When the brewing financial crisis erupted into full boil last fall, I was reading Dante’s Divine Comedy for the first time. Being a banking law professor, I couldn’t help but speculate about which circle of hell Dante would have found most appropriate for the various actors in the meltdown. Some clearly belonged with greedy “hoarders and spendthrifts” in the fourth circle: banks lending to borrowers with incomes insufficient to support repayment; investment bankers reaping profits on derivatives they did not understand; politicians burying their heads in the sand for the sake of substantial political contributions from the financial services sector; and homeowners buying homes they could not afford. Others clearly belonged in the eighth circle with the “perpetrators of fraud”: predatory lenders engaging in outright deception or exploiting vulnerabilities generated by need or lack of access to legitimate banking sources. But in this era of unrestricted interest rates, would anyone be condemned to the seventh circle where Dante placed the “usurers,” as perpetrators of violence against God and nature?
Attempting to differentiate among the categories of culpability for the crisis is more than an amusing parlor game, for this crisis is the result of a complex convergence of behaviors that we are only beginning to appreciate. Understanding the different types of behavior that got us to this point is crucial to crafting an intelligent plan for digging us out of this hole and preventing us from falling back into it in the future. Can appropriate limits to greed be legislated without compromising the vitality of our markets? Are some outright caps on how much money lenders should make appropriate, in the form of usury laws or compensation restrictions? With respect to fraudulent activity, where is the line between aggressive selling and outright lying?
A significant consideration in assessing possible responses to these questions should be the application of subsidiarity. Subsidiarity is a fundamental tenet of the Catholic Church’s social doctrine. As Pius XI wrote in Quadragesimo Anno :
Just as it is gravely wrong to take from individuals what they can accomplish by their own initiative and industry and give it to the community, so also it is an injustice and at the same time a grave evil and disturbance of right order to assign to a greater and higher association what lesser and subordinate organizations can do.
The Compendium of the Social Doctrine of the Church cautions that it “is impossible to promote the dignity of the person without showing concern for the family, groups, associations, local territorial realities.”
Subsidiarity plays itself out in our response to the banking crisis in a very significant question: Should the federal government be the sole arbiter and enforcer of consumer credit law, or should some power be retained by state governments? The battle over the expanding federal preemption of state consumer credit laws has been raging in banking circles and federal courts for years. It is currently before the Supreme Court yet again, in the case of Cuomo v. Clearing House, L.L.C . It is also one of the points of contention among the members of the Congressional Oversight Panel on Regulatory Reform that prompted two of its five members to withhold their support from the Panel’s January 2009 Special Report on Regulatory Reform .
The basic question is whether a state has the authority to regulate the terms under which national banks can lend money to consumers within that state. Over the past few decades nationally-chartered banks have come to be insulated from the reach of virtually all state consumer credit laws. Aggressive interpretations of federal banking laws by the Comptroller of the Currency, uniformly ratified by the Supreme Court, give national banks the power to export the regulatory regime of the state in which they are headquartered to borrowers in other states. Lenders who want to offer credit to consumers across the country on uniform (and essentially unregulated) terms charter national banks in states with no regulation of credit; they export this lack of regulation to all of their borrowers across the nation.
For example, if the state of Minnesota were to enact a usury law limiting interest rates for credit card loans in Minnesota to 25 percent, a national bank headquartered in Delaware (which imposes no restrictions on credit card interest rates) could “export” Delaware’s law and ignore Minnesota’s law when lending to residents of Minnesota. The case currently before the Supreme Court is a challenge to one of the most aggressive assertions of exemption from state authority¯the position that the Attorneys General of various states do not have the power to investigate national banks or their subsidiaries for suspected violations of federal or state banking laws.
Exportation powers were not given to national banks for the express purpose of evading regulation. Rather, the expansion of exportation was motivated by the transformation of consumer lending from a local business to a national business. As legal barriers to interstate branching and bank mergers fell, the demand for uniformity in loan products grew. Congress and the banking regulators were sympathetic to the operational obstacles posed by having to monitor and comply with fifty different states’ consumer credit laws. But since the headquarter states of choice were (naturally enough) those with no credit regulation, exportation became a vehicle for deregulation.
The current collapse of the national mortgage lending market¯initially triggered and substantially intensified by the collapse of the subprime mortgage market¯raises questions about the ultimate cost of that uniformity and efficiency. Some of the most fiercely fought battles in the preemption wars were over attempts of states such as Georgia to regulate the subprime mortgage lending. As the Congressional Oversight Panel points out, “states first sounded the alarm against predatory lending and brought landmark enforcement actions against some of the biggest subprime lenders, including Household, Beneficial Finance, AmeriQuest, and Delta Funding.”
In applying the principle of subsidiarity, we are asked to give preference to governance at the most local level at which a government’s purposes can be achieved. To the extent that the government’s purposes in preventing future financial crises include assessing the appropriate limits to greed, or setting an appropriate line between the “hard sell” and outright fraud, perhaps this could be achieved more effectively at the state level, even at the cost of the uniformity and efficiency available at the federal level. The faces and tactics of the greedy and the fraudulent look different in urban areas with large minority communities than in suburban areas with largely white populations. In the urban areas, subprime loans tended to be pushed on borrowers by lenders anxious to lend at rates that are higher than market justified. In the suburban areas, in contrast, mortgage fraud was more likely to involve participation by borrowers themselves, who inflated their incomes and accepted unjustified appraisals. This sort of a differentiated understanding of the different categories of culpability is easier to achieve at the local level. Similarly, judgments about the point at which legislative curbs on greed start to compromise the vitality of credit markets could vary in different states. The way in which greed and fraud affects its victims is also subject to regional variation, perhaps explaining why local enforcement officials have proven to be more adept at recognizing predatory lending earlier than federal officials.
What state governments offer their citizens that is not so readily available at the federal level is the more intimate contact that fosters solidarity, something that the Church insists must moderate the delicate application of subsidiarity to economic activity. The Compendium warns:
The action of the state and other authorities must be consistent with the principle of subsidiarity and create situations favorable to the free exercise of economic activity. It must also be inspired by the principle of solidarity and establish limits for the autonomy of the parties in order to defend those who are weaker. Solidarity without subsidiarity, in fact, can easily generate into a “Welfare State,” while subsidiarity without solidarity runs the risk of encouraging forms of self-centered localism.
Three members of the Congressional Oversight Panel recommend reversing the laws that currently immunize national banks from state consumer protection laws while two members reject that recommendation, in the interest of maintaining a “strong well-balanced federal regulation that allows national firms to compete effectively with global peers.” There is, however, some middle ground. The power of exportation should be extended not as an automatic feature of a national bank charter, but rather as a privilege for banks willing to submit to some threshold level of substantive consumer credit regulation. This threshold level could be imposed by federal law, or by the law of the state where a bank is headquartered. Banks located in states that do not enact at least the threshold regulations should be denied exportation powers. And, at the very least, we should restore states’ investigative powers over national banks lending to their citizens, so that states can continue to act as the canaries in the consumer credit coalmines.
Elizabeth R. Schiltz is an associate professor of law at University of St. Thomas.
