Coming Consumer Restrictions

The Congressional conference tasked with combining the Senate and House financial services reform bills appears to have reached an agreement on a new consumer financial protection agency (CFPA) housed inside the Federal Reserve. Essentially, this agency will be fully independent, yet it will have access to Fed profits and the political cover of the Federal Reserve. As we—and countless others—have been writing for over a year, the concept behind the CFPA isn’t bad: we all want consumers to be protected from fraud.

But the manifestation of the CFPA doesn’t do that.

Instead, as I wrote last October, the CFPA will pile on burdensome new rules, restrict innovation, hurt small businesses, increase the cost of doing business, spawn a massive bureaucracy, and create severe conflicts between state and federal law.

The merging of the two congressional bills doesn’t change this concern. Congress and the White House are claiming these new rules will benefit consumers at the expense of big corporate businesses. But that isn’t the real story. Let’s look at auto companies as an example.

Of the Big Three automakers, only Ford was able to survive without a bailout from the TARP program—though they did receive separate support from the government to help them meet fuel efficiency standards and the bailout of GM and Chrysler did give Ford fringe benefits like saving suppliers. Today, Ford Motor Credit, the financing arm of the historic company, is back to being profitable. In the first quarter of 2010, FMC made $2.1 billion, though they still have over $31 billion in debt to work down. FMC has been critical in the rejuvenation of Ford, since auto financing arms can be used by the parent company to help move cars by offering lower interest rates than banks. But the financial services “banking” bill might change that.

The House won a battle on CFPA over the Senate to exclude auto dealers from the new consumer protection laws. As a result, dealers can continue to provide financing to potential buyers without dealing with the CFPA. However, not all is well. Because dealers work like brokers, finding a good financing deal and then making the loan themselves, they still have to sell the loan back into the market. And that is where new CFPA rules could make it very difficult for lenders.

First, there is politics: the CFPA could put restrictions on banks regarding buying loans for less fuel efficient cars. Second, there is meddling: the CFPA could make it difficult for banks to buy loans that were issued to low-income borrowers in order to prevent the spread of toxic debt. This would, in effect, limit the loans issued in the first place, since dealers can’t get stuck holding a lot of loans themselves.

The restriction of credit is the biggest worry American consumers should have. The new CFPA could make it a lot harder, and more expensive, to get auto financing. Not great news for anyone looking to buy a car. And not great news for companies looking to sell cars.

But it gets a bit worse. If you are a global auto company like Toyota, you’re dealing in a lot of currencies. Toyota thus uses derivatives to hedge against currency shifts and thus lock in certain rates. But with the proposed derivatives legislation, they may not be able to do that, and could be forced to scale back certain operations or risk losses.

Not to be outdone, some auto financing arms are facing possible added pressure from a systemic risk regulator. Exact language on systemic risk has yet to be finalized, but a company like Toyota Financial Services (with over $65 billion in assets under management) or Ford Motor Credit (with $117 billion in assets under management at the end of 2009) will almost certainly fall within the designated boundaries for what defines a potentially systemically risky company. This means there is the potential for a federal regulator to find Toyota Financial, an auto financing company, to be a systemic risk to the economy and step in to take them over in order to keep them from becoming too big to fail. The political and business ramifications of this are simply staggering.

So ultimately, there are three big problems consumers should be aware of when they find it harder to get an affordable auto loan: (1) consumer “protection” laws are limiting credit; (2) derivatives rules are limiting lenders from being safe and prudent with their lending, thus limiting lending; and (3) systemic risk rules are threatening companies, causing them to be much more cautious about growing, and therefore limiting lending.

For those that would say such concerns are worst-case-scenario-hogwash, you need only look at the unintended consequences of limiting credit card fees and limiting banking fees. Card issues had to increase interest rates to protect themselves, banks are having to drop free checking accounts to make up for their lost revenue in overdraft and other fees, and low-income consumers have found it harder and harder to get credit (while the rest are seeing rewards programs scaled back). This isn’t a scare tactic… this is a very real concern from a struggling industry that won’t be helped much by these extensive new restrictions.

It is unlikely that members of Congress will head warnings about these things now, when they are on the cusp of a major political win. But then again, who would have thought the U.S. could score in the 91st minute against Algeria to win their group in the World Cup?