Relevant and even prescient commentary on news, politics and the economy.

Elizabeth Warren 2009

As the Senate election begins in earnest in Massachusetts, with a great deal of money already pledged and attack ads begun, the contest has the ability to capture the nation’s attention and imagination. We will be following aspects of the election for our readers as the year progresses. Re posted is a statement she made on regulation and the role of non-banks in our system. Of course the issues are ongoing today:

Angry Bear post 2009

Elizabeth Warren of the Congressional Oversight Committee for TARP, and champion of an active voice for consumer protection regulation, offers her thoughts in Real Change: Turning up the heat on non-bank lenders with one of her latest essays at New Deal 2.0, part of the Roosevelt Institution.
We have watched regulation slip away, which is of course not always bad, through terminating good rules, decreased funding to an agency to make enforcement less of an issue, and leadership in an agency to change the intent of regulatory function.

 

The big banks are storming Washington, determined to kill the Consumer Financial Protection Agency (CFPA). They understand that a regulator who actually cares about consumers would cause a seismic change in their business model: No more burying the terms of the agreement in the fine print, no more tricks and traps. If the big banks lose the protection of their friendly regulators, the business model that produces hundreds of billions of dollars in revenue — and monopoly-size profits that exist only in non-competitive markets — will be at risk. That’s a big change.
But there is an even bigger change in the wind: regulating the non-banks. Democrats and Republicans alike agree that the proliferation of unregulated, non-bank lenders contributed significantly to the financial crisis by feeding millions of dangerous financial products into the economic system. Non-bank institutions were active participants in the race to the bottom among lenders. From subprime mortgage loans to small dollar loans, they showed how to wring high fees and staggering interest rates out of consumer lending. Their fine-print contracts, and new tricks and traps, transformed the market.
Despite widespread agreement about the problem, the U.S. has never made a sustained, systemic effort to regulate non-bank lenders…

