This article appeared in the Fall 2001 issue of the New Rules Magazine.
If George W. Bush means what he says about states’ rights, then he’ll use his new post to rein in two rogue federal agencies that have systematically gutted the ability of state policymakers to protect their citizens from greedy and unscrupulous banks.
Few Americans have heard of the Office of the Comptroller of Currency (OCC), the chief regulator of national banks, or its sister agency, the Office of Thrift Supervision (OTS), which regulates thrifts (savings and loans). Yet these two unelected agencies—they’re both part of the Treasury Department and are headed by presidential appointees—have preempted numerous state banking laws designed to pre- vent anticompetitive practices, ensure fair lending and protect consumers.
“Time after time when states have tried to come up with creative and reasonable solutions to very real consumer problems, ” observes Santa Monica City Attorney Adam Radinsky, “the OCC has stepped in to tie their hands. ”
In some cases, the agencies have preempted state authority with the blessing of Congress. But in many instances they have acted in ways directly at odds with the express intention of federal lawmakers. “The OCC’s actions on preemption appear to be more those of an indentured servant of the industry than a regu- lator concerned with the will of Congress, ” argues Ed Mierzwinski, consumer program director for the U. S. Public Interest Research Group.
In 1994, Congress formally reprimanded the OCC for “inappropriately aggressive” preemption activi- ties, concluding that the agency had preempted state laws that Congress had no intention of overriding. The OCC ignored the reprimand and has actually accelerated its preemption actions in the years since.
Historically, banks have been subject to both federal and state oversight. National banks—those chartered at the federal, rather than state, level—have been required not only to comply with federal rules and regulations, but also the laws of the states where they operate. In crafting banking laws, Congress has gen- erally chosen to provide a basic framework of regula- tion and to establish minimum standards. States have been allowed to enact additional rules and higher standards, particularly with regard to consumer pro- tection, an area Congress has largely viewed as a state responsibility.
There are multiple benefits to such an approach. States are more nimble than Congress and better able to respond to industry changes. The challenges and needs of rural communities in Maine are often quite different from big cities in California. States can func- tion as a laboratory of ideas; effective policies develop a track record and are copied elsewhere. Unlike fed- eral laws, bad policies adopted in one state will not undermine the entire financial system.
A good example of this principle in action can be found in the Congressional approach to regulating automated teller machines (ATMs). In 1978, Congress enacted legislation “to provide a basic framework establishing the rights, liabilities, and responsibilities” of both purveyors and users of this new technology. The law contains a variety of consumer protections, but expressly authorizes states to establish more strin- gent standards.
Not surprisingly, state laws governing ATMs evince differing circumstances and priorities. New York lawmakers were concerned about safety and required adequate lighting and surveillance cameras at all ATM locations. Iowa lawmakers felt universal access was necessary in a state with a relatively sparse population of both people and ATMs. They mandat- ed that ATMs be networked in such a way as to enable any resident with a cash card to withdraw money from any machine. Neither safety nor universal access is addressed in the federal ATM law.
Ensuring that banks meet the needs of local residents has long been the responsibility of state policymakers. So, in early 1991, as legislation requiring all banks to provide basic, low-cost checking accounts moved through the New Jersey statehouse, no one ques- tioned whether the state had the authority to act. Industry deregulation and a wave of mergers in the 1980s had caused the cost of basic banking services to skyrocket. Banks stopped paying interest on deposits and began charging fees for everything from visiting a teller to writing a check. As a result, millions of Americans could no longer afford bank accounts and were forced to operate on a cash-only basis. Check cashing outlets proliferated. New Jersey legislators responded by requiring all banks operating in the state to offer a no-frills, low- cost checking account. This “lifeline” account must include eight free checks per month, a minimum bal- ance of only $1 and monthly fees of no more than $3. All residents without a current checking account are eligible.
The law could hardly be considered burdensome to national banks. It specified that no bank would be required to offer an account below its actual costs and authorized state regulators to grant exemptions. Many national banks already offered accounts that qualified.
