The problems of the recent credit crisis, which are far from over, stemmed from the fact that there was no governing body strong enough to stop deteriorating credit standards and unsafe mortgage products from taking hold in the market place.
Fannie Mae and Freddie Mac were beset by accounting scandals and in no position to push against private label 'Option arm products', which turned mortgages into high exposure credit cards without any regard to who would bear home price risk. As a result, the mortgage -- once considered the safest consumer finance product -- turned into a huge source of risk. Although many people feared a housing bubble and collapse, Wall Street Investors paid no heed given the high demand for mortgage backed securities.
The lack of a watchdog of consumer financial safety led to one of the safest financial products – the mortgage -- becoming the source of systemic risk in the US and global financial markets.
There is nobody strong or vested enough to safeguard the micro foundations of our economy, the individual borrower. The closest groups that could have potentially lobbied against this successfully, Fannie Mae and Freddie Mac, were beset by their own accounting scandals. Although Fannie Mae initially stayed out of the option arm products and lost large market share, it could not take a proactive and aggressive stances against the ills of those products given its distractions.
The safety of financial products is an issue that has been neglected by the media, Wall Street, and even consumers themselves. If we are to learn anything from this credit crisis, we must learn that we all live an interconnected world of global financial markets with unpredictable macroeconomic interactions and effects.
This means that there is excessive risk in the system. Without any protection or watch dog, financial institutions are able to craft complicated products which pass this risk onto borrowers. The risk of home price decline, unemployment, and inflation are large and systemic, and individual families are not well equipped to deal with this risks. Once a macroeconomic risk presents itself it is very difficult for governments to manage it. Besides throwing taxpayer money and seeking to boost confidence, there is little that can be done at the tail end of a crisis. An ounce of prevention is worth more than a pound of cure.
For a democratic society to function with a high quality of life, it is essential to safeguard and protect the individuals that, as the Noble Laureate Thomas Schelling wrote, provide micromotives which shape macrobehavior. To reduce individual risk is much cheaper than to fight system risk in the aggregate. President Obama and Professor Elizabeth Warren are right in pushing for a strong Consumer Financial Protection Agency (CFPA) so we can stop exposing individuals to financial risk which will snowball into a larger problem.
We need a strong CFPA now more than ever to ensure all Americans have access to safe financial products. A consumer watch group, like CFPA, will not only make consumer finance products safer, it will create greater efficiency in terms of product standardization and commoditization. At the end of the day, credit is a commodity, albeit a necessary one. It should work like utilities and be made simple, safe and transparent.
Leaving consumers unprotected at the mercy of financial markets and macro economic risks poses a great danger to the well being of both the quality of life of US citizens. A consumer's ability to obtain and use capital – without assorted tricks and traps and dangers -- is an essential part of living the American dream. This is worth fighting for. If we leave individuals, the backbone of this country and foundation of the economy, unprotected and exposed without any standards or body of consumer finance safety, we are taking on excessive macro-economic risk that no amount of bailouts can cure.
Dhruv Sharma is a Credit Risk Manager and Interdisciplinary Scholar with over nine years experience in risk management at one of the largest mortgage and consumer credit organizations in the U.S.