…As lending abuses became more obvious, there was no effort to close regulatory gaps and loopholes or to devote federal resources toward the oversight of non-bank institutions. The reasons are many, but one of the most benign explanations is that policymakers for too long assumed that states could deal with the non-banks because the non-bank lenders are often small and often operate locally (although Countrywide showed that state-based organizations can metastasize rapidly). As it turns out, the states actually faced several limitations in reining in these lenders.
States, just like the federal government, were subject to intense lobbying by creditors. In short order, many states changed their rules to undercut basic protections. For example, the consumer finance industry succeeded in rewriting state interest rate regulation to allow for massive increases in allowable effective rates — even when the advertised rate looks far lower and obscures the true cost of credit. In many states, making an end run around local usury laws is now as easy as running around a single fencepost. At the same time, state legislatures face the perpetual lag-behind problem. They are unable to adjust to a rapidly changing financial services market, too slow to identify problems and not capable of changing the laws quickly enough to head off serious problems.
Moreover, resources are always constrained at the state level, and the enforcement of consumer credit laws competes with a wide variety of other state obligations. When consumer credit laws were violated, states often lacked the capacity to undertake serious investigations or to prosecute offenders. Some states made heroic efforts, but others left consumer financial issues far down their priority list.
The problem of enforcement has been exacerbated by a serious structural problem. When an abuse surfaced-for example, a local paper ran a news story about an unfair practice or a consumer group assembled evidence of sharp practices-local officials often responded by jumping on small banks. The non-banks were often scattered and difficult to find, while the biggest financial institutions were typically protected from local prosecution through pre-emption. That left the small banks holding the bag. These small banks, often those with state charters, were the easiest institutions to locate and the cheapest to prosecute — even if they were only tangentially involved in deceptive practices. The result was that the worst offenders slipped away. Non-banks could shut down for a while, and then reappear when the heat was off. In effect, the state enforcement structure benefitted the big banks and the non-banks.
The CFPA presents the first real opportunity to change that harmful structure.
First, the CFPA will regulate consumer financial products across the board-using the same rules for all mortgages or for all small dollar loans, regardless of whether the mortgage or the loan is issued by a national bank, a state bank or a non-bank. The old practice of different sets of rules and different regulatory structures for the same products would disappear. Instead, the CFPA would create a coordinated set of baseline rules applicable across the board.
Consolidated rule-making will also stop the practice of lenders shopping around for the regulator with the weakest rules. Bank holding companies have enjoyed an enormous advantage by having the freedom to structure their many business divisions to exploit regulatory weakness. They can operate a federally chartered bank when preemption is valuable to them. At the same time, they can purchase the products of non-banks in bulk, creating informal partnerships that exploit gaps in the state regulatory system. In fact, the Center for Public Integrity found that 21 of the 25 largest subprime issuers leading up to the crisis were financed by large banks. (Remember this the next time you hear a lobbyist blaming the crisis on non-banks and denying the role of the bank holding companies.) With consistent rules across the board, the CFPA would put an end to these practices.
Consistent rules are important, but, as we now know, it isn’t enough to have good rules on the books. There must also be a serious effort to enforce those rules. With the right sources of funding and some smart strategic thinking about how to force non-banks to follow the same rules as other lenders, the entire landscape of consumer lending would change.
From history, we have learned that an agency’s source of funding is critical to its success. By allowing the Agency to tax lenders directly — perhaps a dime for every open credit card account, a quarter for every open mortgage, etc. — Congress can make sure that the CFPA stays well-funded in the years ahead. The right funding structure will allow the Agency to develop the capacity to go after the non-banks and the dangerous products they originate, and it will insulate the Agency from political efforts to starve-the-regulators into inaction. Moreover, as we now know, the cost of even a well-funded agency is dwarfed by the cost to the government and the economy as a whole of bank failures. The cost of the failure of just one thrift – IndyMac — was almost ten times the annual budget of the Securities and Exchange Commission.
New forms of strategic thinking will also be needed. By creating a system for mandatory lender registration, for example, CFPA will be able to keep track of the consumer lenders out there — something that no current regulators have the tools to do. To encourage compliance, the CFPA can work with other federal agencies — like the Treasury Department or the Internal Revenue Service — to identify unregistered lenders. In states that already register certain non-bank lenders, the CFPA can work off those registrations and collaborate with state officials. This is tough work, but a consumer agency with expertise and resources will rise to the challenge.
The CFPA can also get smarter with enforcement by exploiting concentration points, places where small players are effectively grouped together. In the case of mortgage brokers, for example, without the large bank holding companies and their subsidiaries as customers for the loans they place, many would be out of business. Focusing regulatory attention on the buyers would create substantial leverage over the brokers as well. If the sponsors and funding mechanisms for the worst practices go away, so will the worst practices.
There is more that we can do to deal with non-bank lenders, but only if Congress creates a strong CFPA. If we stick with the status quo — which treats loans differently depending on who issues them and places consumer protection in agencies that consider it an afterthought – we know what will happen because we have seen it happen before. Lenders will continue their tricks and traps business model, the mega-banks will exploit regulatory loopholes, and the non-banks will continue to sell deceptive products. In that world, small banks will need to choose between lowering standards or losing market share, and they will still get too much attention from regulators while the non-banks and big banks get too little. Dangerous loans will destabilize both families and the economy, and we’ll all remain at risk for the next trillion-dollar bailout.
Regulating the non-banks hasn’t been tried in any serious way. The CFPA offers a real chance to level the playing field, to add balance to the system, and to change the consumer lending landscape forever.

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Weak consumer confidence and real wage growth portend weak consumer spending

Yesterday the Conference Board released its measure of consumer confidence, which dropped to 44.5 in August. This brings the Conference Board measure of confidence in line with the Reuters/University of Michigan measure of consumer sentiment. Bloomberg summarizes the Conference Board results.

Confidence is important, since consumer spending accounts for the lion’s-share of aggregate spending. Consumer confidence measures are highly correlated with the annual growth in real personal consumption expenditures – the correlation coefficients are 75% and 67% for the University of Michigan Sentiment index and the Conference Board’s Confidence index, respectively.

(Chart axis identifcation amended…rdan)

Ultimately, though, it’s all about jobs and personal incomes.



READ MORE AFTER THE JUMP!

To date, while July real wages and salaries (deflated using the CPI) fell on the month, the 3-month average continues its ascent. Clearly the sluggish climb in real wages and salaries is not enough to spark a surge in confidence and spending. Neither will consumers draw down saving, as was the case over the last decade amid debt-financed consumption. In fact, saving is more likely to rise as a share of income than fall as the balance sheet repair process furthers.