But before the law took effect, the OCC deter- mined that New Jersey’s law was preempted by feder- al law and authorized national banks to ignore its provisions. The agency based its opinion on the Bank Enterprise Act (BEA), in which Congress had given its blessing to low-cost accounts by providing financial incentives to banks that offered them. Nothing in the BEA indicates that Congress had any intention of overriding state efforts to make bank accounts more widely available. Yet the OCC ruled that, because Congress had legislated in this area, it was now off- limits to the states.
At the time, many other states were moving to enact legislation similar to that of New Jersey. The OCC’s action brought these efforts to an abrupt halt. Although a handful of states have since enacted some form of low-cost banking legislation, none of these laws apply to national banks, which control nearly 60 percent of all bank deposits. Today, accord- ing to a recent estimate by the Federal Reserve, 13 percent of families lack a checking account.
The OCC contends that it is merely carrying out the will of Congress when it preempts state laws. “The OCC does not choose ‘to preempt; ’ it is federal law that preempts, ” insists Comptroller John Hawke, Jr., the agency’s head.
Congress itself has reached a different conclusion. In the Conference Report that accompanied the 1994 Riegle-Neal Act on interstate banking, Congress admonished the agency for acting outside the scope of federal law:
[T]he Conferees have been made aware of certain circumstances in which the Federal banking agencies have applied traditional pre- emption principles in a manner the Conferees believe is inappropriately aggressive, resulting in preemption of State law in situations where the federal interest did not warrant that result. . .
The report singles out two instances of OCC pre- emption that lawmakers found especially egregious. One was the agency’s preemption of New Jersey’s life- line checking account law. “[T]he fact the Congress has acknowledged the benefits of more widespread use of lifeline accounts through the enactment of the Bank Enterprise Act, ” the conferees wrote, “did not indicate that Congress intended to override State basic banking laws. .. ”
With Congressional support in hand, the New Jersey banking department requested that the OCC review its preemption decision. The agency published notice of the review and a request for comment in early 1996. Five years later, however, the OCC has yet to issue a ruling on the matter.
Indeed, in the years since the Congressional repri- mand, the OCC’s preemption efforts have only accel- erated. “The OCC has given national banks the impression that they can do whatever they want, ” contends Iowa Assistant Attorney General Kathleen Keest. National banks now routinely request cover from the OCC when they encounter a state law with which they’d rather not comply. The agency invari- ably obliges and has joined banks in several lawsuits aimed at overturning state laws.
The OCC’s opinions carry significant weight in the courts. The Supreme Court has held that judges must give deference to the opinions of regulatory agencies. If the meaning of a federal law is ambigu- ous, as it often is, then the courts decide only whether the OCC’s interpretation is reasonable, not whether it is the best or most substantiated reading of Congressional intent. As the OCC consistently favors preempting state authority, the effect of deference has been to undermine federalism.
In 1996, the Supreme Court heard a case brought by California credit card customers against Citibank for charging late fees prohibited by California law. The 1863 National Bank Act authorizes national banks to charge “interest at a rate allowed by the laws of the State. .. where the bank is located. ” In 1978, the Court had ruled that the words “where the bank is located” refer to the bank’s home state, not the state where the customer resides or where the loan is issued. This enables banks to estab- lish credit card offices in states with lenient lending rules and thereby evade usury laws in other states. Citibank’s credit card headquarters is in South Dakota, which does not cap interest rates.
The question before the Court in the Citibank case was whether late fees qualify as interest. If so, they would be subject to the laws of South Dakota, not California. As the case wound its way through the legal system, the OCC issued a new regulation to extend the meaning of interest in the National Bank Act to cover all manner of credit card fees, including late fees. As a result, by the time the case reached the Supreme Court, the issue was no longer whether Congress had intended in 1863 to revoke the right of states to restrict credit card fees. Instead, the Court considered only whether the OCC’s interpretation of the meaning of “interest” was reasonable. The Court concluded it was.
Big banks are especially intent these days on evading state laws governing ATMs and other forms of elec- tronic banking. These technologies are not only a rich source of revenue, they’re the industry’s future. National banks want to operate their ATM networks without regard to local rules and be bound only by the limited consumer protections found in federal law.
