Bank Lawyer's Blog

A Bitter Blow To The Class Action Bar

In July, I quoted attorney Joe Lynyak's prediction that the Congressional Review Act would likely undue the CFPB's arbitration rule. Last week's action by the Senate to rescind the rule made Joe a prophet, and not one of those depressing prophets who encourage the donning of sackcloth and the wallowing in ashes, but a prophet who, since we were both together at a conference when the Senate sealed the rule's fate, will down a glass or two or three of red wine with you while you toast both the action of the Senate and the coming firestorm of sheep-bleating from Warren & Co. over what a heinous batch of evil-doers the Rep-thug-licans are.

Advocate for the American consumer and, well, for Americans in general, Al Jazeera (yes, the Al Jezeera that is a media enterprise owned by the government of Qatar, not the Al Jazeera who is a guy who owns a hookah lounge in Detroit) was representative of the critics. Under the subtitle "Banks Rob Consumers," contained in a larger article excoriating The Orange Lord, these unbiased observations were unleashed:

Under the cover of night, the US Senate voted on Wednesday in favour of a rule rollback that could have a huge impact on American consumers.

The rule allows Americans to launch class-action lawsuits against big banks and credit-card companies in financial disputes. In announcing its implementation in July, the Consumer Financial Protection Bureau (CFPB) justified the change, saying it ensures consumers do not have to go it alone in disputes with banks and credit companies, which can cost an individual massive legal fees, sometimes in a dispute over a nominal amount.

The White House and Republicans in Congress disagreed, claiming the CFPB rule encourages trial lawyers to create "frivolous" lawsuits. Vice President Mike Pence made the trip to Capitol Hill to cast the tie-breaking vote in favour of killing the rule. Democratic Senator Elizabeth Warren called the decision "a giant wet kiss to Wall Street."

"Liz Warren: She knows a giant wet kiss when she sees, or gets, one." I smell a campaign slogan for 2020.

A less emotionally fraught analysis of the vote was attempted by the American Banker, which quoted a number of observers who, like our friend Mr. Lynyak, wondered why the CFPB's approach was so ham-handed.

"In an era in which the GOP runs both Congress and the White House, how could the CFPB not have seen the benefit of a more pragmatic approach that would have benefited consumers, and not just plaintiffs' lawyers?" said Richard Gottlieb, a partner at Manatt, Phelps & Phillips. "The CFPB arbitration rule demonstrates blind support for the failed class action device as an engine for change."

[...]

Jenny Lee, a partner at Dorsey & Whitney and a former CFPB enforcement attorney, said the repeal was a "huge lesson in lost opportunity."  

Critics noted that the CFPB's own study and other evidence rebutted claims (see Al Jazeera's above) that arbitration is "massively expensive," and results in lower awards to consumers than does class action litigation.

The industry repeatedly cited the CFPB's own study as a reason why the rule should be repealed because it found that consumers received just $32 on average from class action lawsuits, but $5,400 on average from a handful of disputes in arbitration.

The article outlines a number of ways in which the CFPB could have "tempered" the rule, from increasing transparency regarding the arbitration process and consumer choice, to giving the consumer the right to opt-out of arbitration. Of course, all this is Monday morning quarterbacking. The Congressional Review Act provides that the CFPB can not revisit the rule or attempt to impose a "substantially similar" rule in the future. So, could-a, should-a, would-a... So sorry, too late now.

Richard Cordray is neither stupid nor a politically inexperienced. Therefore, the best explanation I've heard for the handling of the arbitration rule by Cordray is still the one proffered by Mr. Lynak last July: "hubris." The kind of hubris that leads a man to think that he can change the mind of Donald Trump with a personal appeal.

If this the first in a series of future missteps by Mr. Cordray, then perhaps the Republicans should stop devoting so much effort to trying to find "cause" to dismiss him and let him hang around until his term ends next July.

