Learning experience.

Photographer: Ricky John Molloy

Misbehaving Consumer Agency Gets Sent to Time Out

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
Read More.
a | A

An appeals court has just thrown a bit of a spanner into the works at the Consumer Financial Protection Bureau, ruling that the entire control structure of the bureau is itself unconstitutional, and also that the agency erred in slapping a hefty fine on mortgage lender PHH. That first conclusion is getting big headlines and will hearten critics of the agency. But the more narrowly written part of the decision will ultimately matter more.

The bureau accused PHH of having given out a sort of kickback (involving an arcane mortgage reinsurance arrangement), and whacked them with a hefty fine. Their interpretation of the relevant regulations, said a three-judge panel of the D.C. Circuit on Tuesday, was retroactively applied to behavior engaged in before the rules were changed. The judges agreed with the mortgage lender on both of the main thrusts of its argument: that the bureau had misinterpreted the relevant law and also that, correct or not, the bureau had no right to apply its interpretation to actions taken before it changed the rules.

They also, however, said that as set up, the agency was itself unconstitutional, because of the way the head is appointed: The head can be removed only for cause, and only by the president. This is the most controversial part of the ruling and will therefore get the most press.

The constitutional objection is that the president cannot delegate substantial amounts of power unless the president is effectively controlling the person who exercises that power. To be sure, there are other independent agencies controlled by appointees who enjoy fixed terms, rather than serving at the pleasure of the president. They constitute, as the court wrote, “a headless fourth branch of the U.S. Government.” The court argues that their lack of accountability is already a threat to liberty, but that their power has historically been checked by the fact that the independent agencies had board members, directors or commissioners who could at least check each other and the appointee.

The D.C. Circuit panel said that the Consumer Financial Protection Bureau’s structure was unconstitutional because it vested too much power in a single individual. The judges said the bureau must cede some of its power. Specifically, the president must be able to fire the director at any time.

This may cause some agitation among folks who like the idea of rule by unaccountable technocrats. But ultimately, it probably isn’t going to make all that much difference to the political economy of the U.S. Indeed, it’s not clear to me why the bureau was set up like this in the first place.

There are valid arguments for insulating some agencies from political pressure. None of us would like to live in an economy where, for example, presidents could easily order the Federal Reserve to deliver them a nice burst of inflation right before every election. But the bureau is not handling this sort of important, election-sensitive question; it’s supposed to be in the rather pedestrian business of making sure that our lenders don’t cheat us.

I’ve heard arguments that this highly independent structure will keep the agency from getting in bed with the industries it regulates. This argument has always seemed to me to fundamentally misunderstand the reasons that regulators tend to end up reflecting the world view of the industries they regulate, none of which have much to do with the president’s ability to fire the head of the agency.

This phenomenon, known as regulatory capture, happens first of all because humans are social animals, and it’s natural to develop relationships between people you spend a lot of time with; second of all, because ultimately the main source of information about the industry in question is always going to be the industry itself, and the information its members provide will always be heavily inflected by their world view; third of all, because of a logical “revolving door” because the industry will tend to be the main source of employees who understand the industry, and also of jobs for people leaving the regulatory agency; and fourth of all, because even if the preceding three points were not true, it’s in everyone’s interest for industry and regulators to develop a friendly relationship.

The agency does not want to waste massive amounts of manpower battling the industry over every trivial wording change, and the industry does not want to spend a fortune hiring lawyers to defend petty violations. Both sides therefore have an incentive, over time, to figure out what the other side wants, and settle on a working compromise where most of the time, the other side gets it. This will happen no matter what exotic management structure you think up.

To be sure, this has not yet happened at the Consumer Financial Protection Bureau. Its critics have some rather pungent opinions about its aggressively, perhaps excessively, adversarial stance against the finance industry. But the bureau is young. Like people, during their early years, agencies are often firebrands. Ten or 20 years in, they look back at how much time they wasted and decide to spend less time scoring Pyrrhic victories -- like issuing an aggressive new interpretation of the law and retroactively applying it, thus ensuring that you’ll get smacked down in court.

So the unique structure of the bureau is unlikely to keep it from getting more friendly with industry; that will happen, over time, simply because it always does. There is only one real benefit of an agency head who can’t be fired: The president does not have to take much responsibility for anything their agency head does, because the commander-in-chief can always just say “Hey, I don’t have any more control over them than you do.” This is, of course, a very attractive feature for presidents. But those of us who ultimately think that government should be accountable to the governed will probably find it less enticing.

However, it’s not as if there is currently a groundswell of popular outrage against the government for being too hard on those dear, sweet bankers. So I doubt that this change will cool the bureau’s youthful eagerness.

The other half of the court case -- where the court said “No, you can’t just go around issuing aggressive new interpretations of the rules, and then slapping penalties on bankers who you feel ought to have complied with that interpretation before the bureau even existed” -- is likely to matter more. This case was viewed as one of the first big tests of the infant agency’s power. The results are in. It didn’t fail -- but it did get a big red “Needs Improvement” across the top of its exam.

Agencies do not enjoy this experience any more than the rest of us do. This failed test, unlike the revised structure, will probably encourage the bureau to be more cautious in the future. Ten or 20 years from now, people will probably look back and mark this decision as the beginning of the end of the bureau’s firebrand phase. And they’ll probably be right. But not because of the big headline-grabbing part of the decision.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor responsible for this story:
Philip Gray at philipgray@bloomberg.net