In 1998, Bank One, which owns the largest fleet of ATMs in the nation, sued the state of Iowa. It argued that, as a national bank, it was exempt from several provisions of the state’s ATM law. Bank One enlisted the support of the OCC, which filed a friend-of-the- court brief on behalf of the bank.
The OCC’s argument hinged on what Iowa Attorney General Thomas Miller termed a “minor definitional change” in the 1996 Paperwork Reduction Act. The sentence in question amended the major federal law governing national banks, the National Bank Act (NBA), to indicate that ATMs are not “branches. ” Since states are allowed to regulate national banks that “branch” into their borders, the OCC contended, if ATMs are not branches, then states cannot regulate them.
Within this bit of legalistic acrobatics, it’s hard to divine a clear Congressional intent to override state authority. The amendment offers the only mention of ATMs in the entire NBA. The Paperwork Reduction Act was designed to reduce unnecessary paperwork. As the heading of the defi- nitional change clearly spells out, its purpose was to eliminate the need for banks to file lengthy branch office applications every time they install a cash machine.
Not only is the OCC’s interpretation a stretch, it must be weighed against the 1978 federal ATM law’s clear language pre- serving state authority: “This subchapter does not annul, alter, or affect the laws of any State relating to electronic fund trans- fers, except to the extent that those laws are inconsis- tent with the provisions of this subchapter, and then only to the extent of the inconsistency. A State law is not inconsistent with this subchapter if the protection such law affords any consumer is greater than the protection afforded by this subchapter. ”
Nevertheless, the 8th Circuit Court of Appeals sided with the OCC, overturning a lower court ruling and voiding two provisions of Iowa’s law as it applies to national banks. One involved a restriction on advertising on ATMs. The other required a bank to establish a branch office, or partner with a bank already operating in the state, before installing an ATM. The latter rule was designed to ensure that consumers could quickly and easily seek redress for ATM malfunctions.
In a co-signed brief, twenty state attorneys gener- al contend the ruling could “have a chilling effect on state initiatives to protect consumers as national banks have methodically cornered the ATM market in many communities. ” In Iowa, national banks have not in fact cornered the ATM market—at least not to the degree they have elsewhere. Four banks own fewer than 20 percent of all the ATMs in Iowa. By comparison, in Massachusetts just two banks control more than 65 percent of the machines.
Iowa’s more competitive market largely results from the unique structure of its ATM network, as mandated by state law. Unlike networks in other states, banks and credit unions of all sizes have an equal say in network decisions. This has produced one of the most equitable and lowest cost ATM sys- tems in the nation. But if the OCC has its way, inno- vative state laws like Iowa’s will be overturned in favor of a one-size federal regulation that fits no one save a handful of the nation’s largest banks.
In 1999, two California cities, San Francisco and Santa Monica, banned surcharges, the fees consumers pay to use an ATM operated by a bank other than their own.
There are two primary reasons for banning sur- charges. One is to protect consumers from excessive bank fees. The other is to prevent big banks from using their market power to undermine smaller rivals. By imposing surcharges, banks that own a dominate share of the ATMs in a local market can induce customers of smaller banks to move their accounts to one of the large banks in order to avoid the fees. As David Balto of the Federal Trade Commission has noted, surcharges “present a per- verse form of price competition where firms can actu- ally gain customers by raising prices. .. ”
Eliminating surcharges does not mean banks must provide ATM service for free. Banks are in fact already compensated for providing ATM service to noncustomers through an inter-network fee paid by the customer’s own bank.
Shortly after San Francisco and Santa Monica pro- hibited surcharges, Bank of America and Wells Fargo sued the cities in federal court. The two banks own 86 percent of the ATMs in San Francisco and 72 percent in Santa Monica.
The OCC filed a friend-of-the-court brief in sup- port of the banks. The agency argues that the federal ATM law, with its express preservation of state authority, is not the relevant statute under which the case should be decided. Instead, the OCC contends that the controlling statute is the NBA, which autho- rizes banks to exercise, “subject to law, all such inci- dental powers as shall be necessary to carry on the business of banking. ” Charging fees is an incidental power, according to the agency, and cannot be restricted by state or local laws.
The cities argue that such an expansive reading of the NBA directly contradicts the intent of Congress as spelled out in the federal ATM law. Moreover, the NBA itself does not authorize banks to charge fees and expressly preserves the right of states to regulate national banks.
