Maximilian D. Schmeiser Federal Reserve Board of Governors Disclaimer:

1. Recent Developments in Federal regulation of Consumer Financial Products and their Implications for Consumer Well-Being Maximilian D. Schmeiser Federal Reserve Board of Governors Disclaimer: The views expressed here are solely my own and do not necessarily represent the views of the Federal Reserve Board of Governors, the Consumer Financial Protection Bureau, or any other agency of the Federal Government

2. Overview • Numerous legislative and regulatory changes related to consumer financial products and services prompted by recent economic crisis • Including the elimination of one regulator (Office of Thrift Supervision) and creation of another (Consumer Financial Protection Bureau) • Changes resulted from perception that financial institutions were engaging in predatory and deceptive practices to exploit consumers • Also to address the systemic risks posed by large financial institutions

3. Overview • As a result, consumer financial service market is changing: • Banks need to develop new sources of revenue to offset losses due to regulations • Reevaluation of lending practices/tighter credit (particularly for mortgages) • Consumers have experienced mortgage defaults and foreclosures, delinquency on credit, declines in asset values (particularly home equity) • Consumers are changing their financial behaviors

4. Overview • Regulators are also changing • Sense that all the regulators failed to adequately protect consumers over the past several years • Missed signs of the impending financial crisis • Got overly attached to a free market ideology • Reforming practices to be stronger enforcers and more attentive to the needs of consumers • Taking a consumer-centric approach to the design and development of rules, regulations, and disclosures

5. Agenda • Recently passed legislation and what it means for consumers • CARD Act • Dodd-Frank Act • The Consumer Financial Protection Bureau (CFPB) • Recent regulatory changes/initiatives to help consumers • Using research to inform regulation • Summary • Questions

6. The CARD Act • Signed into law May 2009 • Most provisions took effect February 22nd, 2010 • Arose from perception that certain practices in the credit card industry were not fair and transparent to the consumer • Curtailed many credit card fees and practices

7. The CARD Act • Specific provisions of the CARD Act: • CC company must send you a notice 45 days before they can increase your interest rate; change fees (annual fees, cash advance fees, and late fees); make significant changes to the terms of your agreement • Improved disclosure of costs of making minimum payment, interest paid, etc • Over-limit transactions are now opt-in and only one fee per billing cycle can be imposed • Cap on card fees at 25% of initial credit limit • Under age 21 need to show proof of ability to pay or need co-signer

8. The CARD Act • Specific provisions of the CARD Act (continued): • Standard payment dates and times (i.e. minimum 21 days between statement date and payment due; due date same day each month; payment cut-off time 5pm or later on due date; if payment day falls on a weekend or holiday due next business day) • Any payment above minimum must go to highest interest balance first • Banned double cycle billing (We couldn’t figure out how to explain that to consumers) • Late payment fee cap of $25 or your minimum payment, whichever is less • No inactivity fees • Interest rate fixed for first 12 months unless adjustable rate

9. Consequences of CARD Act • Credit card companies responded by: • Making nearly all credit cards variable rate • Increasing minimum payments to $25 • Promoting business/professional cards, which were not subject to the CARD Act • Reintroducing annual fees • Minimum finance charges • Increased balance transfer fees/foreign transaction fees • Complaining about lost income • Consumers now have protections against many questionable practices, lower costs, transparent fees

10. Dodd-Frank Act • “The Wall Street Reform and Consumer Protection Act” • 800+ page law with hundreds of new rules, regulations, mandated reports, agencies, oversight, etc. • Much of it related to regulation of banks, financial institutions, insurers, and other “systemically important” entities, as well as financial markets • Abolished OTS (“dysfunctional” regulator of IndyMac, AIG, WaMu, etc) • Created CFPB

11. Dodd-Frank Act • Dodd-Frank Rules for Mortgage Market: • Prohibit mortgage originators from receiving compensation that varies based on loan terms; eliminates yield spread premiums (selling consumers high cost products) • Requiring reasonable ability to repay the loan, and that credit decisions be based on verified financial resources (should have been done in the first place) • Define minimum underwriting standards for various types of mortgages • Limiting pre-payment penalties • Adding new mortgage disclosures • Define Qualified Residential Mortgage (banks can securitize without holding 5%)

