Stateline Story

Fed Plan Would Shrink States' Powers

  • April 09, 2008
  • By Pauline Vu

Some state officials see the federal government's plan to overhaul the country's financial regulatory systems as an intrusion on their powers to enforce state laws, and state regulators warn that it could carry grave consequences for consumers.

Insurance rates could climb, efforts to fix the mortgage industry mess could be stalled and a grassroots banking system that paved the way for innovations such as interest-paying checking accounts would be threatened, they predict.

"There's no room for state law," said John Ryan, the executive vice president of the Conference of State Bank Supervisors (CSBS), which represents state bank regulators. "This has been Wall Street's and a handful of big banks' dream to get away from the states."

Last week's proposals by the U.S. Department of Treasury that include taking over systems long-controlled by states were aimed at modernizing the financial oversight system, now regulated by a combination of state and federal agencies. The current system is considered by critics to be inefficient and at times redundant. The report calls for several federal agencies to be combined to cover a wider regulatory area that would be monitored by the Federal Reserve.

But states see the heavy hand of the federal government in some of the report's proposals.

One plan would establish a federal mortgage commission that would set minimum licensing standards for brokers, although states are already working with Congress to establish such standards. Another proposal would increase federal oversight of state-chartered banks, which make up about 70 percent of all banks. And another recommendation is to create an optional federal insurance charter, which could infringe on state powers to set rates, inspect policies and require coverage for those whom insurance companies would otherwise exclude.

The plan to set up a Mortgage Origination Commission is meant to address the troubled subprime mortgage industry, according to the report. These adjustable-rate interest home loans taken out by borrowers with risky credit have been blamed for the economic downturn, and the Treasury report laid much of the blame for them on the states.

It stated that in recent years, state-regulated mortgage brokers and lenders originated more than 50 percent of the loans. "These mortgage originators are subject to uneven degrees of state-level oversight (and in some cases limited or no oversight)," according to the report.

A Mortgage Origination Commission would draw up minimum licensing standards for all mortgage brokers and lenders, and rate and report the strengths and weaknesses of each state's mortgage licensing system.

A CSBS spokesman acknowledged that state licensing standards and supervision have been uneven, but said the report ignores previous and current state efforts to tighten control over mortgage originators. More than 30 states have passed predatory lending laws, and in January the states unveiled the Nationwide Mortgage Licensing System , an online database in which states share licensing and oversight information about mortgage firms that operate in several states.

States also worked with Congress on a current bill to set up minimum licensing standards for brokers. Michael Stevens, CSBS's senior vice president of regulatory policy, said passing the bill would be the fastest way to achieve the commission's goals.

If the federal government moves forward with a mortgage commission, Stevens said, valuable time would be wasted while the commission is being set up.

"I think the message you're sending to state legislators and state regulators is, don't do anything" in the meantime, he said. "Any movement occurring at the state level to update laws, update regulations and generally step up their licensing requirements would stop while people waited for the federal government to act."

Another Treasury proposal would bring all banks under federal control. For now, the department is calling for only a study on this, but opponents charge that in the long term, such a move would lead to a consolidated industry, reduce banking choices for consumers and destroy community banks.

It could also stifle banking innovations, since state-chartered banks have been the pioneers of financial inventions such as checking accounts, interest-bearing checking accounts and home-equity loans - all services later copied by federal banks.

"Crippling state banking charters will weaken banking in America," Edward L. Yingling, the president and CEO of the American Bankers Association , said in a statement.

The federal government is also trying to assert itself in the insurance sector, where it claims the patchwork of state laws makes it tougher for U.S. firms to compete abroad and for foreign firms to enter U.S. markets. State insurance commissions have powers such as setting rates, monitoring claims practices and reviewing policy forms.

The federal plan recommends creating a federal insurance charter to regulate life and property insurance, which would give companies the option of operating under the federal charter or state law.

The Optional Federal Charter Coalition (OFCC), a group of financial and insurance industry representatives, has long supported the idea of a charter, saying it would reduce costs and foster competition, which would, in turn, lower insurance premiums for customers.

Companies could also roll out new products faster under the federal plan. "If you have a new product, if you want to break the market, you need to qualify for each individual state across the country, versus just launching that market after getting one approval," said Jon Snowling, a spokesman for the American Bankers Association, a OFCC member.

But Sandy Praeger, Kansas insurance commissioner and president of the National Association of Insurance Commissioners , said states are better equipped to handle insurance issues that are unique to their states. "Insurance is a fundamentally different financial product from banking and securities that presents unique public policy, regulatory and consumer protection issues, which state officials are best able to address," she wrote in an e-mail.

She also disagreed with the argument that states can't compete internationally. States comprise four of the top 10, and 26 of the top 50, insurance markets in the world, she said, and "when state insurance markets are compared to other national insurance markets around the globe, the size and scope of those states' markets - and therefore the responsibility of state regulators - typically dwarfs the markets of whole nations."

The idea of an optional insurance charter has been debated for the past decade and is unlikely to pass now, said J. Robert Hunter, the director of insurance for the Consumer Federation of America and the former Texas insurance commissioner.

The Treasury proposal pushes for deregulating insurance, Hunter said, but insurance is the kind of industry that requires oversight. He recalled during his tenure as Texas insurance commissioner that he warned people against companies that offered low-cost plans that appeared sound, but in the fine print turned out to offer little coverage.

Additionally, a dual federal-state regulatory system would pressure states to loosen their insurance standards so that more companies would choose to operate under state law, creating a race to the bottom when it comes to insurance regulations, critics said.

"People would be less protected," Hunter said. "Rates would be higher, there'd be more discrimination against low-income and minority people. It would be a mess… Deregulation doesn't work."

Some states' attorneys general also oppose the proposals as hindering their authority to enforce state laws.

Bob Brammer, spokesman for Iowa Attorney General Tom Miller (D), who leads a subprime task force for the National Association of Attorneys General, said deregulation is a disturbing trend.

"It takes power away from the states and gives it to the federal government," Brammer said. "The states are some of the most important regulators and law enforcement people throughout the brewing home foreclosure crisis."

Most of the report's recommendations would require approval by Congress, which is unlikely to consider the plan this year.