CFPB California Style

Almost a decade after U.S. Senator Elizabeth Warren (D-Mass.) declared that the federal Consumer Financial Protection Bureau (CFPB) would become a new “cop on the beat” protecting consumers of financial products and services, California Governor Gavin Newsom signed a law creating a new state regulatory agency that some commentators have dubbed the “CFPB California style.”

Effective January 2021, the California Consumer Financial Protection Law establishes a state Department of Financial Protection and Innovation (DFPI) aimed at protecting consumers of financial products and services from predatory business practices. According to Manuel P. Alvarez, commissioner of the newly created DFPI, the agency will address “an increase in predatory financial lending and scams” due to “the economic downturn induced by the COVID-19 pandemic.” He claims that the DFPI will be able to “increase consumer protections without imposing undue burdens on honest and fair operators.”

In particular, the drafters of the new California law seek to restore many of the financial protections that have been rescinded under the Trump Administration. To some critics, however, the DFPI suffers from many of the same defects as the CFPB—in particular so-called “regulation by enforcement.”

Regulation by enforcement refers to actions taken by the CFPB to initiate enforcement actions—or other legal proceedings—to prevent financial product or service providers “from committing or engaging in an unfair, deceptive, or abusive act or practice.” To critics, the standards for what constitutes an “unfair, deceptive, or abusive act or practice” are excessively vague. That vagueness results in companies’ self-regulating to avoid enforcement actions, critics charge, which deters companies from providing products and services that may benefit consumers.

But champions of these standards, such as former CFPB director Richard Cordray, argue that they can prevent a regulatory agency from “limiting its discretion and responsibility to evaluate each case individually on its own facts and circumstances.” He claims that no rigid formula could comprehensively encompass all cases in which CFPB action would be necessary to protect consumers. Under Cordray’s leadership at the CFPB, the bureau’s enforcement actions returned almost $12 billion to the hands of consumers.

Although relatively scant empirical evidence exists to show what effect the CFPB’s enforcement actions have had on consumers, in a 2018 working paper, economists Andreas Fuster and Matthew Plosser from the Federal Reserve Bank of New York and James Vickery from the Federal Reserve Bank of Philadelphia found that CFPB enforcement and oversight did not reduce the amount of credit offered to consumers. Fuster and his coauthors compared the changes in the amount of credit offered by banks under CFPB’s oversight with smaller banks not subject to CFPB oversight. Although they found CFPB oversight did not affect the amount of credit offered, they did find that CFPB oversight decreased the amount of credit offered to risky borrowers.

Despite a lack of clear evidence showing that CFPB enforcement actions harm consumers, the CFPB has drastically reduced the number of its enforcement actions during the Trump Administration. Earlier this year, the CFPB announced it would challenge abusive conduct only when the harm to consumers was greater than its benefit, and it said it would seek monetary damages only on a showing of “bad faith” on the part of financial service and product providers.

In response to retrenchment of the CFPB at the federal level, legislators in California sought to fill the “leadership void for Californians” at a time when “the President is weakening the federal bureau.” Cordray, who advised the California legislature on the drafting of the bill, reportedly said that the creation of the DFPI “is a major, major initiative that will make a big difference not only in California—certainly in California—but also nationally.”

The DFPI has authority to regulate a wide swath of financial institutions such as banks, credit unions, securities firms, payday lenders, and fintech companies, and it is empowered with the same “unfair, deceptive, or abusive act or practice” standard of enforcement as the CFPB. The statute, however, expressly excludes “finance lenders, broker-dealers, residential mortgage lenders, mortgage servicers, mortgage originators,” and check sellers, as well as banks and credit unions chartered federally or by another state. Some critics see the choice to exempt certain previously licensed entities, such as banks and auto lenders, but not others, such as payday lenders and student loan services, as reflecting the outsized influence lobbyists had on the law creating the DFPI.

Yet critics and champions alike seem to agree that, although the DFPI will not be the only state consumer financial regulator in the United States, the size of California’s economy will likely mean that the DFPI will have a significant impact on consumer finance in the years to come.