Recent Developments in Federal regulation of Consumer Financial Products and their Implications for Consumer Well-Being

M A X I M I L I A N D . S C H M E I S E R F E D E R A L R E S E R V E B O A R D O F G O V E R N O R S D I S C L A I M E R : T H E V I E W S E X P R E S S E D H E R E A R E S O L E L Y M Y O W N A N D D O N O T N E C E S S A R I L Y R E P R E S E N T T H E V I E W S O F T H E F E D E R A L R E S E R V E B O A R D O F G O V E R N O R S , T H E C O N S U M E R F I N A N C I A L P R O T E C T I O N B U R E A U , O R A N Y O T H E R A G E N C Y O F T H E F E D E R A L G O V E R N M E N T

Overview

   Numerous legislative and regulatory changes related to consumer financial products and services prompted by recent economic crisis  Including the elimination of one regulator (Office of Thrift Supervision) and creation of another (Consumer Financial Protection Bureau) Changes resulted from perception that financial institutions were engaging in predatory and deceptive practices to exploit consumers Also to address the systemic risks posed by large financial institutions

Overview

 As a result, consumer financial service market is changing:  Banks need to develop new sources of revenue to offset losses due to regulations   Reevaluation of lending practices/tighter credit (particularly for mortgages) Consumers have experienced mortgage defaults and foreclosures, delinquency on credit, declines in asset values (particularly home equity)  Consumers are changing their financial behaviors

Overview

 Regulators are also changing   Sense that all the regulators failed to adequately protect consumers over the past several years Missed signs of the impending financial crisis   Got overly attached to a free market ideology Reforming practices to be stronger enforcers and more attentive to the needs of consumers  Taking a consumer-centric approach to the design and development of rules, regulations, and disclosures

Agenda

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Recently passed legislation and what it means for consumers CARD Act Dodd-Frank Act The Consumer Financial Protection Bureau (CFPB) Recent regulatory changes/initiatives to help consumers Using research to inform regulation Summary Questions

The CARD Act

    Signed into law May 2009 Most provisions took effect February 22 nd , 2010 Arose from perception that certain practices in the credit card industry were not fair and transparent to the consumer Curtailed many credit card fees and practices

The CARD Act

 Specific provisions of the CARD Act:  CC company must send you a notice 45 days before they can increase your interest rate; change fees (annual fees, cash advance fees, and late fees); make significant changes to the terms of your agreement  Improved disclosure of costs of making minimum payment, interest paid, etc  Over-limit transactions are now opt-in and only one fee per billing cycle can be imposed   Cap on card fees at 25% of initial credit limit Under age 21 need to show proof of ability to pay or need co signer

The CARD Act

 Specific provisions of the CARD Act (continued):  Standard payment dates and times (i.e. minimum 21 days between statement date and payment due; due date same day each month; payment cut-off time 5pm or later on due date; if payment day falls on a weekend or holiday due next business day)      Any payment above minimum must go to highest interest balance first Banned double cycle billing (We couldn’t figure out how to explain that to consumers) Late payment fee cap of $25 or your minimum payment, whichever is less No inactivity fees Interest rate fixed for first 12 months unless adjustable rate

Consequences of CARD Act

  Credit card companies responded by:  Making nearly all credit cards variable rate    Increasing minimum payments to $25 Promoting business/professional cards, which were not subject to the CARD Act Reintroducing annual fees   Minimum finance charges Increased balance transfer fees/foreign transaction fees  Complaining about lost income Consumers now have protections against many questionable practices, lower costs, transparent fees

Dodd-Frank Act

     “The Wall Street Reform and Consumer Protection Act” 800+ page law with hundreds of new rules, regulations, mandated reports, agencies, oversight, etc.

Much of it related to regulation of banks, financial institutions, insurers, and other “systemically important” entities, as well as financial markets Abolished OTS (“dysfunctional” regulator of IndyMac, AIG, WaMu, etc) Created CFPB

Dodd-Frank Act

 Dodd-Frank Rules for Mortgage Market:     Prohibit mortgage originators from receiving compensation that varies based on loan terms; eliminates yield spread premiums (selling consumers high cost products) Requiring reasonable ability to repay the loan, and that credit decisions be based on verified financial resources (should have been done in the first place) Define minimum underwriting standards for various types of mortgages Limiting pre-payment penalties   Adding new mortgage disclosures Define Qualified Residential Mortgage (banks can securitize without holding 5%)

Dodd-Frank Act

 General consumer related rules:  Limit debit interchange fees (Durbin amendment)  Right to obtain credit score if it negatively affects them in a financial transaction or hiring decision  Increases deposit insurance from $100,000 to $250,000 for each account  Improve disclosures for remittances