12. Dodd-Frank Act • General consumer related rules: • Limit debit interchange fees (Durbin amendment) • Right to obtain credit score if it negatively affects them in a financial transaction or hiring decision • Increases deposit insurance from $100,000 to $250,000 for each account • Improve disclosures for remittances

13. Durbin amendment • Federal Reserve charged with setting debit interchange fees that are “reasonable and proportional to the cost of processing debit transactions” • Proposed limit of $0.12 down from average $0.44 for banks over $10 billion in assets • Not clear can have higher price for smaller institutions • May increase in final rule • Expected to cost banks about $12 billion in fees each year • Either transferred to retailers or consumers (or both) through lower costs/prices • Recent attempts to delay Durbin defeated in Senate, now on to courts

14. Dodd-Frank Act • Effect on consumers-mortgage market: • Unclear what the implications are in the mortgage market since private market barely functioning • Long-term may limit availability of mortgages to high-risk consumers; raise interest rates for all consumers • Effectively bans balloon payment mortgages, restricts availability of interest only and negative amortization loans (need cash on hand to pay off balloon to qualify, loans underwritten using worst-case-scenario assumptions, or even worse than worst case) • Designation of qualified mortgages (those for which banks do not need to have “skin in the game” of 5%)

15. Dodd-Frank Act • Effect on consumers-banking: • Debit interchange fee cap most significant proposal • Banks will seek to recoup lost revenue through account maintenance fees, reduced or eliminated debit rewards, etc • Major effect on consumers comes through the new role of the CFPB in regulating financial institutions

16. The Consumer Financial Protection Bureau • Created as the regulator who’s primary emphasis is protecting the consumer • Consolidates consumer protection functions of numerous other regulators under one roof • Tasked with monitoring most aspects of the consumer financial market for unfair, deceptive, or abusive products and services • Payday loans, check cashers, money transfer companies, etc • Has significant authority to regulate many aspects of the consumer financial market

17. The Consumer Financial Protection Bureau • Also has primary responsibility for educating consumers about financial issues and receiving consumer complaints about financial products: • Has branch dedicated to financial literacy/financial education • Has branches specifically focused on the issues facing: students; older Americans; and service members • Is required to launch a consumer complaints hotline on July 21st, 2011 and attempt to resolve these complaints

18. The Consumer Financial Protection Bureau

19. The Consumer Financial Protection Bureau • Key staff: • Director has yet to be named • Raj Date heads Research, Markets, and Regulations Division • Gail Hillebrand heads Consumer Education and Engagement Division • Holly Petraeus Assistant Director for Service Member Affairs • Sendhil Mullainathan Assistant Director for Research • Richard Cordray, Assistant Director for Enforcement • Patricia McCoy, Assistant Director for Mortgage and Home Equity Markets • Zixta Martinez, Assistant Director for Community Affairs

20. The Consumer Financial Protection Bureau • Off to rocky start: • Many key staff have yet to be named • Unclear that a director will be in place by July 21st (only option recess appointment assuming Republicans recess) • Limits ability of CFPB to write certain regulations and supervise certain types of financial services institutions • Agency is political flash point—push to change from director to board; subject it to appropriations (now funded by Fed); allow FSOC to veto rules/regulations with majority vote (instead of 2/3rds)

21. The Consumer Financial Protection Bureau • Short-term implications: • Other agencies (Fed) getting out of financial education—extent of efforts unlikely to be fully replicated anytime soon • Delays in implementation of various regulations • Long-term implication: • Uncertain future for CFPB • If subject to appropriations may be unable to fulfill all it’s duties (think SEC) • Senate approval of any director highly unlikely • If Obama loses in 2012 may be significantly altered

22. The Consumer Financial Protection Bureau • Implications for consumers: • Won’t have the strong “cop on the beat” envisioned by consumer advocates • Products that were expected to be regulated may not be due to lack of a director • Agency seems intent on research and testing driven disclosures, so likely to improve disclosures (clear, concise, useful) • Consolidation of TILA/RESPA disclosures for mortgages

23. Other Recent Regulatory Changes for Consumers • Overdraft fees on checking accounts: • Federal Reserve issued new rules that limited banks ability to charge consumers overdraft fees on ATM and debit transactions • Overdraft now an opt-in rather than opt-out (or no choice) account feature • Consumer can cancel (or opt-in) anytime • Doesn’t apply to checks and direct-debits

24. Consumer Testing

25. Using Research to Inform Rules & Regs • Many of our consumer financial protections rely on disclosures to consumers so that they can make the optimal decision for themselves • In the past many such forms were designed by lawyers with little input from consumers • However, more recently extensive consumer testing has become the norm for revising existing disclosures or creating new ones • Now mandated by Dodd-Frank

26. The Situation Exposure  Attention  Comprehension  Memory  Decision making • Consumers don’t read disclosures • Consumers don’t understand what they’re reading Disclosures that are not read or cannot be understood are not disclosures.

