With a key Congressional committee moving on legislation creating a powerful consumer financial products watchdog, the agency’s vague and unusual funding structure is likely to draw greater scrutiny.
“The whole issue of how it gets funded--how it fits into the appropriation process and whether taxpayers pay for it--all has to be worked out,” says veteran banking industry analyst Bert Ely of Ely & Company. “To what extent is it supposed to cover all its costs or produce revenue that exceeds its costs?”
Questions abound about the controversial agency, which was first proposed by the Obama administration in June and is meant to assume some of the existing regulatory responsibilities of the Federal Reserve as well as other entities.
And buried under the financing discussions is the fundamental issue of whether Congress is encroaching on the central bank's independence.
Unlike existing banking regulatory agencies, such as the Office of the Comptroller of the Currency, the CFPA will not be entirely funded by industry fees, known as assessments. It also wouldn't receive supplemental income via the normal Congressional appropriations process.
What’s more, who and what will be paying those assessment fees is still unclear.
The House Financial Services Committee discussion draft of the bill simply states “any person who engages directly or indirectly in a financial activity, in connection with the provision of a consumer financial product or service … or in connection with the provision of a consumer financial product or service, provides a material service….”
That casts a net beyond the typical financial sector.
“The thinking in part is to assess non-bank financial institutions,” said one knowledgeable Congressional source, ahead of the committee's markup Thursday. "Pay-day lenders, mortgage companies.”
Mortgage companies are definitely in. Not only are their products specifically mentioned in the bill, but the industry has been vilified for its predatory lending practices, the subprime mortgage meltdown and its contribution to the foreclosure crisis.
Credit unions, say analysts, are very likely out. Credit card companies, given the recently passed credit card law, would presumably be in. But what about insurers?
It gets complicated because five bank holding companies (JPMorgan Chase , Citigroup , Bank of America, Goldman Sachs and Wells Fargo ) now regulated by the Fed are all in the mortgage lending and/or servicing business. Many banks also have credt card operations.
“It becomes a huge issue: What industries, organizations are going to subject to it,” says Ely. “It also becomes very much of a cost-shifting exercise" in that assessment fees by other agencies may either be shared and/or diverted.
Nationally chartered banks, for instance, already pay assessment fees to the federal comptroller to cover safety-and-soundness exams as well as compliance activities. A similar arrangement exists on the state level. So would funding from the comptroller be diverted?
Given the lack of detail at this point—more than usual for massive legislation—it’s impossible to determine how many institutions would be covered, what the assessment rates would be and thus what percentage of the operating funds would be generated from that source.
On top of that, all institutions, apparently, will not be treated equally, which would presumably require additional criteria and metrics.
Fees will be “based on the size and complexity” of a covered entity, the draft bill states, but also “its compliance record.”
That sounds punitive, say analysts, and “highly unusual”, according to one former Fed official.
Analysts say an unusually high amount of detail will seemingly be left to the new agency's director.
Fed Piggy Bank
Highly unusual certainly describes the agency’s other source of funding.
The bill states that each year the Fed's “Board of Governors shall transfer funds in an amount equaling 10 percent of the Federal Reserve System’s total system expenses (as reported in the Budget Review of the Board of Governors most recent Annual Report to Congress) to the [CFPA] Director for the purposes of carrying out the authorities granted in this title.”
That 10 percent presumably represents the Fed’s operating costs for supervision and compliance activities of its consumer division, a good part of which entails implementing and enforcing the Community Reinvestment Act, according to people familiar with central bank’s operations. (The new agency will be in charge of the CRA.)
Based on the most recent report, system expenses, excluding the costs of printing and transporting the US currency, totaled $3.37 billion in 2008. Some $3.45 billion was budgeted for 2009.
Ten percent of those levels amounts to $337 million and $345 million, respectively.
Yet, there’s no single line item in the budget review that fits the compliance description, making it difficult to extrapolate, and the Fed’s consumer functions are carried out by both the board and the regional banks, further complicating the issue.
The Fed did not respond to a request to break down its consumer protection functions, staffing levels or operating costs.
“It is pulling ten percent out of the hat,” says veteran economist David Jones, who has written several books about the central bank. “It’s sort of an artificial construct.”
Breaking The Bank
The budget, however, does include the following:
In 2008, the board spent almost $56 million on banking supervision and regulation. Another $20 million went to consumer and community affairs. There were about 270 staff positions.
In the same year, the 12 regional banks in the Federal Reserve System spent $642.2 million on supervision and regulation in 2008. About $714.2 million was budgeted for 2009.
By contrast, the FDIC’s operating budget for 2009 was $2.24 billion, up slightly from the year before, but more than double what it was in 2005.
“The size and cost aren’t clearly defined, leaving both questions open ended,” says Scott Talbott, SVP and head of government affairs for the Financial Services Roundtable, which, like many other business group, strongly opposes the CFPA.
Though the math may be puzzling, the broader role of the Fed in funding the CFPA is troublesome.
“This is the first time we would fund something non-Fed by the Fed. I find this troublesome,” says Mark Calabria of the Cato Institute, who recently worked for Richard Shelby of Alabama, the ranking GOP member of the Senate Banking Committee. “This seems to be a huge transfer of power to an agency that will never have to come back for funding.”
“It’s a way of doing a back-door appropriation,” says Robert Glauber, a former senior Treasury Department and Boston Fed official, who recently stepped down as non-executive interim chairman of Freddie Mac .”
That’s because the Fed’s budget is essentially independent of Congressional oversight and works in a self-funding way. Practically speaking, the central bank derives its income by buying government bonds and notes from the Treasury and collecting the interest like any other investor. The Fed keeps a certain amount of the profit while the rest goes back into general government coffers.
Calabria and others say Congress is being inconsistent, having previously attacked the Fed for the aggressive use of its emergency lending powers under its charter to leverage its balance sheet and provide all kinds of liquidity to individual firms like AIG (AIG ), as well as the overall system, which essentially circumvented Constitutional rules on spending authority. (President Obama is an advocate of the CFPA.)
In the same way, many in Congress were also unhappy about the Treasury Secretary’s unusual authority and discretion in deteriming the allocation of funds under the $700-billion TARP program.
Though most of that money went to bail out Wall Street firms, Congress was somewhat appeased when tens of billions of dollars were redirected to efforts benefiting small business and consumers, such as the Obama administration’s massive foreclosure prevention program.
Glauber, who played a key role in the Bush administration’s reform efforts in the wake of the savings and loan crisis 20 years ago, says the CFPA funding issue is less about a money shuffle than a power grab.
“This goes to the heart of the bigger issue, and that’s the future of the Fed and its independence, ” he says. “When Congress starts allocating the Fed’s profits you take one step closer to Congressional oversight of the Fed.