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Stephen Brobeck, Consumer Federation of America, March 2012

      I selected the topic -- The Consumer Financial Services Marketplace:

The Good, The Bad, And The Ugly -- because this marketplace was central

to the worst economic crisis our nation has experienced since Great


      The spike in consumer bankruptcies in early years of last decade

foreshadowed this crisis. From 1985 to 2005, these insolvencies rose from

about 300,000 to over 2 million a year. In the latter year Congress passed

legislation limiting consumer access to bankruptcy, so a year later

bankruptcies fell to about 600,000 but recently they're back up over 1.5


      These insolvencies were driven largely by increasing consumer access

to and use of credit card debt, particularly by moderate income hhs. But

only several years later, another type of consumer insolvency grew to similar

levels. That was increasing home mortgage defaults and foreclosures, which

for several years have cost about 2 million families a year their homes.

      These defaults were the principal cause of a financial meltdown that

threatened economic collapse and depression. And this probably would

have occurred if not for the courageous and skillful leadership of our

financial regulators, chiefly Fed Chairman Ben Bernanke. Yet, we still have

not completely recovered from this debacle . Among other problems,

unemployment remains above 8%, those dependent on savings and

investments have seen severe cutbacks in their earnings, and nearly one-third

of homeowners with mortgages are under water -- their mortgage debt is

greater than the value of their homes.

      I also think this topic is interesting because we've not only felt the

macroeconomic impacts, but also experienced the microeconomic realities

that led to these impacts. And these realities have not always been positive

for consumers.

      To really understand today's consumer financial services marketplace,

I think we need to go back two or three decades and compare key banking

products then with the same products today. So I will begin by discussing

three of these products -- checking, credit cards, and mortgages -- and how

they've changed over the past 20 to 30 years. Then I'll identify the four key

factors that help explain changes in these three products. And finally, I'll

talk about the way legislators and regulators have addressed the crisis,

particularly the unfair and deceptive practices against consumers.

      Let's begin with a product all of us probably have -- a checking

account. Back in the 1970s it was fairly inconvenient to use one. To deposit

or withdraw funds, we usually had to stand in line at a bank branch. ATMs

were just being introduced but they were still few and far between. In

Cleveland, for ex, there were over 400 bank branches but only 40 with


      Yet these accounts had the virtue of not being very expensive. They

were free if, on a monthly basis, we maintained a $200 checking balance or

a $500 savings account balance. And if we failed to do so, we were charged

only $1.50 or $2 plus, at some banks, a small per transaction fee. If we

bounced a check, the charge was only $5, and we could avoid this charge by

arranging overdraft protection that typically cost us only 15% on the funds


      Today, checking is much more convenient. Paychecks and

government checks usually are directly deposited. Almost all of us use

widely available ATMs to get cash and also sometimes to make deposits.

And debit cards allow us to make easy purchases.

      However, for many, checking is much more expensive today than

decades ago. It is true that at most banks there are no monthly or transaction

fees if paychecks or government checks are deposited directly, and about

three-quarters are. But if yours aren't, and you don't maintain an average

balance of at least $1500 you'll be charged monthly fees that are often $10-

15. And three-fifths of all households can't even maintain an average

balance of $1000.

      Yet, the most expensive checking charges relate to overdrafts. About

one-third of checking customers overdraw their accounts at least once a

year. And about one-third of this one-third do the lion's share of the

overdrawing -- over 80%. These account holders pay a high price --

typically $30-35 for each bounced check. And if they purchase so-called

overdraft protection, they will still be charged a hefty fee. All these fees

have recently totaled about $25b annually. One reason this amount is so

large is the frequent bank practice of reordering checks, largest to smallest,

so that the first overdraft is more likely to trigger subsequent ones. Not

surprisingly, lower income consumers are almost twice as likely to overdraw

their accounts as are higher-income consumers.

