FEBRUARY 2004

Preemption Wars

In 2003, the single most important legislative issue for retail financial services was the Fair Credit Reporting Act, specifically, the renewal of federal preemption of state laws in several key areas of credit reporting. As we begin 2004, preemption promises to again be the most important regulatory issue facing the credit granting industry. This time the issue revolves around the extent to which states can pass laws that affect the operations of national banks. State and municipal government attempts to impose regulations that would curb abusive mortgage lending have brought the issue to a head.

The U.S. Office of the Comptroller of the Currency (OCC) has taken a strong stand that such laws generally do not apply to national banks. On January 7th of this year it issued a rule that broadly asserted its preemption powers over state and municipal laws. According to the OCC, since the creation of the national bank charter by Congress in 1863, there have been approximately 70 federal judicial opinions that have upheld its preemptive powers. The pace of judicial challenge has quickened. Twelve of those opinions have come in the past two years, and 40 since 1990. Prominent among the most recent decisions were two federal court rejections of the state of California’s attempts to impose consumer protection legislation on national banks. One case involved credit card minimum payment disclosures and the other involved limits on the exchange of information across affiliated companies. Indeed, the OCC has used these and other recent examples to argue that the states are becoming more aggressive in trying to limit the powers of national banks, and that the OCC’s rule offers the banks clearer guidance as to which local rules apply to them.

Concerns over predatory lending practices have focused the preemption issue in 2004. The state Attorneys General (and consumer activists) argue that state regulatory and enforcement agencies are being proactive in trying to protect consumers from what they claim is a rising incidence of abusive mortgage lending practices. They assert that the OCC does not have a good enforcement record on such issues, in large part because it is understaffed relative to the problem. Given the strong support that the OCC has received from the court system, it will ultimately be Congress that decides whether the preemption power claimed by the agency is still appropriate.

The opening salvo in the larger Congressional debate was fired on January 28 in Washington, DC when a subcommittee of the House Financial Services Committee held hearings to determine whether the OCC should delay the implementation of its broad January 7th rule. Representative Barney Frank (D-MA) said that while it may currently be legal for the OCC to offer national banks broad preemption protection from state consumer protection laws, he added that "just because something is legal doesn’t make it right. There are a lot of legal things that you can do that are kind of stupid or counterproductive. What we have here is a fundamental policy question of how banking authority ought to be divided." The debate seems likely to turn on an assessment of whether the OCC has sufficient manpower to enforce its own regulations across the 50 states. However, the American Banker reported that the chairman of the House Financial Services Committee, Michael Oxley (R-Ohio), was generally supportive of the OCC rule, making it unlikely that legislation that would curb the agency’s authorities would emanate from his committee this year.

What seems clear is that, especially in an election year, many politicians at all levels of government will grab for a piece of this consumer protection issue. Whether the heightened focus on abusive mortgage lending will raise the likelihood of federal legislation (with preemptive provisions) remains to be seen.