27. The Constraints • Limited flexibility • Statute and regulations requirements e.g. opt in vs opt out • Not starting with a “blank sheet” • What consumers want vs what consumers need

28. The Goal • What do we want consumers to do or to know after reading this disclosure? • Shopping? • Make a decision? • Do something? • Understand risks?

29. The Means to the End • Consumer testing • Focus groups • One-on-one cognitive interviews • Usability interviews • On-line evaluation • Quantitative validation studies • In-person • On-line

30. The Consumer Testing Process

31. What is “Consumer Testing”? • Government agencies are increasingly using consumer testing to design and validate disclosures • Agencies generally test model forms to ensure that they “work” for consumers • Once released, model disclosure forms represent a “safe harbor” for institutions

32. Goals of Consumer Testing • The Dodd-Frank Act requires that every new model form is tested with consumers to ensure that it: • (A) uses plain language comprehensible to consumers; • (B) contains a clear format and design, such as an easily readable type font; and • (C) succinctly explains the information that must be communicated to the consumer. • Testing also ensures that disclosures can be effectively used to make decisions

33. Three Strategies Used in Testing • Focus Groups: Discussion sessions held with 8-12 people +: Good for exploratory questions, brainstorming, gathering ideas or info about consumer attitudes and behavior -: Not ideal for in-depth analysis of how consumers read a document or whether they understand the content

34. Three Strategies Used in Testing • In-Depth Interviews: Interviews conducted with one (or two) people where they are shown documents +: Allow interviewer to measure understanding of a document, and probe areas of confusion -: Do not produce quantitative, statistically significant data

35. Three Strategies Used in Testing • Large-Scale Experimental Tests: Shorter interviews done with large numbers of people +: Provide precise and definitive answers to specific questions -: Can only answer very specific questions; expensive

36. Structure of In-Depth Interviews • Interviews are usually 60-90 minutes long • One round of cognitive interviews often represents feedback from 7-10 people • If testing is conducted rigorously, that number is sufficient to detect most usability problems

37. Types of Interview Questions • Observational (think-aloud) • “Review this document just as you normally would, and as you do tell me what you are thinking.” • Comprehension • “If you used this card to buy something at a store, what interest rate would you be charged?”

38. Types of Interview Questions • Use in Decision-Making • “Look at these two mortgage loan offers. Which of the two loans would you choose, and why?” • Preference • “Which of these two forms do you think is clearer and easier to read?”

39. Iterative Rounds of Testing • Testing is usually an iterative process: • Draft form is developed • Form is tested with consumers • Based on findings, form is revised • Revised form is tested again…, etc. • Eventually, form is finalized • Number of iterative rounds can vary • Timeline can vary from one month to several years

40. General Findings from Testing • Consumers don’t read disclosures carefully • Need to highlight key pieces of information • Adding more information can decrease understanding • Disclosures often must serve consumers with different needs • e.g., More vs. less savvy mortgage borrowers

41. General Findings from Testing • “Plain language” makes a difference • “Finance charge”  “Fees and interest” • “Default rate”  “Penalty rate” • Disclosures don’t always work • Sometimes it proves impossible to explain things to consumers, even using plain language

42. Use of Consumer Testing

43. www.consumerfinance.gov/ knowbeforeyouowe/

44. Evolution of the Privacy Notice

45. Evolution of the Privacy Notice

46. Evolution of the Privacy Notice

47. Evolution of the Privacy Notice

48. Evolution of the Privacy Notice

49. Evolution of the Privacy Notice

50. Testing Considerations • Language/word choice • Plain language • Meaningful language • Design testing • Part to whole • Frame (e.g. Why, What, How) • Usability testing • Understand content • Validation testing – does it work for general population? • Decisions consistent with preferences