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Let states set consumer protections

By Jeff Sovern, Special to CNN
  • Jeff Sovern says states in the best position to protect citizens from predatory lending
  • But, he says, federal regulators said state rules were pre-empted by federal law
  • States know local citizens better than federal regulators; can shape appropriate laws
  • Congress should free states to enact and enforce consumer financial protection rules

Editor's note: Jeff Sovern is a professor of law at St. John's University School of Law and co-coordinator of the Consumer Law and Policy Blog, which is hosted by Public Citizen's Consumer Justice Project.

Jamaica, Queens, New York (CNN) -- The attempted Times Square bombing could have been much worse, but for the intervention of those who know the area best: a local peddler and the New York City police. Unfortunately, the country was not so lucky when it came to subprime lending.

When, beginning in 1999, states passed statutes designed to protect their citizens from predatory lending, federal regulators declared them pre-empted by federal law.

And when states tried to enforce consumer protection laws against national lenders, federal officials sued to block their efforts. For example, the federal Office of the Comptroller of the Currency went to court to stop New York's attorney general from investigating whether national banks had violated New York's fair lending laws.

As Congress rewrites consumer lending laws, some senators are working closely with Wall Street lobbyists to develop new ways to restrain states trying to protect their citizens from abusive lenders. That would be a terrible mistake. Instead of handcuffing state consumer protection efforts, Congress should see states as partners in preventing another lending crisis and should free states to enact and enforce consumer financial protection rules as they see fit.

One lesson of the subprime crisis is that federal regulators did not understand how best to protect borrowers. That is understandable, to some extent: Lenders can create new types of loans swiftly and push those loans harder in areas of the country where the lenders can make the most money. Meanwhile, federal lawmakers need time to identify the best rules for an entire nation.

In contrast, states often know their local citizens better than federal regulators and can tailor their laws to local conditions. But pre-emption prevents states from using that knowledge to protect their citizens and mandates a one-size -fits-all approach, even for very different states.

Different states can also experiment with different approaches to troublesome practices. If New Jersey and neighboring New York tackle the same problem differently, and one produces a better outcome, other states, and ultimately the federal government, can follow. Experimentation is especially appropriate for rules for new financial products, like those that led to the subprime crisis. But when Congress pre-empts state laws, the only approach that can be tried is the one dictated in Washington. And Washington's choice may not be the best one.

States also have a key role to play in enforcing laws. Just as the New York police were the first responders to the Times Square bomb attempt, state officials can lead efforts to stop improper lending practices. State attorneys general are often far more aggressive at protecting consumers from troublesome acts than federal regulators.

Federal regulators may have failed to protect borrowers because they were "captured" by financial institutions. But it is much more difficult for an industry to capture 50 offices than one. If state attorneys general had been able to move against lenders, it is possible the economy would now be in far better shape.

Financial institutions say that having to comply with the laws of 50 states increases their costs. Instead of one set of forms, they have to use 50. But we should be wary of cost predictions by those who did not foresee the cost of the subprime crisis.

Back in 2000, when the Federal Reserve changed a predatory lending rule, the banking industry claimed that the then-new rule would drive lenders out of the subprime market. We all know how that prediction turned out. And, what's more, every other industry does just fine navigating through state laws. They simply hire some lawyers and consider it a cost of doing business -- and they don't go to Washington asking to block the states.

The wisdom of the New York City police in acting swiftly and decisively to protect the personal safety of New Yorkers is obvious. We should enable states to protect the financial safety of their citizens just as swiftly and decisively. Anyone who supports states' rights -- and doubts that Washington always knows best -- should agree.

The opinions expressed in this commentary are solely those of Jeff Sovern.