Durbin amendment

    Federal Reserve charged with setting debit interchange fees that are “reasonable and proportional to the cost of processing debit transactions” Proposed limit of $0.12 down from average $0.44 for banks over $10 billion in assets   Not clear can have higher price for smaller institutions May increase in final rule Expected to cost banks about $12 billion in fees each year  Either transferred to retailers or consumers (or both) through lower costs/prices Recent attempts to delay Durbin defeated in Senate, now on to courts

Dodd-Frank Act

 Effect on consumers-mortgage market:     Unclear what the implications are in the mortgage market since private market barely functioning Long-term may limit availability of mortgages to high-risk consumers; raise interest rates for all consumers Effectively bans balloon payment mortgages, restricts availability of interest only and negative amortization loans (need cash on hand to pay off balloon to qualify, loans underwritten using worst-case-scenario assumptions, or even worse than worst case) Designation of qualified mortgages (those for which banks do not need to have “skin in the game” of 5%)

Dodd-Frank Act

 Effect on consumers-banking:  Debit interchange fee cap most significant proposal  Banks will seek to recoup lost revenue through account maintenance fees, reduced or eliminated debit rewards, etc  Major effect on consumers comes through the new role of the CFPB in regulating financial institutions

The Consumer Financial Protection Bureau

    Created as the regulator who’s primary emphasis is protecting the consumer Consolidates consumer protection functions of numerous other regulators under one roof Tasked with monitoring most aspects of the consumer financial market for unfair, deceptive, or abusive products and services  Payday loans, check cashers, money transfer companies, etc Has significant authority to regulate many aspects of the consumer financial market

The Consumer Financial Protection Bureau

 Also has primary responsibility for educating consumers about financial issues and receiving consumer complaints about financial products:  Has branch dedicated to financial literacy/financial education   Has branches specifically focused on the issues facing: students; older Americans; and service members Is required to launch a consumer complaints hotline on July 21 st , 2011 and attempt to resolve these complaints

The Consumer Financial Protection Bureau

The Consumer Financial Protection Bureau

 Key staff:  Director has yet to be named    Raj Date heads Research, Markets, and Regulations Division Gail Hillebrand heads Consumer Education and Engagement Division Holly Petraeus Assistant Director for Service Member Affairs   Sendhil Mullainathan Assistant Director for Research Richard Cordray, Assistant Director for Enforcement   Patricia McCoy, Assistant Director for Mortgage and Home Equity Markets Zixta Martinez, Assistant Director for Community Affairs

The Consumer Financial Protection Bureau

 Off to rocky start:  Many key staff have yet to be named  Unclear that a director will be in place by July 21 st recess appointment assuming Republicans recess) (only option  Limits ability of CFPB to write certain regulations and supervise certain types of financial services institutions  Agency is political flash point—push to change from director to board; subject it to appropriations (now funded by Fed); allow FSOC to veto rules/regulations with majority vote (instead of 2/3rds)

The Consumer Financial Protection Bureau

 Short-term implications:  Other agencies (Fed) getting out of financial education—extent of efforts unlikely to be fully replicated anytime soon  Delays in implementation of various regulations  Long-term implication:  Uncertain future for CFPB    If subject to appropriations may be unable to fulfill all it’s duties (think SEC) Senate approval of any director highly unlikely If Obama loses in 2012 may be significantly altered

The Consumer Financial Protection Bureau

 Implications for consumers:     Won’t have the strong “cop on the beat” envisioned by consumer advocates Products that were expected to be regulated may not be due to lack of a director Agency seems intent on research and testing driven disclosures, so likely to improve disclosures (clear, concise, useful) Consolidation of TILA/RESPA disclosures for mortgages

Other Recent Regulatory Changes for Consumers

 Overdraft fees on checking accounts:  Federal Reserve issued new rules that limited banks ability to charge consumers overdraft fees on ATM and debit transactions   Overdraft now an opt-in rather than opt-out (or no choice) account feature Consumer can cancel (or opt-in) anytime  Doesn’t apply to checks and direct-debits

CONSUMER TESTING

Using Research to Inform Rules & Regs

    Many of our consumer financial protections rely on disclosures to consumers so that they can make the optimal decision for themselves In the past many such forms were designed by lawyers with little input from consumers However, more recently extensive consumer testing has become the norm for revising existing disclosures or creating new ones Now mandated by Dodd-Frank

The Situation

Exposure   Attention Decision making  Comprehension  Memory • • Consumers don’t read disclosures Consumers don’t understand what they’re reading Disclosures that are not read or cannot be understood are not disclosures.

The Constraints

• • •

Limited flexibility

Statute and regulations requirements e.g. opt in vs opt out Not starting with a “blank sheet” •

What consumers

want

vs what consumers

need

The Goal

• • • • •

What do we want consumers to do or to know after reading this disclosure?

Shopping?

Make a decision? Do something?

Understand risks?