      Let's move on to credit cards, which about four-fifths of households

possess, and most without a card are the very old and the very poor. But

three decades ago, only middle and upper income consumers were likely to

be offered this plastic, especially bank cards. Moreover, banks typically

allowed only a $500 credit line initially and rarely increased it beyond $1000

or $2000. And they required 5% minimum monthly payments. So it

shouldn't surprise us that, in the mid-1970s, consumers owed only about $15

billion in credit card debt. We typically paid only 18% on the first $600 of

debt and 12% on amounts over that. And we paid no fees at all for late

payments. If we didn't make regular payments -- which weren't required for

30-60 days depending on the timing of our purchase -- the bank simply took

away our card.

      Over the past several decades, however, this market has changed

considerably. Even today, after sharp recent cutbacks in credit card

availability, a large majority of families have at least one card, and we

revolve over $800 billion in balances on these cards -- up from only $15

billion less than 30 years ago. Until recent reforms, we had to be very

careful about using these cards, or we'd end up with significant charges. If

we had a late payment or two, we'd not only be hit with a $25 to $39 fee but

also be charged penalty interest rates usually in the 25-29% range, and these

rates may well have been applied, not just to new debt, but also retroactively

to old debt. Furthermore, we were less likely to make credit card payments

on time simply because banks had shrunk the real payment period, in some

cases, to less than a week. So each year we ended up paying about $20

billion dollars in fees and over $100b in interest charges.

      Finally, let's look at mortgage loans. Several decades ago, the typical

home mortgage required a 20% down payment, had a fixed interest rate, and

had fixed monthly payments that by the end of a 15 or 30 year period would

have fully amortized the loan. Yes, banks were offering adjustable rate

mortgages, and they had begun to charge points on the front end. But these

lenders held and serviced many of our mortgages, which is why they usually

practiced due diligence in making the loans -- for example, they'd actually

verify our income. So while they did assume interest rate risk -- they

couldn't raise our rate but we could refinance to a lower rate -- there were

relatively few refis because rates weren't coming down. And the banks

could be fairly confident of receiving our monthly mortgage payments.

      Now let's jump to the first decade of this century. Mortgage loans

with 20% down payments on first home purchases had become curiosities.

We now could usually obtain a loan with only a 3% down payment -- the

FHA standard -- and sometimes with no down payment at all. Lenders

might actually finance our down payments, which raises an interesting,

almost philosophical question, as to whether you can call this a down

payment. Increasingly these loans had adjustable rates, often after a period

of 3-5 years, which reduced the lender's interest rate risk. But what

dramatically heightened payment risk is that they increasingly did not

practice due diligence in assessing the credit risk of loan applicants. You've

probably heard of no doc loans, where information from applicants wasn't

checked, and sometimes was even invented by mortgage brokers. But just

as risky was allowing some borrowers initially just to repay interest, not

principal, or not even cover interest obligations -- the notorious pay option

arms -- which one influential housing columnist labeled toxic mortgages.

      Yet these new mortgages by themselves did not cause the most

damage to borrowers. What devastated millions of us, especially older

Americans, were cash-out refis pushed by mortgage brokers. In the past

several years, as mortgage interest rates declined from about 6 to 4 percent,

millions of Americans wisely refinanced their mortgages. Or tried to do so -

- financial institutions often are not letting borrowers who are under water

do so. But in the previous decade -- from 2001-2004 when rates were not

declining -- mortgage brokers persuaded millions of Americans to use their

homes as piggy banks by refinancing their mortgage loans and taking out

hundreds of billions of dollars of accumulated home equity. These brokers,

who correctly noted that housing prices were rapidly rising, often offered

lower initial monthly payments through arms, interest-only only arms, or

option arms. And many homeowners, not fully understanding the risks

involved -- declining housing prices and higher payments eventually -- took

the bait. In one four year period, there were more refis than home purchase

loans. On top of this, the terms of many of these mortgages were deceptive

and unconscionable. As a result, millions of Americans who'd been

conscientiously making mortgage payments for decades effectively lost

much of their life savings with tragic consequences. For most of us, paying

off a mortgage helps allow us to retire because it lowers our living expenses

and provides us with a substantial asset. Absent both, we often have to keep

working or rely on the generosity of family members.

      The conclusion I draw from this analysis is that, over the course of

more than two decades, banking customers gained much greater

convenience but also were often asked to bear greater costs and risks. Now

let's try to better understand why these changes took place. I believe that

four factors account for most of these changes. The first factor was the

implementation of technological advances that made it much easier, some

would say too easy, for consumers to utilize banking services. Most

importantly, the widespread adoption of electronic funds transfers made

possible easier consumer deposits, withdrawals, payments, and borrowing.

