommendations” on monetary policy or interest rates. Ranking member Bachus echoed the chairman’s concerns. He stated that the only way that federal preemption frameworks could work was if the federal agencies had the ability to replace state frameworks. He said that in the absence of the traditional frameworks, financial institutions had adopted “sharp practice” that ran counter to business norms. Representative Bachus also left the witnesses with a warning: “Financial literacy and disclosure is not an end all, do all.” After opening statements by committee members, the hearing heard from one panel of witnesses, which consisted of federal banking “supervisors” and the chairperson of the Federal Trade Commission (FTC), Deborah Platt Majoras, as well as the Iowa Attorney General Tom Miller and Commissioner Antonakes. With the exception of state officials and the FTC chairman, the witnesses proved resistant to accepting new statutory authority or resources. Testimony by Randall S. Kroszner, a member of the Federal Reserve Board of Governors, was the first to violate Representative Bachus’s warning. Governor Kroszner assured the committee that current laws protected consumers: “Many of these laws are based on ensuring that consumers receive adequate information in the form of disclosures about the features and risks of a particular product.” The hearing went down hill from there. Comptroller of the Currency John C. Dugan insisted that it was possible to have “too many cops on the beat.” He insisted that national banks were heavily regulated, although he stressed that the quality of oversight should not be judged by the number of enforcement actions. Dugan described a system of financial regulation that in the insurance sector is known as jawboning: “Come on, please behave, you are making us look bad.” Scott M. Palakof of the Office of Thrift Supervision delivered testimony which focused on examinations that are based on safety and soundness. Palakof made it clear that he believed that this approach could meld oversight of financial condition and consumer protection, in contradiction with the view expressed by the committee leadership. Ms. Platt Majoras’s testimony on behalf of the FTC stood in stark contrast with the other federal agencies. The commission, which falls under the oversight jurisdiction of another House committee, certainly provided the committee with an example of what nationally uniform and effective oversight could look like. At present, the FTC does not have jurisdiction over depository institutions, life insurance or the business of insurance regulated by state law. Iowa Attorney General Miller urged the Financial Services Committee to use its oversight authority to strengthen financial oversight. He testified that the recent Supreme Court rulings in favor of OCC preemptions of state law had changed business practices for the worse. He still would like Congress to try to pass legislation that would reverse the preemption doctrine with regard to the OCC altogether. He expressed concern that federal agencies were unable to meet the volume of consumer complaints or to manage and process complaint data. Attorney General Miller opined that the federal agencies do have authority that they are not using with regard to banning abusive practices or driving investigations based on consumer complaints or industry data. There appeared to be a working majority in favor of moving forward with drafting one or more pieces of reform legislation aimed at increasing federal facilities for consumer protection in financial services. The days of Congress tying states’ hands and providing no federal framework to fill the void appear to be over. All-perils coverage At the June 13 hearing, several members of the committee made reference to the difficulty that consumers have in figuring out where in the federal government to file complaints about financial institutions. At a July 17 hearing on insurance, the Housing and Opportunity Subcommittee of the Financial Services Committee turned its attention from regulatory roulette to coverage roulette, and they were just as disappointed. This hearing focused on HR 920, The Multiple Peril Insurance Act of 2007. The legislation would amend the National Flood Insurance Program to combine flood and wind damage coverage into a single policy. The bill’s sponsor, Representative Gene Taylor (D-Miss.) explained the need for his legislation by pointing to the actions of State Farm Insurance after Hurricane Katrina. “Two weeks after Katrina, State Farm issued a Wind/Water Claim Handling Protocol that instructed its adjusters that “Where wind acts concurrently to cause damage to the insured property, coverage for the loss exists only under flood coverage, when available.” In the words of Representative Taylor, “State Farm took the position that covered wind damage became uncovered flood damage once the water reached the property.” Call it the alchemy of risk, or call it bait and switch—in either case Representative Taylor is not happy. The National Association of Insurance Commissioners sent Kansas Insurance Commissioner Sandy Praeger to testify in support of the concept of HR 920. In addition, the NAIC testimony suggested expanding the proposal to include other natural disaster coverage, such as fire and earthquake. “Consumers expect all-perils coverage and, in some cases, they incorrectly believe they have it,” Praeger said. “We think Rep. Taylor’s proposal should be considered in the broader context of natural catastrophes, and today we offer some alternative concepts to consider.” The NAIC offered the subcommittee four key principles to shaping an effective program: • A national program should promote personal responsibility and preparedness among policyholders; • A national program should support reasonable building codes, development plans, and other common-sense mitigation tools; • A national program should maximize the benefits and strength of the private markets, and; • A national plan should enable the government and decision makers with quantifiable risk management. “Our current policy is inefficient and discourages personal responsibility and risk avoidance by relying too heavily on the federal government. Providing consumers with all-perils coverage would unify these disparate approaches under one policy, shifting the burden off the consumer. Structuring such coverage with federal involvement could help pre-fund the government’s involvement when a large disaster occurs, and capitalize on the government’s ability to spread the risk over time,” Praeger testified. Commissioner Praeger suggested something that readers of this column will remember being proposed here in several editions of Rough Notes—the creation of a federal reinsurer of last resort, which the NAIC would limit to natural disaster coverage. Commissioner Praeger suggested the National Flood Insurance Program (NFIP) could be restructured to function as a reinsurer. By doing so, any debate over what might have caused the loss would be between the insurer and the NFIP, not the consumer. Alternatively, the private market could offer all-perils coverage and be supported by a federal backstop or credit line that would cap the industry’s share of such catastrophic losses—helping insurers manage their claims-paying ability while keeping insurance affordable for consumers. These proposals could be structured to leave the private market as the first line of defense, while recognizing the roles of state and the federal government in managing natural disasters. Just as the Federal Reserve system does not preclude a private system of interbank loans, a reinsurer of last resort could provide primary insurers with the flexibility of spreading the risk of potential losses across the entire country. In addition, such a reinsurance function could provide a facility that enhances national harmony and efficiency in shaping forms and policy language. The approach would do much to eliminate confusion among consumers. With reinsurance coverage through the expanded flood program, flood and other perils could be rolled into the homeowners coverage, which would increase customer satisfaction and reduce incentives for litigation. * The author |
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