In fact, among the instances of unwarranted pre- emption singled out by Congress in 1994 was an OCC regulation that empowered national banks to charge fees without regard to state law. Congress rejected this blanket preemption of state authority and ordered the OCC to revise its rule. The new regulation indicates that questions of preemption will be decided on a case- by-case basis, implicitly acknowledging that in some cases states do have the authority to limit bank fees.
This regulation and its Congressional history are completely inconsistent with the OCC’s argument in the surcharge case, according to San Francisco Deputy Attorney Owen Martikan. In what can only be seen as an attempt to remove this inconsistency, in January the OCC issued notice that it planned to revise the regulation. “It’s more than suspicious that they would do this two weeks after final briefs were filed, when we can’t respond, ” says Martikan.
The case is currently before the 9th Circuit, which is not expected to rule for at least a year. In April, five national banks likewise filed suit, with the support of the OCC, against Iowa’s surcharge ban. Iowa is the only jurisdiction that currently prohibits the fees. Meanwhile, the threat of preemption and litigation have brought consideration of surcharge laws in dozens of cities and states to a standstill.
“Preemption is the 500-pound gorilla in the closet waiting to pounce on whatever states do, ” says North Carolina Assistant Attorney General Phil Lehman. “It’s immensely frustrating. ”
North Carolina is one of several states trying to stop predatory lending, a fast-growing practice that targets low-income and elderly borrowers with high- cost home loans. Predatory loans have high interest rates and are loaded with unnecessary fees. They’re often structured to keep the borrower in perpetual debt, by, for example, including one large balloon payment at the end of the loan. Unable to pay, the bor- rower will be forced to refinance. In the worst cases, the lender will “flip” or refinance the loan repeatedly to earn additional fees.
Many borrowers saddled with predatory loans actually qualify for less expensive mortgages. Those who try to refinance with another lender, however, find that steep prepayment penalties—as much as 5 percent of the principal—make getting out of the loan impossible.
Predatory lending expanded rapidly in the 1990s. Between 1993 and 1998, the number of high interest, sub-prime loans—not all of which are considered predatory—issued each year grew from 80,000 to 790,000. Foreclosures also climbed dramatically, partic- ularly in low-income minority neighborhoods. Many of the nation’s top banks and mortgage companies, includ- ing Citibank and First Union, are engaged in predato- ry lending, either directly or through a subsidiary.
Responding to rising interest rates in the late 1970s, federal lawmakers exempted housing creditors from certain state laws. The goal was to increase the supply of credit and relieve strapped savings and loans, which, at the time, accounted for half of all home lending. Over the years, the OTS and OCC have steadily expanded the scope of these exemptions, rendering states virtually powerless to protect their citizens from predatory lenders. A 1979 federal law, for example, exempted most residential mortgages from state interest rate caps. Although the legislative history suggests Congress intended the law for home purchases only, in the mid 1980s, the OTS concluded that it applies to other types of loans, provided they are secured by a lien on the borrower’s home. This encourages lenders to make loans for cars and other purchases contingent on refinancing the consumer’s mortgage. The refinanced mortgage, including the car loan, is thus free from state usury limits. Moreover, the lender can foreclose on the home, rather than repossess the car, should the borrower default. It’s a bad deal for consumers and frustrates the original purpose of the 1979 law, which was to expand home ownership.
Unable to cap interest rates, state policymakers have tried to stamp out predatory lending by target- ing particular terms and conditions common to predatory loans. Nearly half the states, for example, ban or restrict prepayment penalties, which lock bor- rowers into unfavorable loans. More than 70 percent of sub-prime loans carry prepayment penalties, com- pared to only 1 percent of prime loans (those made to borrowers with solid credit histories). Under OCC and OTS regulations, however, state restrictions on prepayment penalties do not apply to national banks and thrifts.
Moreover, in 1996, the OTS concluded that state- licensed housing creditors are also exempt. These nondepository mortgage companies make more than half of all home loans and are responsible for most predatory lending. The OTS based its decision on the 1982 Alternative Mortgage Transaction Parity Act, which authorized housing creditors to issue adjustable-rate loans regardless of state laws limiting such loans. Following the OTS opinion, lenders chal- lenged prepayment laws in several states, bringing lawsuits against both New Jersey and Virginia. Thus far, the courts have sided with the OTS.