Direct deposit, ATMs, debit cards, and credit cards all benefited from this


      There is probably no consumer in the country that does not appreciate

these electronic fund transfers. But some critics have noted that these easy

transfers also tended to increase consumer spending and related risks.

Studies have shown that we spend the most with a credit card, next most

with a debit card, next most with a check, and least with cash. This greater

ease of purchase made possible by plastic -- think shopoholics at a mall --

encouraged some consumers to overspend. There is a striking positive

correlation between the consumer use of credit cards and personal

bankruptcies, and just as striking a negative correlation between credit card

use and personal savings rates. The same could be said of widely available

ATMs, which allowed consumers to gain access to cash much more easily.

      The second factor was increasing economic volatility starting with the

stagflation of the 1970s and double-digit inflation of the early 1980s. This

inflation threatened the post-Depression model of banks and savings and

loans accepting consumer deposits, paying relatively low capped rates on

these deposits, but then lending these funds back to consumers at relatively

low rates that sometimes were capped. As prices rose so did interest rates,

and the financial institutions feared loss of their deposits to higher-yielding

money market funds and also the increased costs of getting capital from the

Fed and the private marketplace. These changes and fears encouraged

policymakers to begin deregulating banking markets.

      A second kind of economic volatility was the run-up of housing prices

in the early years of this century. Between 2000 and 2006, these prices

nearly doubled, feeding the fever not just for homeownership but also for

home flipping and purchase of investment properties. This fever was often

exploited by an increasing number of mortgage brokers who sold us houses

we could afford only if home prices continued to rise, and often, not even

then. The inevitable bursting of this bubble, predicted by many as early as

2005, began in earnest in 2007.

      The third factor was deregulation of much of the banking sector, in

the 1980s and 90s, spurred not just by inflation but also by increasingly

popular deregulation theory. In the 1970s, the government permitted banks

and s&ls to sell only a limited array of products, whose prices were

sometimes capped -- deposit rates by the federal government and consumer

loan rates by state governments -- in limited geographical areas. By the year

2000, few of these restraints still existed. Nor did the separation of

commercial and investment banking, eliminated by Gramm-Bliley

legislation in 1999, which contributed to the recent financial crisis in ways I

don't have time to explain.

        These economic changes also brought on cultural changes within the

industry. Before deregulation, bankers focused on providing their limited

services in risk-free ways according to what was humorously known in the

industry as the 3-6-3 rule -- pay depositors 3%, charge borrowers 6%, and

tee off at the country club at 3 pm. Deregulation eroded this banker way of

life. Forced to increasingly compete, they examined and cut costs, took

greater risks, and were more likely to use tricks and traps to increase fees

and rates. In the process, the most profitable customers -- large depositors

and borrowers -- often gained preferential access to services and lower


        The fourth factor was increasing use of new financial instruments. In

the consumer product area, the most important was greater securitization of

consumer and mortgage loans. Securitized loans are those packaged and

sold directly to investors through intermediaries such as Fannie Mae and

Freddie Mac, or Wall Street firms who increasingly competed with these


        The increasing securitization of credit card debt in the 1990s reduced

banker risk and fueled the explosion of card marketing and credit extension.

By 2005, big banks were mailing out several billion credit card solicitations

each year. And had made available to bank card holders about $5 trillion in

credit lines. Think about this -- $5 trillion available to 100 million

households with credit cards -- that's $50,000 per household. One could

argue that consumers exercised great restraint in never borrowing more than

$1 trillion of this $5 trillion. Combined with more lenient payment terms --

for example, minimum payments that had fallen from 5% to 2% -- this

increased bank marketing and credit extension was the principal cause of

escalating credit card debt and bankruptcies. I've always thought the banks

had a lot of chutzpah to blame these bankruptcies mainly on cardholders,

who often assumed that banks only offered credit they thought could be

repaid. At the height of the financial crisis, consumers were defaulting on

more than 10% of the credit card debt they owed. To put that into

perspective, losses in the 1970s were more like 3%, and for credit unions,

well under 1%.