Jobs and incomes will drive consumption.

To be sure, measures of confidence are “better” predictors of economic activity when the economy is fragile. We know that the economy is now much more fragile than previously thought. Weak confidence plus meager real wage and salary growth is, unfortunately, a harbinger of further ‘weak’ economic activity.

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Inflation Detour: Trimmed Mean PCE

Today’s release by the Federal Reserve Bank of Dallas of October’s Trimmed Mean Personal Consumption Expenditure gives us a chance to check this “alternative measure of core inflation.”

The clearest thing is that it does what the FRB Dallas intends: generally reduces the measure of inflation:

For the graphic above, any value above the line shows where the 12-month Average of the Trimmed Mean PCE is greater that the Annualised CPI for that same period. With few exceptions, those points are places where the actual CPI is negative for the period. (Note also that all of periods where CPI is over 5.0-5.5% are below the line. While the 12-month average of Trimmed Mean PCE has a maximum of 8.7%, while CPI reaches slightly over 14.75% in the same time period.)

So the natural next step is to compare it to a measure of Consumer Sentiment. Let’s do that below the fold

Comparing Trimmed Mean PCE to the University of Michigan Index previously referenced:

Again, the preponderance of data points are to the right of the line, indicating that the Michigan Consumer Inflation Expectations is higher than the monthly Trimmed Mean PCE. But there is much more balance: the largest cluster of Expectations Dominance is between 2 and 4%; that is, periods of normal inflation.

The two measures correlate rather well with each other (86.13%) while a simple fitted regression that excludes a constant term has an adjusted R-Squared of 94.1% and yields MICH = 1.0416*Trimmed Mean PCE.

Trimmed Mean PCE may well understate inflation, but it appears to compare fairly well with what people think of when they think about inflation.

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Consumer confidence: fluff or thrill

by Rebecca Wilder

Thrill. The Conference Board reported that the August consumer confidence index (CCI) jumped 14% in August to 54.06. In contrast, the August University of Michigan Consumer Sentiment index (CSI) fell; but the two generally trend together, and the CSI is subject to revisions reported tomorrow.

Confidence can be swayed by current political agenda or asset prices, but nevertheless, it is a coincident measure of the business cycle. And broken down into its two components – the present economic situation index and expectations index – the August report was quite positive (as positive as can be coming off of record lows).

The expectations index surged almost 16% in August to 73.48, its highest level since December 2007 and 2.7% over its previous high in May 2009. The current conditions index grew around 7%, but is hovering at low levels with no strong sign of improvement.

Clearly, the expectations index is making much more headway than the present situation index. And this is why that information is important: historically, the expectations index, rather than the current conditions index, is a good indicator of consumer spending growth.

The chart illustrates annual personal consumer spending growth and the two components of the CCI, with associated simple correlation coefficients. The correlation between the overall CCI and annual PCE spending growth spanning June 1977- June 2009 is 0.63. However, the biggest weight is coming off of the expectations component of the CCI, correlation = 0.69, rather than the present situation component of the CCI, correlation = 0.45.

On the other hand, the present-situation component of the CCI is a decent indicator of current labor market conditions.

The chart illustrates annual employment growth (measured by the nonfarm payroll), and the two components of the CCI. The simple correlation between the overall CCI and employment growth is 0.59 (noticeably smaller than the PCE correlation), which according to its correlation, is more heavily weighted by the present situation component of the CCI.

Based on this simple analysis, the CCI reading is consistent with an oncoming surge in spending growth over the next six months. Even in the recovery after the 1991 recession, when the expectations index improved quickly while spending growth was sluggish to rise, spending growth jumped from essentially 0% annual growth to almost 3.6% in just four months – after the surge in expectations index and before the bottom in the current conditions index.

Yes, there are plenty of credit-related issues why this might not happen. And there is an obvious economic link between employment, income, and spending. However, for those indicators that are critical to recovery, i.e., consumer spending (housing and inventories are important, too – see the second chart on this post), the expectations index is certainly a positive signal for spending events to come.

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