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Wednesday, July 1, 2009

Regulating "Fine Print"

As part of the new Consumer Financial Protection Agency, President Obama wants to focus on regulating the so called "fine print".

The Consumer Financial Protection Agency would be in charge of regulating those products in the same way other government agencies regulate the safety of drugs, food and toys

Obama said Americans are demanding it.

"Those ridiculous contracts with pages of fine print that no one can figure out—those things will be a thing of the past," the president said in a statement accompanying the 152-page draft bill. "And enforcement will be the rule, not the exception."

The CFPA is part of Obama's broader plan to increase oversight of the financial industry and eliminate regulatory gaps believed to have contributed to the economic crisis.

The agency would be dedicated to protecting consumers when buying mortgages, using credit cards and taking out high-rate "payday loans." It also would monitor terms set on savings, checking and debit card accounts, including overdraft charges.

The problem here is that the Obama administration assumes that all that "fine print" was created by banks and credit cards simply to fool the consumer. Of course, that's not the reality. Most of the so called fine print was created to meet one regulation or another.

Let't take the mortgage process. The longest document, up to fifteen pages, is the Mortgage itself. The Mortgage gets recorded with the County in which the property is located. So, it's up to fifteen pages in order to satisfy the requirements of the County. Why is it so many pages? It explains such mundane things as what happens in case of fire damage, what chemicals can and can't be used in the home, etc. Without those situations addressed, the County wouldn't record the Mortgage?

The Promissory Note is the document that lays out the terms of the loan and the conditions for repayment. Since a loan can be either a fixed rate, variable, or even a negative amortization loan, all of that must be listed on the Note. Payment due dates and the amortization schedule also must be listed. It's also the document that is used during foreclosures. As such, if the Note is incomplete or inaccurate, the bank won't be able to foreclose. So, the so called "fine print" is the manner in which banks word the document to make sure it holds up to a foreclosure proceeding. Now, the president wants to regulate the very same fine print.

Let's look at another document, the Net Tangible Benefits disclosure. This is a fairly new disclosure. This has recently become nationalized. This document discloses the purpose of the loan in a refinance: be it to lower the rate, the payment, fix the payment, or get cash. So, how will a regulator regulate the fine print when the fine print was only created because of a different regulation?

That's the reality of mortgage documents. The reason there's so much fine print is because there's already so many regulations. Now, the president wants to create a new regulator to make sure there isn't so much fine print even though it's only there because of other regulations. You can see how this process would likely become troublesome. The problem of fine print is that there are already too many regulations. Now, the president wants a regulator to regulate the fine print that responds to all of those regulations.

The president says this.

Those ridiculous contracts with pages of fine print that no one can figure out—those things will be a thing of the past," the president said in a statement accompanying the 152-page draft bill. "And enforcement will be the rule, not the exception."

How can those contracts be a thing of the past when they are the way they are to stand up to the scrutiny of our current regulatory framework?


Anonymous said...

As a contract law professor, I live in the world of fine print. The reality is that the language used doesn't matter because consumers never read the contracts anyway. I anticipate that this new agency will create standard form contracts that must be used by the industry.

There are several problems with that approach. First, agencies are always subject to capture by the regulated entities. Thus, the standard mandatory contracts will more closely resemble an industry wish-list than a consumer wish-list over time.

Second, a significant body of research suggests that businesses use standard form contracts to control their costs, occasionally (but not unless they have to because of competition) passing some of the savings on to consumers. Government mandated standard forms remove all flexibility from the system and prevent business from competing through their standard terms. This in turn reduces flexibility and innovation by business in producing new products.

mike volpe said...

There's a lot of excellent points in that comment. I agree entirely. I will point out that one of the main reasons that people don't read contracts is because they are long, wordy, and tedious. That's because they are responding to regulations.