Caveat vendor

“CAVEAT emptor”, the principle that a marketplace is best regulated by cautious individual buyers, is a largely obsolete doctrine, much like child labour and unconstrained working hours, explains Richard Cordray, the head of the Consumer Financial Protection Bureau (CFPB). Indeed, the CFPB was set up to protect the little guy from predatory financial firms in the wake of the financial crisis and the deceptive mortgage issuance that helped to precipitate it. Republicans have tried to impede its work, believing it will saddle financial firms with onerous regulation and unreasonable investigations. Mr Cordray is helping to resolve the argument, by proving the CFPB’s critics right.

Although the CFPB has been around since 2011, it started work in earnest only in July, when Republicans abandoned their efforts to block Mr Cordray’s nomination to head it. Until recently its conduct had seemed largely unobjectionable. It reached a handful of multimillion-dollar settlements with big credit-card companies and debt-refinancing outfits for misleading marketing or outright deceit. Credit bureaus have been pursued for giving out false information and making little or no effort to correct it. These errors are particularly harmful because regulators often require firms weighing applications for credit to refer to credit bureaus. And since the individuals being harmed are not the bureaus’ customers, there is a clear misalignment of incentives—just the sort of problem the CFPB is designed to address.

Lately, however, the agency has taken more controversial steps. In January it issued new rules to clarify when a borrower might reasonably be considered capable of repaying a mortgage. The text, as with so many recent financial rules, stretches to hundreds of pages once lengthy preambles and other fleshing-out are taken into account. It is packed with exceptions and ambiguities, and grants regulators enormous discretion.

This opacity and complexity is worrying to mortgage lenders, since they face dire consequences if they do not follow the rules correctly and no exception has been obtained from the CFPB. They might have to repay all the payments made on a mortgage that has been granted improperly, and be precluded from foreclosing on the mortgaged property. The CFPB has said it will handle minor breaches with clemency, and take into account the efforts of banks to comply, however that is measured—but that simply piles on further ambiguity. Both Democratic and Republican congressmen questioning Mr Cordray on January 28th asked whether the new rules might harm poor borrowers more than they helped them, by deterring banks nervous about the paperwork and legal liability from lending to them altogether.

An equally striking move came in December when Ally Financial, the former lending arm of General Motors, now owned by the government, agreed to a $98m settlement after the CFPB investigated it for discriminating against minority customers. Ally collects no information on the ethnicity or race of its customers, making it hard to prove that it favoured white applicants for car loans over those with darker skin.

The CFPB, according to the complaint it filed with a court in Michigan, argued that “information about the race and ethnicity…can be calculated based on public data published by the United States Census Bureau…using a process called the Bayesian Improved Surname Geocoding method.” In other words, it tried to infer the race of Ally’s customers using data about where they lived and what their surnames were, and then based its complaint on this inference. The customers who were probably minorities, according to the complaint, paid an interest rate that was up to 0.29 percentage points higher than those who probably were not, adding perhaps $300 to their borrowing costs over the life of the loan.

Whether such a tendentious argument would have prevailed in court is unclear. Ally put out a statement denying discrimination, but otherwise has offered no comment. It had an incentive to settle: not long after the deal was announced, regulators granted it a special status that allows it to borrow from the Federal Reserve and the government sold a big chunk of its shares, both steps Ally had long sought.

The CFPB is not stopping there. A rule it has proposed but not confirmed would require financial firms in America to submit plans to ensure that their staff and suppliers are sufficiently diverse (again, in a racial rather than prudential sense), a novel government intrusion into hiring and purchasing. The CFPB is also said to be considering investigating loans to small businesses—consumers of a sort, after all—which would put another big chunk of the economy under its aegis.

All this is especially alarming to the CFPB’s critics, since it is unusually independent. Its funding does not come from Congress, but from the Federal Reserve. It is not led by a panel with overlapping terms, but by a single director with a five-year term. This means it is much more likely to bend to the agenda of the president who happens to be in office when a new boss is appointed. Lending, already buffeted by the economic cycle, may soon fall victim to a political one too.

^{Correction: In an earlier version of this article we wrote that the CFPB had complained that discrimination against some car-buyers had added $300 a year to their borrowing costs. It should have been $300 over the life of the loan. Sorry.}