May 24, 2011

Who's Watching the Watchmen?

Testimony before the House Committee on Oversight and Government Relations, Subcommittee on TARP, Financial Services, and Bailouts of Public and Private Programs
  • Todd Zywicki

    George Mason University Foundation Professor of Law, Antonin Scalia Law School, George Mason University
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It is my pleasure to testify this afternoon on the question of “Who’s Watching the Watchmen? Oversight of the Consumer Financial Protection Bureau.” This is a crucially important question to ask at a crucially important time in our economic recovery. Economic recovery remains fragile, housing markets are still in flux, and consumer credit markets are still recovering from the credit crisis and the imposition of regulations that have increased the cost and reduced the availability of credit to consumers and small businesses, from credit cards to bank overdraft protection. In addition, the Durbin Amendment to the Dodd-Frank financial reform legislation will take effect this summer, imposing confiscatory and punitive price controls on debit card interchange fees and shifting those costs onto American banking consumers. It is estimated that when the dust settles, these new banking fees will mark the end of free checking for low-income Americans and drive some one million of them out of the mainstream banking system and into the hands of check cashers, pawn shops, and fee-laden prepaid cards.1

This constant interference with the ability of lenders to price their risk accurately has resulted in higher interest rates, billions of dollars slashed from consumer credit lines, and record popularity for payday lenders and pawn shops.2

But these impositions are just the tip of the iceberg of the possible damage that poorly conceived regulation can do to consumer credit, small business credit, and the overall American economy. Just weeks from now the Consumer Financial Protection Bureau (CFPB) will enter its operative phase. If not subject to effective congressional oversight, the massive, vaguely defined powers and expansive reach of the new consumer credit “super regulator” could prove an economy killer, producing still-higher credit costs for consumers, and accelerating regulatory pressures that drive consumers out of the mainstream financial system and into the alternative, high-cost financial sector. Moreover, because millions of small, independent businesses rely wholly or partly on personal and consumer credit to start and build their businesses, heavy-handed, misguided regulation could strangle job creation and economic dynamism.3

Indeed, based on standard economic analysis and the history of consumer credit regulation in America, an entirely foreseeable consequence of an unchecked CFPB will be—ironically—to produce higher levels of fraud and abuse of American consumers. This is because oppressive and misguided regulation stifles competition, reduces consumer choice, and drives consumers from the mainstream banking system into non-traditional lending products.

At this point, there seems to be a general consensus that the overall impact of the CFPB will be to increase the cost of, and reduce access to, consumer and small-business credit, and to increase the regulatory burden on financial institutions. Even supporters of the CFPB and its continued insulation from responsible oversight generally acknowledge that this will be the overall impact of the body as a purely descriptive matter—they simply believe that higher cost and reduced credit access to mainstream credit is a good thing in light of the experience of the past decade.

I disagree—economics and history teach that reducing access to credit does not reduce consumer need for credit. Washington bureaucrats cannot wish away the need of American families for credit. If you need $500 to repair your transmission to get to work on Monday, you need that $500 —regardless of whether you have a bank account or credit card. If you need $300 to pay your rent or electric bill, then you need that money regardless of whether you have it saved up or not. And if you can’t get a credit card because a paternalistic Washington bureaucrat doesn’t think you deserve one, then you are simply going to go to a payday lender. And if payday loans are regulated out of existence, you are going to turn to a pawn shop. History teaches the unfortunate lesson that if all else fails, illegal loan sharks stand ready to meet your needs.

Even if one believes that increasing the cost and reducing access to credit is a good thing, there should also be agreement that regulators should not try to increase cost and reduce access unduly. But the current organizational structure and lack of responsible oversight of CFPB creates an extreme danger that the agency will overreach, imposing costs on consumers, small businesses, and the economy that will stifle economic growth and drive vulnerable consumers into the arms of less-savory lenders. My testimony today will focus on some structural reforms that might help to minimize those unintended consequences.

At the outset, however, let me add one word—we have seen this movie before and we know how it ends. Beginning with the New Deal, central planners in the United States government created a flotilla of massive, unaccountable bureaucracies dedicated to micro-managing the American economy. And we know what happened: by the 1970s, these unaccountable regulatory behemoths had strangled the life out of the American economy—bringing about stagflation, reduced innovation, and declining American competitiveness--until the deregulation efforts, beginning with the Carter Administration and continuing through the Reagan Administration, restored dynamism to the American economy.

The structure of the CFPB is a throwback to this Nixon-era bureaucracy, from which we learned the following: you cannot give massive discretionary powers to unaccountable Washington bureaucrats, however well-intentioned, and expect they can run the American economy and still preserve innovation, competition, and consumer choice. That idea has been tried and has failed. Since that time, scholars have analyzed that historical experience to distill the general lessons of the pathologies that arise from unaccountable bureaucrats tasked with a narrow tunnel-vision focus. I hope this body will take steps to avert the pain that will come from relearning those lessons.

I will focus on several different areas of possible reform to mitigate the damage that the CFPB will do to the economy: structural changes, increased accountability, and substantive changes to the agency’s mission. At the outset, let me emphasize that I agree with the motivation underlying the creation of the CFPB—to create a more modern, coherent, and integrated consumer-protection regime for the regulation of consumer credit. Unfortunately, the CFPB is not likely to bring about this result.

Related material: "Public Choice Concepts and Applications in Law" 


  1. David S. Evans, Robert E. Litan, and Richard Schmalensee, Economic Analysis of the Effects of the Federal Reserve Board's Proposed Debit Card Interchange Fee Regulations on Consumers and Small Businesses (Feb. 22, 2011).
  2. See Todd J. Zywicki, Why Aren't Banks Lending? Because Bureaucrats and Politicians Won't Let Them, Washington Times, page B1 (June 10, 2010).
  3. Thomas A. Durkin, The Impact of the Consumer Financial Protection Agency on Small Business. U.S. Chamber of Commerce, Center for Capital Markets Competitiveness, Sept. 23, 2009,