Moral Hazard

I was struck by remarks made by FDIC Vice Chair Thomas Hoenig in a speech to an international conference earlier this month about the "moral hazard" presented by insured deposits and how regulators ought to confront that moral hazard. Luckily for me, credit union consultant Marvin Umholtz also noted Hoenig's address and I'll defer to Marvin, who expresses himself better than I. The following is from Marvin's "Hot Topics" email newsletter (to subscribe, email Marvin at [email protected]).

In October 11, 2017 remarks presented to the International Association of Deposit Insurers (IADI) during its meeting in Quebec City, Canada, Thomas M. Hoenig, the Vice Chairman of the Federal Deposit Insurance Corporation (FDIC) https://www.fdic.gov/news/news/speeches/spoct1117.html, spoke to the topic, “Deposit Insurance: Addressing Its Moral Hazard.” Among other comments, FDIC Vice Chairman Hoenig said, “In the more than 40 years that I have worked in bank regulation and supervision at the FDIC and the Federal Reserve Bank of Kansas City, as well as in monetary policy on the Federal Open Markets Committee, I have had the opportunity to observe firsthand the sense of security that deposit insurance gives bank customers and creditors, with the objective of providing increased financial stability. Unfortunately, I also have observed that deposit insurance, like any insurance system, inherently invites its own abuse – moral hazard – that can cause unintended serious destabilizing effects on an economic system. While this experience does not provide me with the ability to outline a fail-safe solution to remedy this conflict, it does offer me some insight on the matter that I want to share with you, my colleagues, here today. Deposit insurance serves a most useful purpose, and I am not implying that its use be discontinued because of the moral hazard side effects. I am suggesting, however, that we can mitigate those effects if we, as insurers and supervisors, insist on good oversight through sound bank supervision, reliable capital standards, and insurance pricing that holds banks accountable for the risk profile they choose.” Unfortunately, the U.S. federal government has a very poor track record for appropriately pricing deposit insurance risk.

 

During his remarks, FDIC Vice President Hoenig also discussed counter balances to moral hazard, effective supervision, and owner equity capital. Returning to deposit insurance pricing, he said, “The final tool I will mention for counterbalancing moral hazard involves the pricing of deposit insurance, specifically, the use of risk-based premiums against currently held assets. A well-designed risk-based premium system can help to mitigate moral hazard by making it more costly for insured institutions to undertake risky activities or practices. If institutions are faced with higher premiums for taking actions that expose the deposit insurance fund to greater risk, this can serve as a deterrent to excessive risk taking. Higher premiums for actions that expose DIF [FDIC’s Deposit Insurance Fund] to greater risk can serve as a deterrent to institutions that engage in excessive risk taking. Designing and implementing an effective risk-based premium system is not easy. It requires a great deal of data and sophisticated analytics to get it right. Even then, political realities make it difficult to charge adequately for the full risk exposure that well-connected, but high-risk, institutions may pose to the insurance fund.   For these reasons, it is important to keep in mind that risk-based pricing of deposit insurance should not be viewed as a substitute for strong supervision and capital standards, but rather as a potentially useful component under those circumstances that allow for the development of a robust premium system tied to risk.” This correspondent often wonders when credit union officials will get tired of repeatedly paying for the risk taking follies of their morally hazardous risk-inclined credit union brethren, and demand that the NCUSIF move to a risk-based premium as well.

 Hoenig's concern about "effective supervision" would be addressed by regulators having the "guts" (Honeig's term) to stand up to banks in boom times and sound the warning bell when undue risk is perceived, such as asset valuation bubbles. As to capital, Hoenig thinks that tangible equity capital ought to be the primary focus. Rather than trying to assign risk weights across the industry to specific types of assets, a process that Hoenig asserts costs billions of dollars and is often "gamed," risk weighting ought to be done by bank management, with the concurrence of regulators, an an institution-by-institution basis, based upon each institution's situation. I assume that the more tangible equity capital, the more risk that will be permitted, a form of "pay-to-play."