The OTS itself provides only limited consumer protections and has yet to strengthen these rules in response to the growing predatory lending crisis. In a letter last year, 46 state attorneys general accused the OTS of contributing to the crisis and urged it to restore state authority. “We tend to look with disfavor on attempts to preempt state laws designed to protect our citizens, particularly when the federal regulatory scheme offers no similar protections, ” they wrote.
State policymakers are likewise powerless to protect consumers from a new breed of loan sharks. Known as payday lenders, these companies make small loans based on personal checks held for future deposit. A consumer might, for example, write a check for $120 and receive $100 in cash. The lender agrees to cash the check two weeks later, on payday. These loans carry a 300 to 900 percent APR. Many borrowers end up in perpetual debt, rolling the loan over every two weeks for another $20 fee. Payday lenders made an estimated $10 billion in loans last year, earning $2 billion in fees.
Most states have regulated or outlawed payday lending. Nearly twenty states cap interest rates on small loans at about 36 percent APR. Others limit the amount of the loan or require certain disclosures to borrowers.
But payday lenders have found a way around these laws by partnering with national banks and thrifts. They claim their affiliation with federally chartered institutions grants them immunity from state laws. Dollar Financial Group, the nation’s sec- ond largest check-cash- ing chain, for example, has partnered with Eagle National Bank and is making payday loans in at least four states in defi- ance of their laws.
National banks and thrifts are essentially renting their federal charters—and all the powers inherent— to payday lenders. Thus far, there’s been no penalty. The OCC has even given Eagle a satisfactory evalua- tion under the Community Reinvestment Act. The agency only considered the bank’s activities in the four counties surrounding its Illinois headquarters. The 250 locations where its Dollar affiliates drain money out of low-income neighborhoods were not counted.
Years of overly aggressive, unwarranted federal preemption have had a chilling effect on efforts to challenge these rent-a-charter schemes in court. When California consumers sued Dollar for violating the state’s usury law, they took an early settlement offer, explaining, “We were also concerned, frankly, that the OCC would likely weigh in on the defen- dants’ side. .. ”
Congress had an opportunity to curb preemption abuses by the OCC and OTS in 1994, as lawmakers considered the monumental Riegle-Neal Act on interstate banking. In day after day of testimony, con- sumer advocates and state officials, as well as mem- bers of Congress, hammered the agencies’ track records on preemption.
In the end, however, Congress did little. Lawmakers reprimanded the OCC for preempting New Jersey’s lifeline bank account law, which remains overturned, and ordered the agency to be especially mindful of state authority “regarding com- munity reinvestment, consumer protection, fair lend- ing, or establishment of intrastate branches. ” State laws in these areas should be overturned only when “the Federal policy interest in preemp- tion is clear” and after a public comment period. But the core of the Riegle-Neal Act, in a nut- shell, authorizes banks to establish interstate branches and requires them to comply with state laws, except where those laws are preempted by federal statute. Determining what laws are preempted was left to the OCC and OTS, despite their long history of unwarranted preemption.
Congress had another significant opportunity in 1999 as lawmakers debated the Gramm-Leach-Bliley Financial Modernization Act (GLBA), which demol- ished barriers among banks, insurance companies, and securities firms. The legislation allows banks to sell insurance products, exposing a whole new vein of preemption issues. Insurance companies are state- licensed and monitored, and regulation of the indus- try has always been left in the hands of the states. Now, however, with national banks offering insur- ance products, the future of state authority is uncer- tain.
National banks have been working their way into the insurance business for quite some time. In 1916, the OCC successfully lobbied Congress to allow banks in towns of fewer than 5,000 to sell insurance. In 1971, the agency adopted regulations allowing banks to sell insurance in small towns from branch offices, even if their main office was located in a big city. In 1986, the OCC ruled that banks could sell insurance nation- wide, provide they had a branch in a small town.
With GLBA, Congress further extended banks’ powers with regard to insurance and formally entered the dispute over state authority.
