Longtime critic joins government

Until Senate majority leader Harry Reid tapped her in November to help oversee the federal bank bailout, the "financial crisis" that most preoccupied Elizabeth Warren was the shadow looming over millions of American families from growing mountains of personal debt.

The plight of America's struggling middle class has long been Warren's great passion. Since the 1980s, the Harvard law professor has studied how medical debts, credit-card traps, and crises such as job loss and divorce have pushed millions of families toward a financial cliff, and often into bankruptcy.

Life can take strange turns. After years as an outside critic who blamed ineffective federal regulation for the problems she saw, Warren has a new role in Washington. She's the intellectual godmother of a proposed new regulatory agency: a Consumer Financial Products Administration, an idea embraced by President Obama and fought by the finance industry and its Capitol Hill allies.

In an article last year in the University of Pennsylvania Law Review, Warren and co-author Oren Bar-Gill said lenders sell credit products "designed to obscure their risks and to exploit consumer misunderstanding."

During an interview, Warren discussed her vision for the new agency, including her idea that financial products such as mortgages and credit cards can be made safer if regulators push lenders to offer them in "plain vanilla" versions. These simpler products would be based on approved templates, making it easier for consumers to understand and compare the lenders' terms.

Question: What do you mean by "vanilla"? How would that work, say, for credit cards?

Answer: The template would have the basic terms of a credit-card agreement, and would have four blanks or so for the lender to fill in. One for the interest rate. One for the penalties. A third for what triggers the penalties. And the fourth blank for how you get your free gift, the double miles, or the dollars that they're going to give you back.

Other than that, it's just plain vanilla. Card issuers' products should be clear enough that people can understand and make a choice. They could say, "Oh, I want this card. I don't want that card. This is the card that's the most expensive. This is the card that's the riskiest."

The plan is to work with the industry and with consumer groups to develop the template, then say to the industry, "If you will use the template, you can fill in whatever you want on the blanks. And if you'll use the template, you're done on regulation. It's all over. You've met all the federal regulatory requirements."

Q: What if a lender doesn't want to use the template?

A: If a lender wants to offer a variation, then it can do so as long as it meets certain regulations. With credit cards, that might include that it can be read in five minutes by somebody with an 11th-grade education.

If a lender wanted to sell something that's very dangerous, like reverse mortgages that are sold to the elderly, the rules would be tougher. By the way, we have this tiered level of regulations in the current system - reverse mortgages already have heavy regulations. The difference is that no regulator pushes to make the less-dangerous products simpler and easier to understand.

Q: So some products would require more traditional regulation?

A: Right. The idea behind this agency is to pick the low-hanging fruit. Do a lot of plain-vanilla products, and let the market drive those products toward the marginal cost of production and lower prices. That probably will be about 95 percent of all consumer loan products.

I could put four credit-card agreements in front of you today and you'd have more than 100 pages of incomprehensible text. If credit-card agreements were a page and a half long and the fill-in-the-blank parts were clear, you could tell immediately which is the cheaper card, which is the riskier card, and how much the free gifts really cost.

Q: Why can't existing regulators, such as the Federal Reserve or the Office of the Comptroller of the Currency, handle this?

A: People who want to become regulators at the Fed want to do monetary policy, not consumer protection. They're not interested in car loans and credit cards, they're interested in M1 and M2 and the velocity of money. That doesn't make them bad people. It just means they have expertise in a different area and an interest in a different area. The people who go to the OCC want to do prudential regulation to see if the banks have enough capital reserves. They don't go there because they want to do consumer protection.

There is no one in Washington - no agency - whose principal responsibility is the consumer, or watching out for the economic health of the American family. No one.

Q: How do you answer critics who say this will stifle financial innovation?

A: It's exactly the reverse. The best example is the Food and Drug Administration. Back in the 1920s, anybody with a bathtub and a bunch of chemicals could become a pharmaceutical company. They could bottle anything and make any fantastic claim and sell it. A lot of people died. A lot of people were blinded.

Over time, the FDA put some rules in place, getting rid of the worst products and making the disclosures clear. Eventually, the rules required that products really have to do something.

Remember Carter's Little Liver Pills? The FDA said, "Wait a minute. What does a liver pill do? Prove it does what you're claiming."

Here's what's interesting about innovation. The FDA discovered that when it pushed the deceptive products out of the market, they made room for real innovation. So companies had an incentive to do R&D and to bring good products to market. So long as companies had to compete with snake-oil salesmen, nobody had much incentive to produce a better product.

Today's competition in financial services is not about bringing a better product to the consumer. It's about loading up the credit-card agreement with more tricks and traps. Why do you think credit-card agreements have gone from a page and a half in 1980 to more than 30 pages today? It's not because the industry wanted to help consumers. They did it in large part because that's where the revenue enhancers are. Fee income has become the fastest-growing part of the credit-card business.

How did all those tricky mortgages work? They worked by loading up with fees on the front end and on the back end: prepayment penalties, rates that went up later on. It was all about the tricks and traps. That's what made them so extraordinarily profitable.

Q: Why is the finance industry against the proposal?

A: The opposition is driven by the big banks. The big issuers are raking in billions of dollars on tricks and traps, and they don't want to give that up. Once those products are clear and customers can choose the cheapest one, then costs will drop. Consumers will see a real savings, and that means less money for the megabanks.

It also means that smaller banks will be able to compete better with big banks. Right now it's about who can run a hundred-million-dollar advertising campaign. There are good products out there offered by some credit unions and community banks. But they're drowned out by the volume of the big issuers' tricks and traps.

The small banks are also bearing the brunt of what is now a fractured and complex regulatory system. They can't hire an army of lawyers and spread the costs of regulation among several million customers. A streamlined system of regulation, one that is mostly about streamlined products that people can understand, will help level a lot of playing fields.

Age: 60.

Birthplace: Oklahoma City.

Occupation: Leo Gottlieb Professor of Law at Harvard University; chair of Congressional Oversight Panel on TARP.

Hometown: Cambridge, Mass.

Education: Bachelor's in speech pathology and audiology at University of Houston; J.D. at Rutgers University.

Personal: Married to Bruce Mann, law professor and legal historian at Harvard; mother of Amelia Warren Tyagi and Alexander Warren. Elizabeth Warren and Tyagi have coauthored two books, including "The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke" (2003).

Philadelphia ties: Before Harvard, Warren and Mann taught at the University of Pennsylvania Law School.EndText