Hoenig's comments ought to be taken into account as Congress sorts through the "regulatory relief" that was proposed by the Trump administration in its Seven Core Principles announced earlier this year and that is embodied in the Financial CHOICE Act that made it through the House but lies fallow in the Senate. The concept of an "off ramp" from many regulatory restrictions for banks willing to maintain higher leverage ratios, a concept contained in the Treasury Deprtment's recommendations and in the CHOICE Act, might be gaining traction.

Cordray Certainly Does Not Have T-Rex Arms

While Republicans in Congress (except those with upcoming election contests in "blue" or "purple" states) are busy pushing legislation that would, if not exactly castrate the CFPB, at the very least push its singing range up from baritone to soprano, CFPB Director and future Ohio gubernatorial candidate Richard Cordray is making sure that his last year at the helm consists of one power grab after another. In addition to (1) banning the use of mandatory arbitration provisions in consumer financial agreements so that class action attorneys will not be denied their second Mercedes or their kids another year at Princeton, and (2) making sure that short term payday loans are no longer profitable for legitimate payday lenders (leaving the field open to the time-honored, street corner payday lenders named "The Lip" and "Squiggy"), Recess Richie is using the recent abysmal cyber security failures (as well as follow-up incompetence) of Equifax as an excuse to grab more power for the CFPB. While the CFPB has had supervisory examination authority over Equifax, Experian, and Transunion since 2012, the FTC is the regulator with authority for enforcing cybersecurity compliance over the Big Three credit reporting agencies. Unfortunately, the FTC has no examination authority (nor examination staff, for that matter), it generally acts only after a foul-up.

Cordray wants Congress to put in place (paid subscription required) "preventive supervision authority" and "more robust standards" to ensure that cybersecurity breaches at the Big Three never, ever happen again. Either the FTC or the CFPB could be given such authority but, because the FTC does not currently have examination staff, Cordray thinks that the CFPB ought to be the agency assigned this task. I guess he assumes that the FTC would be unable to "staff up" like the CFPB did after it was created because...you know...well...uuummmm...Look! An eclipse!

Cordray also fails to explain why the agency with the greatest, and longstanding, expertise in cybersecurity issues (the FTC, in case you haven't been following) wouldn't be a more logical place to vest examination power. Perhaps he assumes that CFPB examiners can go to a trade association's course on cybersecurity, as the CFPB's attorneys did when they attended a banking law course to learn the basics about the industry over which they would have extensive, and virtually unchecked, power. The CFPB inverts the aphorism that "knowledge is power." In its case, it gets the power first, then gains knowledge on the job. Like a bull, finally learning to maneuver its way through a china shop without breaking more than half the place servings.

The linked article quotes a number of observers who are of the view that the CFPB's chances of getting more power from a Republican-controlled Congress are the same as Kim Jong Un winning the annual "Best Coiffed" award from the National Association of Hairdressers and Cosmetologists. Attorney Andrew Sandler sums up the feelings of many of us.

For the bureau to seek to get involved in cybersecurity is unacceptable mission creep...The last thing they should be doing in the current environment is to seek broader jurisdiction. Cybersecurity is not a core consumer protection issue. Iy belongs with the prudential bank regulators, and with the Federal Trade Commission at the federal level. It is a matter of state law for state attorneys general to deal with.

As to the last point, the article notes that Massachusetts has already filed suit against Equifax. Other states should not be far behind.

No one wants to leave the problem of weak cybersecurity controls (and inept responses to breaches) at the Big Three unaddressed. On the other hand, those of us who have enough concerns with the lack of adequate checks and balances on the power of the CFPB will not enthusiastic about that agency gaining more power over any business, including the credit reporting agency business, until those checks and balances are in place.

In Sickness and In Health

This blog was off the air last week because its author was in the hospital and will be off the air for at least another week while he completes out-patient infusion therapy which involves (legal) drugs whose side effects inhibit even the half-baked efforts customarily contained here. 2017 has been a heck of year so far and there's still one quarter left.