The Means to the End

• • • • • • Consumer testing Focus groups One-on-one cognitive interviews Usability interviews On-line evaluation Quantitative validation studies • • In-person On-line

THE CONSUMER TESTING PROCESS

What is “Consumer Testing”?

• • Government agencies are increasingly using consumer testing to design and validate disclosures • Agencies generally test model forms to ensure that they “work” for consumers Once released, model disclosure forms represent a “safe harbor” for institutions

Goals of Consumer Testing

  The Dodd-Frank Act requires that every new model form is tested with consumers to ensure that it:  (A) uses plain language comprehensible to consumers;  (B) contains a clear format and design, such as an easily readable type font; and  (C) succinctly explains the information that must be communicated to the consumer.

Testing also ensures that disclosures can be effectively used to make decisions

Three Strategies Used in Testing

• Focus Groups: Discussion sessions held with 8-12 people +: Good for exploratory questions, brainstorming, gathering ideas or info about consumer attitudes and behavior -: Not ideal for in-depth analysis of how consumers read a document or whether they understand the content

Three Strategies Used in Testing

• In-Depth Interviews: Interviews conducted with one (or two) people where they are shown documents +: Allow interviewer to measure understanding of a document, and probe areas of confusion -: Do not produce quantitative, statistically significant data

Three Strategies Used in Testing

• Large-Scale Experimental Tests: Shorter interviews done with large numbers of people +: Provide precise and definitive answers to specific questions -: Can only answer very specific questions; expensive

Structure of In-Depth Interviews

• • Interviews are usually 60-90 minutes long One round of cognitive interviews often represents feedback from 7-10 people • If testing is conducted rigorously, that number is sufficient to detect most usability problems

Types of Interview Questions

  Observational (think-aloud)  “Review this document just as you normally would, and as you do tell me what you are thinking.” Comprehension  “If you used this card to buy something at a store, what interest rate would you be charged?”

Types of Interview Questions

  Use in Decision-Making  “Look at these two mortgage loan offers. Which of the two loans would you choose, and why?” Preference  “Which of these two forms do you think is clearer and easier to read?”

Iterative Rounds of Testing

• • • • • • • • Testing is usually an iterative process: Draft form is developed Form is tested with consumers Based on findings, form is revised Revised form is tested again…, etc.

Eventually, form is finalized Number of iterative rounds can vary Timeline can vary from one month to several years

General Findings from Testing

   Consumers don’t read disclosures carefully  Need to highlight key pieces of information Adding more information can decrease understanding Disclosures often must serve consumers with different needs  e.g., More vs. less savvy mortgage borrowers

General Findings from Testing

  “Plain language” makes a difference  “Finance charge”  “Fees and interest”  “Default rate”  “Penalty rate” Disclosures don’t always work  Sometimes it proves impossible to explain things to consumers, even using plain language

USE OF CONSUMER TESTING

www.consumerfinance.gov/ knowbeforeyouowe/

Evolution of the Privacy Notice

Evolution of the Privacy Notice

4/29/2020

Evolution of the Privacy Notice

46 4/29/2020

Evolution of the Privacy Notice

4/29/2020

Evolution of the Privacy Notice

4/29/2020

Evolution of the Privacy Notice

4/29/2020

Testing Considerations

    Language/word choice  Plain language  Meaningful language Design testing  Part to whole  Frame (e.g. Why, What, How) Usability testing  Understand content Validation testing – does it work for general population?

 Decisions consistent with preferences 4/29/2020

The Results

• • Identifying what works Can consumers meet the goal for the disclosure?

• • Addressing what does

not

work Identify alternatives – e.g. modify regulations 4/29/2020

The Issues

• • • Transparency Iterative drafts vs final drafts Reports on testing • www.federalreserve.gov/econresdata/ consumerresearch_testing.htm

• • Interpretation Can you read the results differently?

4/29/2020

Credit Cards

Rates Fees

Privacy Notices

Overdrafts

Using Research to Inform Rules & Regs

   Can expect much more consumer, consumer advocate, and industry input into the design of future disclosures CFPB has also promised to be “data driven” in its design of rules and regulations and in their enforcement of these rules  Created separate research sections for households, firms, consumer testing and fair lending Federal Reserve has long been research centric, but is now expanding its consumer financial research unit to include ongoing monitoring of the consumer financial market

Summary

    Financial crisis and its impact on consumers prompted numerous laws and regulations to protect consumers These changes will have both positive and negative effects on consumers  Always unintended consequences Creation of the CFPB potentially represents a positive advancement in consumer protection  Need to get it working first Research and testing will be central to the development of new rules and regulations

Thank You

Contact Information: Maximilian D. Schmeiser Economist Consumer Education & Research Section Division of Consumer & Community Affairs Federal Reserve Board of Governors Phone: 202-728-5882 Fax: 202-785-6085 Email: [email protected]