Stephen Foley: Consumer protection is key to reform

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The Independent Online

US Outlook: I am being lied to all the time. In mailings from insurance firms, telephone calls from debt-restructuring salesmen, and in radio ads for refinancing mortgages, I am being deliberately and outrageously misled.

Perhaps not lied to in the technical, very legal sense of the word, but misled through the use of sophisticated language – by the finance firm which, calling itself something with "Federal" in the title, pretends it is somehow offering a government-backed bailout of my finances, or by the junk mail from a car insurer that, disguised as a final demand invoice, implies I have a legal duty to sign up to its policy.

It is one of the surprises of moving from Britain to the US: the sheer sophistry in the marketing of financial products, the lack of clear information, and the sheer incomprehensibility of the forms one is rushed through in American banks.

When my UK Barclaycard altered its terms and conditions, I got a letter that set out each change in layman's language. An equivalent letter from American Express in the US read like a legal submission, setting out exactly what words had been inserted into paragraphs six and seven of my agreement, but with no way of telling if I am now flush with cheaper credit or likely to go bankrupt next Thursday.

Maybe American finance professionals are simply more devious than British ones. Maybe it is because the US legal system seems to be more interested in the letter of the law than the spirit of the law. Or maybe there is just not much law here.

Which is, of course, one of the problems that underlay the credit crunch, as the Financial Crisis Inquiry Commission investigating its causes heard this week. Many consumers have only a limited ability to understand details of standard mortgage contracts, let alone the complex mortgages that became common during the boom, leaving them vulnerable to predatory lenders and, later, facing financial ruin. By the end of 2009, 8 per cent of the mortgages in the US were in foreclosure or seriously delinquent.

The toxic assets that began poisoning the banking system in 2007 and which sent it into cardiac arrest in 2008 all have at their heart bad loans to US homebuyers. Yes, there is error, irresponsibility and fraud all through the chain, but the chain begins with a mortgage broker turning a blind eye to a borrower's blatant inability to repay his or her mortgage.

Unfortunately, this looks like another lesson going unlearned. The latest smoke signals from Congress are that the proposal for a new Consumer Financial Protection Agency could be dropped, in order to get a bipartisan deal on wider Wall Street reform. If so, it will be a huge short-term victory for the finance industry's lobbyists and a sad day for consumers. It will also come back to haunt the industry.

Rules to improve underwriting standards, to mandate plain English documentation, to punish predatory lending and to ban the worst kinds of financial products are all vital, and not just to prevent the human misery that has unfolded during this crisis.

Something needs to fill the gap that has opened up now that the finance industry has shifted from "relationship banking" to "market-based banking". When a lender kept loans on its books, it cared about a borrower's ability to pay, and was able to respond sympathetically when difficulties emerged; now the lender sells the loan straight into the securitisation market, to be sliced and diced by Wall Street. Investors in mortgage derivatives, and derivatives of mortgage derivatives (not to mention derivatives of those), never had any way of telling what sort of loans underlay their securities. When it became clear these loans were sold by brokers who didn't care if they could be repaid, to consumers who didn't know what they were signing, the collapse in trust ultimately led to a devastating panic.

A consumer financial watchdog doesn't just protect consumers from a predatory finance industry. It protects the finance industry from itself.