      But the greatest damage to consumers and the whole economy was

caused by the securitization of mortgage loans. There is a lot of blame to go

around here -- from the investors worldwide who unwisely bought trillions

of dollars of opaque mortgage-backed securities, to the rating agencies such

as Moody's and Standard and Poor that blessed these securities, to the Wall

Street firms and GSEs that packaged and sold them, to the banks and

mortgage companies that sent the loans to these intermediaries after they had

accepted them from mortgage brokers, to these brokers who failed to tell

consumers the truth about these risky and often predatory mortgages, to the

consumers who through delusion and/or ignorance bought the mortgages,

and to financial regulators who acted as if everything was just hunky-dory.

In a mortgage marketplace based on securitization, neither mortgage brokers

nor lenders have to worry as much about the ability of borrowers to repay

loans. So peversely, ignoring payment risks allowed brokers and lenders to

sell more mortgages, increasing their income from related fees.

      I would note that the banks and GSEs -- Fannie and Freddie -- rarely

took the lead here. The banks became dependent on the paper sold by

independent mortgage brokers, who could shop their mortgages to the

lenders who compensated them the most -- that's the basis for the notorious

yield spread premiums which incented brokers to increase rates and fees.

The banks also were faced with increased competition from mortgage

companies -- such as Countrywide -- whose sales practices were grossly

irresponsible and often illegal. And Bank of America, which absorbed

Countrywide and lived to greatly regret this decision, is still cleaning up the

mess and paying heavy penalties in the process.

      Contrary to one narrative popular with some politicians, Fannie and

Freddie never took the lead in buying suspect mortgages. After watching the

loss of their market share to Wall Street firms, they somewhat reluctantly

started to purchase subprime loans from lenders. But their biggest mistake,

and the biggest cost to taxpayers, resulted from their holding too many

conventional mortgages whose value collapsed when housing prices

plummeted. By comparison, Wall Street firms mainly acted solely as

intermediaries, selling almost all the mortgages they bought and packaged to


      So that's a brief description and explanation of changes in the

consumer financial services marketplace. I will now close by briefly

discussing recent reforms to mitigate related problems and abuses. Though

states such as North Carolina approved mortgage lending protections before

the crisis broke, most significant reforms were approved by Congress or

issued by federal regulators. These included:

    A rule issued by the Office of the Comptroller of the Currency in

      2005 to limit negative amortization practices, which had the effect of

      increasing required minimum credit card payments, thus helping

      check the rise of revolving balances.

    Congressional approval of a credit card law in 2008 whose numerous

      protections included prohibitions on increasing the rates charged on

      old debt, on unauthorized over the limit fees, on mailing monthly bills

      shortly before the payment dates, and on issuing cards to those under

      21 years of age without a co-signer or adequate source of income.

    A rule issued by the Federal Reserve Board in 2009 that required

      banks to obtain consumer approval for enrollment in overdraft

      protection plans.

      But far and away the most important reforms were part of the Dodd-

Frank legislation which Congress approved in 2010. This law represents the

most comprehensive financial services reform since the Great Depression.

Its 2000 pages include extensive regulation to prevent another financial

services meltdown, and also to protect investors. But from a more narrow

consumer perspective, its greatest significance was the creation of the

Consumer Financial Protection Bureau, a new agency with sole

responsibility for protecting consumers in the financial services marketplace.

The Bureau, which was placed in the Federal Reserve System to help

insulate it from politics, was given broad authority to regulate consumer

products and sellers, including non-banks such as mortgage companies and

payday loan operators. It now has an effective director, Richard Cordray,

former Ohio AG, and just announced last week its intention to examine

overdraft loans.

      In conclusion, I would make the following personal observations:

We were extremely fortunate that the financial crisis did not drive the

country into a depression, that we had such capable leaders managing this

crisis, esp. Ben Bernanke but also Tim Geithner and Sheila Bair, that much

of what consumers lost was unavoidable because their earlier gains

represented an unsustainable spike in housing prices, and that subsequent

reforms, while falling short of what we think was needed, nevertheless are

substantial and will help protect both consumers and the future stability of

the whole financial services system.

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