WASHINGTON (MNI) – The following is the second section of the text
of the remarks of Federal Reserve Gov. Elizabeth Duke, prepared Tuesday
for the Consumer Bankers Association Annual Conference in Hollywood,
Fla.:
While liquidity helped restore the market for consumer loan
securitization, liquidity alone did not solve all the consumer credit
problems exposed by the crisis. Additional consumer protection would
also be needed to restore healthy consumer lending.
Enhancing Consumer Protection
The first signs of serious consumer credit distress appeared in the
subprime mortgage market, and much attention has been deservedly paid to
correcting problems in that market. In hindsight, though, we also see
that the developments in the U.S. mortgage market, fueled by the credit
boom, revealed acute weaknesses in mortgage finance that eventually had
far-reaching effects on many other forms of credit. The gradual but
widespread declines in underwriting standards, breakdowns in lending
oversight by investors and rating agencies, and increased reliance on
complex and opaque credit instruments led to the current set of
circumstances in which lenders are skittish about lending, borrowers are
skittish about borrowing, and investors are skittish about investing.
The credit markets must reemerge in sounder and more transparent ways in
order for “normal” lending activity-whatever that will mean in the
coming months and years-to reemerge.
Essential to jumpstarting market activity is rebuilding consumer
confidence. Over the last few years, the Federal Reserve has been just
as aggressive in providing safeguards for consumers as it was in making
liquidity available to institutions. We have created a blanket of new
protections for consumers that we think will go far toward avoiding the
excesses of the recent past. I’d like to take a few minutes to remind
you of some of these changes.
Subprime Mortgage Lending
First, to deal with the subprime mortgage market, changes have been
made under the Home Ownership and Equity Protection Act, adding layers
of defenses for borrowers of highercost mortgages.2 The new rules, most
of which went into effect in October, target higher-priced loans where
borrowers are most vulnerable to abuse. For these “riskier” mortgages,
our new rules require that lenders verify borrowers’ abilities to repay
the loans at a fully indexed rate, ban prepayment penalties if payments
may increase in the loan’s early years, require escrows for taxes and
insurance, and prohibit a range of misleading advertising practices.
Mortgage Disclosure Reform
Currently, the Federal Reserve Board is engaged in a comprehensive
revision of the mortgage disclosures required under the Truth in Lending
Act to improve the effectiveness of mortgage disclosure forms for all
loans. These new forms were developed through consumer testing,
including focus groups and detailed surveys, to ensure that they provide
information that is useful and understandable to consumers. These
disclosures are designed to better focus consumer attention on mortgage
features, such as variable rates, that might be appropriate for
(2 See Regulation Z (12 CFR Part 226),
www.federalreserve.gov/reportforms/formsreview/RegZ_20080730_ffr.pdf,
which implements the Truth in Lending Act and the Home Ownership and
Protection Act. some consumers, but potentially risky for others. And we
have proposed to ban compensation methods that give originators
incentives to steer borrowers to loans with higher rates or
disadvantageous terms.)
Credit Card Protections
Credit card regulations issued by the Federal Reserve in December
2008 and the provisions of the Credit Card Accountability,
Responsibility and Disclosure Act (CARD Act) enacted by Congress last
May combined to create the most comprehensive and sweeping regulatory
reforms of credit cards in the history of the product. In large part,
these reforms respond to concerns that consumers could not accurately
predict the costs associated with their credit cards and therefore could
not make informed decisions about the use of credit. The regulations
improve credit card disclosures and establish a new baseline for
transparency and fairness in the credit card industry.3 Based on
extensive consumer testing, the Fed substantially revised the
disclosures provided with credit card solicitations and disclosures
contained in periodic statements to improve consumers’ understanding of
costs associated with using their cards. In addition, we imposed several
new restrictions to ban certain practices, such as double-cycle billing,
that increase the cost of credit in ways that cannot be effectively
disclosed. Except in certain limited circumstances, issuers are
prohibited from increasing interest rates applied to existing balances.
