Via Electronic Mail

December 16, 2008

Ms. Orice M. Williams
Director, Financial Markets and Community Investment
U.S. Government Accountability Office
441 G Street, N.W.
Washington, DC 20548

Re: GAO Report on Reforming the Financial Regulatory System

Dear Ms. Williams,

Consumers Union, the nonprofit publisher of Consumer Reports, is deeply interested in creating a more effective structure for the regulation of financial institutions and other participants in the financial markets. Financial regulation must be designed to protect individuals as consumers of credit and deposit services, as investors, and as taxpayers.

The spark for the financial crisis was unsuitable, poorly underwritten loans being sold to individual homeowners. The risk was amplified by widespread sale of financial instruments based on those mortgages. The resulting crisis of confidence has led to reduced credibility for the U.S. financial system, gridlocked credit markets, loss of equity for homeowners who accepted subprime mortgages and for their neighbors who did not, empty houses and reduced property tax revenue.

Any future financial regulatory structure must include active federal and state oversight, a priority on consumer protection, steps to make the pricing and features of financial products less complex, and more accountability by financial entities at each step of a financial transaction.

1. Regulators must be required to proactively monitor new products and practices to address dangers before they spread. Financial system regulators must identify, evaluate, and mitigate emerging risks both to the financial system and to individuals. Regulators must abandon the old “wait and see” regulatory approach, where a problem has to grow to be national in scope, and perhaps be in the public eye, before it is addressed. Financial regulators must have independence from the entities they oversee and an express charge to regulate for the prevention of harm both to individuals and to the financial system.

2. Financial system regulators should give the same priority to consumer protection as to safety and soundness. The mortgage crisis and its aftermath dramatically illustrate that the consumer protection and safety and soundness are inextricably linked. Regulators must increase the priority placed on consumer protection.

3. Practices and features that make financial products sold to individuals too complex to understand must be stopped. The report speaks in several places about the need for financial literacy or improved disclosure. However, financial products which are too complex for the intended consumer carry special risks that no amount of additional disclosure or information will fix. In subprime mortgages, for example, many homeowners were induced to refinance an existing loan for one that would offer a reduced payment for just the first two years. Others were assured that they could refinance later, yet the loan documents contained an expensive prepayment penalty. Many of the tens of thousands of individuals who filed comments in the Federal Reserve Board’s Regulation AA docket on unfair or deceptive credit card practices reported that they learned about harmful card issuer practices apparently permitted by the cardholder agreement only when the practice was first invoked against them. Regulatory reform will be incomplete unless regulators identify and stop practices that make credit and deposit products difficult for individuals to understand and evaluate.

4. Federal and state regulatory diversity is essential to robust oversight. We agree with report that it is important to eliminate the bottlenecks that can be caused by the coordination process between multiple federal regulators. However, no single federal agency leader can foresee all of the consequences of new practices and products. For this reason, Consumers Union supports both an independent federal consumer protection agency for financial services products (with concurrent jurisdiction with existing banking agencies), and the power of states to develop and enforce consumer protections. The swift and troubling developments in the financial meltdown show that we cannot rely on a single federal agency leader to anticipate all of the risks in new practices and products, nor to have the inclination or the resources to pursue all of the areas where law enforcement is needed.

5. Accountability must be built into the financial system. During the build-up to the crisis, loan originators and securitization packagers got fees even if loans couldn’t later be repaid. Regulatory restructuring should include changing the incentives in the private market by requiring that everyone who gets a fee in connection with a credit product also keeps some of the risk of future nonpayment and the risk of problems with the loan. In addition, everyone who offers financial products to consumers should be subject to suitability requirements and fiduciary duties.

We appreciate the work of the GAO in this important issue area. Creating a strong, trusted regulatory structure for financial products and the financial markets is essential to rebuilding the public confidence in the U.S. financial markets.

Very truly yours,

Gail Hillebrand
Financial Services Campaign Manager
Consumers Union of U.S., Inc.