Federal Reserve Chairman Ben Bernanke started the new year with a reflective address to the American Economic Association on the causes of the financial crisis and steps to prevent a future crisis. Chairman Bernanke strongly stressed the need for “better, smarter” regulation and concedes that the Fed’s attempts at regulating the mortgage lending market were too little, too late. “Stronger regulation and supervision aimed at problems with underwriting practices and lenders' risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates,” Bernanke said.
If the crisis has taught us anything, it’s that consumer protections must be strengthened and effectively enforced in order to avoid a future crisis. The Consumer Financial Protection Agency (CFPA), which was passed by the House and is likely to be considered in the Senate late this month, would be a strong independent agency with authority to set consumer protection rules for all lenders, including previously unregulated fringe mortgage lenders whose bad loans helped set off the financial crisis. The CFPA would be able to monitor potentially abusive financial products and practices and detect problems before they balloon into a crisis. Finally, the CFPA would end the past pattern of regulators ignoring consumer protection issues in favor of safety and soundness concerns, since consumer protection would be the number-one focus of the agency.
Improving the Community Reinvestment Act (CRA) is another critical piece of a better and smarter financial regulatory framework. The CRA has resulted in billions of dollars invested in lower-wealth and minority communities. These investments were prudent—the Federal Reserve Bank of Dallas argues that the CRA stopped the financial crisis from being worse than it could have been. The CRA Modernization Act would expand CRA obligations to non-bank institutions, who made the majority of irresponsible loans in the days before the crisis. It would also expand the data set we have on mortgage and small business lending, improving the ability of researchers and policymakers to monitor potentially predatory and discriminatory lending practices and ensure that community lending needs are being met. The CRA Modernization Act would both increase investment in neighborhoods and encourage prudent lending practices.
“The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter,” Chairman Bernanke concluded. While we agree on the important role of regulation in our financial system, improving execution and enforcement of existing rules will not be enough. Simply enforcing the insufficient consumer protection laws currently on the books by the very same regulators who failed to act despite warning signs will not solve the problems that led to the recession. We need a new agency with new leadership to keep consumers’ interests at the forefront and institute system-wide reform. The Consumer Financial Protection Agency and CRA Modernization Act are critical components of a regulatory policy that keeps consumers’ and communities’ interests in mind and acts quickly and effectively to prevent future crises.