They must also provide adequate notice of higher rates to be applied to
future balances and are required to apply payments in excess of minimum
payments to the balances that carry the highest interest rate.
(3 See Board of Governors of the Federal Reserve System, “What You
Need to Know: New Credit Card Rules,” webpage,
http://www.federalreserve.gov/consumerinfo/wyntk_creditcardrules.htm.)
Other Consumer Protections
The Federal Reserve has been active in issuing regulations
governing other consumer products as well. We implemented new rules that
will help students shop intelligently for student loans.4 We implemented
provisions in the CARD Act that apply to gift cards and marketing of
credit cards to students.5 We also issued new regulations that prohibit
automatic enrollment in overdraft programs, requiring that consumers opt
in before they can be charged for overdrafts created by ATM withdrawals
and one-time debit card transactions. Furthermore, banks will be
required to offer the same account fees and features to customers
regardless of whether they opt in to coverage for debit overdrafts.6
While the additional protections for consumers are long overdue,
they will require considerable changes in bankers’ business practices
and product pricing and design. The changes reduce the ability to build
profitability models around penalty pricing such as overdraft fees or
raising interest rates on existing credit card balances. They require
pricing to be front loaded and clearly disclosed. I fully expect current
banking products to change as banks adjust to accommodate the new
requirements. And I understand the potential for at least a temporary
lull in service innovation as providers concentrate on change
implementation. At the same time, I have every confidence that
competition will ultimately restore innovation, but with products that
are safer, simpler, and more transparent to consumers.
(4 See Federal Register notices for Regulation Z, Truth in Lending Act,
(12 CFR Part 226), August 14, 2009, vol. 74, no. 156, pp. 41194-41257.
5 See Federal Register notices for Regulation Z, Truth in Lending Act, (12 CFR Part 226), February 22, 2010, vol.
75, no. 34, p. 7925; and Regulation AA, Unfair or Deceptive Acts or Practices, (12 CFR Part 227), February 22,
2010, vol. 75, no. 34, pp. 7925-26.
6 See Federal Register notices for Regulation AA, Unfair or Deceptive Acts or Practices (12 CFR Part 227), vol. 74,
no. 18, January 29, 2009, pp. 5498-5584; Regulation DD, Truth in Savings Act (12 CFR Part 230), vol. 74, no. 18,
January 29, 2009, pp. 5584-94; Regulation E, Electronic Funds Transfers (12 CFR Part 205), vol. 74, no. 18,
January 29, 2009, pp. 5212-43; Regulation Z, Truth in Lending Act (12 CFR Part 226), vol. 74, no. 18, January 29,
2009, pp. 5244-5948. See also Board of Governors of the Federal Reserve System (2008), “Review of Testing of
Overdraft Notices” (December 8),
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20081218a6.pdf.)
Consumer Lending: Post-Crisis
Not only have the regulations that govern consumer products
changed, the consumer to whom those products are sold is considerably
different than the consumer of a few years ago. During the crisis,
household net worth declined about 25 percent from peak to trough.7
While some net worth was restored as stock markets recovered, recent
retrenchment in markets demonstrates the volatility that still remains.
Roughly 20 percent of mortgage borrowers are underwater in their
mortgages, leaving them without home equity to tap through sale or
borrowing and limiting their ability to move to reduce expenses or find
employment. Still 9.7 percent of the workforce is unemployed and nearly
6 percent is working only part time while still seeking full-time
employment. Although low mortgage rates help keep mortgage payments
relatively low from an historical perspective, households remain quite
burdened by debt payments. The household debt service ratio, which
represents the share of household after-tax income obligated to debt
repayment, peaked near 14 percent in 2007 before dropping off to about
12 percent recently. Despite its recent decline, this ratio is still
above its average over the past 30 years. Much of this recent drop
reflects the largest annual decline in aggregate consumer credit
outstanding in the nearly 70-year history of the series.
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** Market News International Washington Bureau: 202-371-2121 **
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