Presidential Politics, the CFPB, and FHFA

Despite calls from Sen. Tim Scott (R-S.C.) for federal regulators to halt rulemaking until after President-elect Donald J. Trump’s inauguration, the Consumer Financial Protection Bureau (CFPB) finalized its controversial bank overdraft fee rule last month. Several financial trade associations have already filed a legal challenge to the rule, contending that the CFPB exceeded its statutory authority in issuing it. Nevertheless, the overdraft rule is just the latest in a series of rulemakings that the CFPB seeks to finalize before Trump assumes office later this month and replaces current director Rohit Chopra with someone more amenable to his views. Similarly, Federal Housing Finance Agency (FHFA) Director Sandra Thompson announced her intention to step down as head of the agency on Jan. 19, just before Trump assumes office.

Indeed, since the decision of two landmark Supreme Court cases, Seila Law LLC v. Consumer Financial Protection Bureau and Collins v. Yellen, the heads of the CFPB and FHFA can be removed at the president’s discretion. This power allows incoming administrations to score short-term policy wins by ensuring that agency actions align with their beliefs and preferences. There are some definite tradeoffs, though, not the least of which is the intrusion of partisan politics into the formation of financial regulations. At a minimum, this arrangement makes for greater uncertainty for market actors; at worst, it allows incumbent administrations to opportunistically manipulate rules in the run-up to elections.

The trouble is that, once agencies have become subject to political discretion it is very hard—if not impossible—to depoliticize them. A more stable, apolitical system is needed. While it might sound extreme, doing away with both the FHFA and CFPB is likely the best option for reducing the influence of the administration, and day-to-day politics, in financial regulation. Indeed, Congress has previously abolished agencies when they have ceased to perform their proper function. Taking this step would not only trim the overall size of the federal regulatory agency but also allow for greater play of market forces in the financial system.

The FHFA

The risk of electoral manipulation is particularly apparent with regard to the FHFA. The agency oversees the federal housing government-sponsored enterprises (GSE): Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. As such, it has the power, among other things, to set the affordable housing goals that enterprises are subject to, and alter the amount of capital they must retain against their mortgage portfolios. When combined with the various fiscal and legal privileges the enterprises are accorded by their charters, manipulating these levers presents a potent tool for incumbent administrations to gain an advantage over competitors before an election by expanding the supply of mortgage credit.

The costs imposed by this sort of electioneering are numerous, not the least of which are the risks to financial stability. Several scholars have studied the effect of elections on credit policy, showing that attempts by governments to use these to gain an advantage at the ballot box generally result in a reduction in the quality of financial assets. This is mainly because attempts to use credit policies in this way serve to extend credit to borrowers and households who usually do not have the financial wherewithal to pay back the liabilities they acquire.

For instance, starting in the Clinton years, successive presidential administrations sought to use the federal government’s influence in mortgage markets to try and drive homeownership among low- and medium-income households as part of an agenda to create an “ownership society.” Crucially, this strategy leaned on the housing goals of Fannie Mae and Freddie Mac, with both firms being forced to purchase ever greater quantities of loans made to less and less creditworthy borrowers. The results were disastrous. Housing prices were inflated, and bad loans came to proliferate the financial system, setting the stage for the 2008 financial crisis and subsequent recession.

The CFPB

Short-sighted policymaking does not end with engineering credit expansions, however. Presidential administrations have come to use the CFPB in recent years to target various politically disfavored industry practices. For example, elected officials have blamed bank overdraft fees, credit card late fees, and other so-called “junk fees” for eroding households’ budgets over the past several years. This resulted in the Biden administration directing the CFPB to crack down on the use of these fees, even though these efforts will likely result in reduced access to credit for low-income borrowers, while disincentivizing sound financial behavior. Nevertheless, such tactics allow politicians to shift attention from the various policies that actually contributed to higher prices while pretending that they are “doing something” about the issue. As a testament to the political profitability of this kind of deflection, the incoming Trump administration is likely to continue this ill-advised campaign.

The ability of presidents to influence the direction of regulation also adds to the uncertainty faced by financial institutions. Campaign trail pronouncements aside, it is rather difficult for market actors to predict the direction of rules and regulations before an election. Once the new administration is in place, there is the added cost of having to comply with whatever rules are promulgated. The effect of having to keep up with ever-changing rules comes at a cost, which is usually borne by consumers in the form of higher rates or reduced supply.

Conclusion

The impact of the Supreme Court’s decision in the above court cases is not limited to the FHFA and CFPB, however. Various administrations have challenged the independence of financial regulators, and these two cases have set a precedent whereby other regulators can be subjected to the whims of the executive branch. Thus, the cycles of short-term policymaking, with the attendant regulatory whiplash and stress they place on the financial industry, are unlikely to end with the election of a different party into office. In light of this, policymakers should seek to reform the financial regulatory system to enhance the stability of rules and reduce the potential for opportunism.

Such stability could be provided by trimming the size of the financial regulatory state. Given the issues that have surrounded the CFPB, Congress should abolish the agency as a whole. As for the FHFA, repealing the congressional charters of the Housing GSEs would remove the sole justification for the agency’s existence. More generally, Congress should take a larger role in the formulation of financial regulations. Regardless, the present system cannot, and should not continue.