At first blush, the legislation appears to favor maintaining state control over insurance. It gives states the power to regulate all sellers of insurance, including national banks, and establishes thirteen “safe harbors, ” or specific state law provisions that cannot be preempted. It also requires courts to give equal deference to state officials and federal regula- tors in cases involving insurance sales by national banks. The deference provision and safe harbors were largely the result of lobbying by insurance companies, who feared that they would be subject to state laws that national banks could evade. For once, consumer advocates and state officials had muscle on their side almost as powerful as banks.
But, ultimately, GLBA is more of the same. Under the law, no state may “prevent or significantly inter- fere with” the ability of national banks to offer insur- ance. What constitutes interference is a question left to the OCC. Given the agency’s history, states have serious concerns. Already, with the swaggering confi- dence of an industry accustomed to having its way with federal regulators, national banks have peti- tioned the OCC to preempt laws in Massachusetts, Rhode Island and West Virginia.
The laws in question are designed to prevent banks from taking advantage of their loan customers’ vulnerability when selling insurance. West Virginia’s law, for example, bars banks from selling insurance to a customer whose loan application is currently under consideration. It requires that lending and insurance occupy separate sections of the bank office, each with their own staff. More than half the states have similar laws. The OCC has taken public comments, but has not yet issued a decision.
Although insurance companies are currently fighting the battle for state authority, that probably won’t last for long. The industry plans to push for an optional federal charter, enabling individual compa- nies to choose either a state or federal charter, much as banks and thrifts do. Moreover, as banking, insurance and securities firms merge into giant conglomerates, they will pose an even more formidable political force for eroding state authority than banks alone.
Over the last decade, the Federal Reserve has doc- umented sharp increases in the cost of basic banking services. The Fed has also found that those banks and thrifts that have benefited the most from OCC and OTS preemption actions—a handful of giant nation- al banks that now dominate most local markets—are far more expensive than smaller financial institutions. On everything from checking account fees to stop- payment and ATM fees, banks with more than $1 bil- lion in assets charge substantially more than banks with less than $100 million in assets.
Banking is costly to those who can afford it, but it is even more costly to those who cannot. Many low- income neighborhoods no longer have local banks and branch offices. They must instead rely on check cashing outlets and fee-laden ATMs. Predatory mort- gages and payday loans further drain wealth from these communities. The OCC’s failure to account for this in evaluating a bank’s Community Reinvestment Act compliance has skirted the purpose of this impor- tant law and enabled banks to escape their obligations to low-income neighborhoods.
The aggressive preemption actions of federal reg- ulators have not only gutted state banking laws, but impeded the passage of an unknown number of new initiatives. Massachusetts recently narrowed a new law limiting the amount banks could charge recipi- ents of bounced checks to apply only to state-char- tered banks. The legislature cited fears of OCC pre- emption.
“Banks are playing the state and national charters against one another to get the lowest possible denom- inator, ” contends consumer advocate Mary Griffin. States are reluctant to require state-chartered banks to comply with rules that national banks may evade. Often these laws are repealed entirely. “The state reg- ulatory system is coming undone, ” says Griffin. “It’s an ever-accelerating race to the bottom. ”
The OCC has a direct interest in expanding the powers of national banks. The bigger and more pow- erful they are, the bigger and more powerful it is. By giving national banks a green light to evade state laws and comply only with its own minimal regulations, the OCC can attract more banks to the national (as opposed to state) charter and thereby expand its own turf.
Congress should immediately remove the defer- ence given to federal regulators in the courts. The presumption should be in favor of state authority, not against it. Congress should also redefine the term “location” in the National Bank Act to mean the loca- tion of the consumer or the transaction, not the bank’s home state. This would enable states to fulfill their original role in establishing consumer lending protec- tions for their own citizens. Finally, Congress should review the state laws overturned by the OCC and OTS, and reinstate local authority where appropriate.
The OCC and OTS are part of the Treasury Department and are led by presidential appointees. If President Bush fails to demand that these agencies respect state authority, it will provide a clear indica- tion that his states’ rights agenda has little to do with restoring democratic decisionmaking at the local level, and more to do with limiting that authority at the national level.
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