Congress gave the Federal Reserve the power to enact rules to protect consumers from unscrupulous mortgage lending in 1994. But as the years passed and risky subprime loans inflated the housing bubble, restrictions on lenders never came.
It wasn't until last summer, long after the bursting bubble triggered the deep recession, that the central bank adopted rules prohibiting unfair, abusive or deceptive lending practices.
The 14 years it took the Fed to act are now cited by Obama administration officials, consumer advocates and lawmakers as a key reason for scrapping a fragmented regulatory structure spread across multiple agencies and replacing it with a new Consumer Financial Protection Agency.
"Its inability to move quickly on consumer protection blocked reform in the mortgage market that could have helped avert this crisis," Michael Barr, assistant Treasury secretary for financial institutions, said of the Fed at a recent Senate hearing.
At the heart of the push for a new consumer agency are two basic bureaucratic realities:
* The priorities of agencies with a lot of responsibilities depend on who's in charge. By all accounts, former Fed Chairman Alan Greenspan didn't make consumer protection a priority. His successor, Ben S. Bernanke, has been forced to elevate it.
* Regulatory agencies are designed primarily to monitor the economy and oversee the health of banks and other institutions.
The Fed and other regulatory agencies have a long-standing culture that puts those responsibilities ahead of protecting consumers from an increasing variety of complex financial offerings, said supporters of a new agency.
"It is definitely second fiddle," Ellen Seidman, a former director of the Office of Thrift Supervision, said of consumer protection at that and other agencies. "I worked very hard to elevate it. And that says something important -- namely that somebody had to work very hard to elevate it."
Seidman, now a senior fellow at the New America Foundation, said she created an award for the best bank examiner on consumer affairs and compliance issues when she headed the agency from 1997 to 2001. Her successor eliminated it.
But it is the Fed that has become the prime example of the government's failures to protect average Americans from financial predators, and it stands to be the biggest loser if Congress creates the new agency.
The Obama administration has made the proposed consumer protection agency a centerpiece of its financial regulatory overhaul. Key congressional Democrats are strong supporters, and a House committee is poised to approve it in September.
But the proposal faces strong opposition from many Republicans and business groups. They argue it will add an unnecessary layer of bureaucracy and limit consumer access to lending and credit by discouraging innovative -- though often higher-risk -- loans and other financial products.
Stripping the Fed
Under the legislation, the central bank would be stripped of its ability to write rules covering mortgages, credit cards and other consumer offerings. The new agency would take over that job, as well as take authority from the Fed and other regulators for examining financial institutions for compliance with the rules and punishing those who violate them.
The Fed's struggles with writing consumer protection rules highlight the secondary position those responsibilities often take at financial regulatory agencies, including the Office of Thrift Supervision and the Securities and Exchange Commission, according to supporters of a new agency.
Consumer advocates, for example, have slammed the Office of the Comptroller of the Currency, which regulates national banks, for blocking oversight of those institutions by state attorneys general, many of whom are more aggressive than federal officials in protecting consumers.
The Supreme Court ruled in June that states could enforce some of their consumer protection laws against such banks, and Obama's regulatory plan would formally give states such a role.
And the dysfunctional nature of spreading consumer protection across eight agencies -- the Fed, the OTS, the SEC, the OCC, the Federal Deposit Insurance Corp., the National Credit Union Administration, the Department of Housing and Urban Development and the Federal Trade Commission -- has become clear in the fight over the Obama administration's proposal.
Some of those other regulators have endorsed the idea of taking away the Fed's rule-writing power while arguing to retain their own compliance and enforcement authority.
"I think one of the lessons learned in the crisis we're in is there were truly gaps," said John E. Bowman, acting OTS director. "Ideally you would have one agency that sets the rules, then delegates the enforcement of those rules to . . . bank and thrift regulators at the state and federal level."
Turf protection has been a major problem in adopting consumer protection rules, which require input from other regulators, said Travis Plunkett, legislative director for the Consumer Federation of America.
"It's like a multi-armed octopus that's very hard to get a handle on," he said of the existing structure. "All the agencies are interested in protecting their jurisdiction over their slice of the financial marketplace, so typically there's a great deal of resistance to imposing uniform restrictions that affect the whole marketplace."
The Fed is fighting back.
Bernanke, who took over in 2006, has admitted the central bank's failure to protect consumers under Greenspan. But Bernanke said he had made consumer protection a priority, noting not only the mortgage rules that finally came out on his watch but also new rules for credit cards and recent proposed changes for mortgage and home-equity loan disclosures.
"We were not quick enough and we were not aggressive enough to address consumer issues earlier in this decade," he told lawmakers. "I think the Federal Reserve in the last three years or so has demonstrated that it can be very effective."
Like the Fed, other agencies are scrambling to highlight their commitment to consumer protection.
Just days after the Obama administration proposed the new agency, the National Credit Union Administration proposed creating a consumer protection office in its 2010 budget. And FDIC Chairwoman Sheila Bair appointed a senior advisor for consumer policy, a new position.
But supporters of the Obama administration's proposal worry that when a new Fed chairman takes over or the financial crisis abates, consumer protection could be pushed onto the back burner again unless those powers are given to a new agency with that sole function.
"Clearly all of the agencies have a core mission that simply reduces consumer protection to the margins," said Rep. Bill Delahunt (D-Mass.).
The prime example of that is the Fed's failure to act on subprime mortgages, said supporters of a new agency.
"There were definitely people at the Fed then who understood the problem and wanted to fix it," said Kurt Eggert, who served on the Fed's Consumer Advisory Council from 2004 to 2007. "They can advise, but the policy comes from the chair."
He said Greenspan, who headed the central bank from 1987 to 2006, was the main reason the agency didn't act.
"The problems in the subprime world were readily apparent well before the crash and during his reign as chair," said Eggert, a law professor at Chapman University in Orange, who has studied the mortgage industry. "It wasn't the lack of information out there. Some of it was not treating it seriously enough and some of it was not viewing the Fed's job as consumer protection."
Greenspan said during a contentious congressional hearing last fall that former Fed Gov. Edward M. Gramlich had warned of the risks of predatory lending in 2000. Greenspan said he didn't think regulations would be successful and opted to leave the problem to free-market forces.
He conceded he was later "distressed" to learn that his long-standing belief in the power of competitive markets had failed when it came to subprime mortgages.
The budget for the Fed's Division of Consumer and Community Affairs, which handles rule-writing, has increased from $25 million in 2005 to $41.8 million this year, and average staffing has risen from 84 employees to 116.
Fed officials said that effort was in addition to consumer protection services provided by economists and others at the agency, mainly bank examiners who integrate consumer protection standards in their routine bank compliance reviews.
When the Fed finally rolled out the mortgage rules last summer, as well as new limits on credit card interest rates and fees, Congress wasn't mollified. Unhappy that the Fed gave banks until July 2010 to comply with new credit card rules, lawmakers this year accelerated the effective date by five months.
"It is true that things have improved, but the Fed's track record over the last 10 to 15 years has been overall dismal in addressing consumer protection concerns in the financial services marketplace," Plunkett said.
"There's no evidence this is a change that will last more than a year or two, until Congress is paying attention to something else."