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Rules Make for Better Rules Than Lawsuits Do

The Consumer Financial Protection Bureau needs to tell people that something is illegal and then punish them if they do it, not the other way around.

Make the rules first, punish second.

Photographer: Andrew Harrer
This post originally appeared in Money Stuff.

I have made a certain amount of fun of Mick Mulvaney's appointment as the acting head of the Consumer Financial Protection Bureau, a job that he is doing part-time after previously calling the bureau a "sick, sad" joke, but here is a client note from Davis Polk & Wardwell LLP calling Mulvaney's memo to the CFPB last week "one of the most remarkable documents to be published by an agency head in many years," and they are not exactly wrong? Here is Mulvaney:

I think it is fair to say that the previous governing philosophy here was to aggressively "push the envelope" in pursuit of the "mission;" that we were the "good guys" and the "new sheriff in town," out to fight the "bad guys."

Simply put: that is what is going to be different. In fact, that entire governing philosophy of pushing the envelope frightens me a little. I would hope it would bother you as well.

Well, it bothers me! We have talked before about regulation by enforcement, in which agencies (or prosecutors) decide that some previously widely accepted practice really should have been illegal, and instead of declaring it illegal from now on, go back and prosecute the people who were doing it before. Regulation by enforcement is appealing to regulators because of its efficiency: You don't have to go through the brainstorming exercise of thinking up new rules about what should be forbidden, or the administrative work of writing and passing those rules. You just see stuff that looks bad, sue the people doing it, and get them to settle for a large fine because, to be fair, it does look bad and they don't want to spend years litigating it. There is a rough justice here: If something looks bad enough to get the regulator angry, and it looks bad enough to embarrass the people doing it into settling, then it probably should have been illegal, and declaring it illegal after the fact makes some sense.

But Mulvaney objects:

On regulation, it seems that the people we regulate should have the right to know what the rules are before being charged with breaking them. This means more formal rulemaking on which financial institutions can rely, and less regulation by enforcement.

The rulemaking is harder for the agency, and makes it more likely that financial institutions who do bad stuff can get away without being punished. (Because the bad stuff, though bad, was not illegal.) Still it seems to me like the right way to regulate: Tell people that something is illegal, and then punish them if they do it anyway, rather than the reverse. Financial markets work better when they are governed by clear written rules rather than by the gut instincts of regulators and prosecutors, even if that does give rise to a certain amount of gamesmanship.

Obviously this message would be more compelling if it came from a legally appointed and Senate-confirmed independent director of the CFPB, instead of an Acting Director who is simultaneously a White House official. (And in a White House run by a president who "does not understand why he cannot simply give orders to 'my guys' at what he sometimes calls the 'Trump Justice Department.'") The commitment to the rule of law here seems angstroms deep. I think financial enforcement could use a deeper commitment to the rule of law, but a commitment to the rule of law only in financial enforcement is troubling too. (Do only white-collar offenders get the benefits of due process?) Still a good memo is a good memo, and financial regulation by rules really is preferable to financial regulation by enforcement.

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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:
    Matt Levine at mlevine51@bloomberg.net

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    James Greiff at jgreiff@bloomberg.net

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