Those seeking to bring down the CFPB should be careful what they wish for

It’s not every day that a federal regulatory agency is declared unconstitutional. Yet that’s just what the Fifth Circuit Court of Appeals did this month regarding the Consumer Financial Protection Bureau, holding that the bureau’s funding mechanism is illegal. The bureau has long been a bugbear to parts of the financial services industry. But in their haste to tear down the CFPB, the agency’s opponents have failed to consider the chaos victory might bring.

If the CFPB’s funding is unconstitutional it throws into doubt the constitutionality of all other self-funded federal bank regulators, including the Federal Reserve Board. Moreover, if the CFPB is unconstitutional, its myriad regulations, upon which the economy depends, are all invalid, creating a compliance nightmare for all manner of financial services businesses.  

The Fifth Circuit struck down the CFPB’s funding mechanism because the bureau is not funded through congressional appropriations from the Treasury. Instead, the CFPB draws annually a capped amount from the Federal Reserve System.

This arrangement is only natural because the CFPB is an independent bureau within the Fed system. The revenues of the Fed system are almost entirely the revenues of the twelve private regional Federal Reserve banks. Congress has given the CFPB a right of assessment on the reserve banks, just as it has given the Federal Reserve Board — another federal regulatory agency with rulemaking and enforcement power — the same right of assessment on the same private Federal Reserve banks.

Similar self-funding arrangements exist for other financial regulators, including the Federal Deposit Insurance Corp., the Federal Housing Finance Agency, the National Credit Union Administration and the Office of the Comptroller of the Currency.

The Fifth Circuit’s beef with the bureau’s funding arrangement is that the Appropriations Clause provides that “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law.” The Fifth Circuit found the combination of the bureau’s executive powers — rulemaking and enforcement — plus unappropriated funding to violate the separation-of- powers principle because, as James Madison once put it, “[t]he purse & the sword ought never to get in the same hands.”

As a textual matter, it is unclear why the CFPB’s funding violates the Appropriations Clause, which by its own terms applies only to the spending of Treasury funds. Federal Reserve System funds are not Treasury funds. Be that as it may, the more troubling problem with the Fifth Circuit’s reasoning is that there’s no principled way to distinguish the CFPB’s unappropriated funding mechanism from that of the Fed or other self-funded financial regulators.

The Fifth Circuit claimed that the CFPB is different because the other self-funded agencies do not “wield enforcement and regulatory authority remotely comparable to the authority the [bureau] may exercise throughout the economy.”

Come again? The Fifth Circuit is claiming the CFPB wields broader regulatory authority than the Fed, a full-fledged bank regulator that engages in rulemaking and enforcement, operates the payment systems that are the backbone of the economy, and regulates monetary policy and employment. This is what is known as “motivated reasoning.”

Likewise, the Fifth Circuit claimed that the CFPB is different because it erroneously believed that the bureau is funded by the Fed, another regulatory agency. The Fifth Circuit claimed this made the bureau’s funding doubly insulated from congressional control, because neither the bureau’s funding nor the board’s is subject to appropriations.

The Fifth Circuit, however, simply had the facts wrong. The CFPB is not funded by the board. Instead, both the bureau and the board are funded directly through assessments on the private Federal Reserve banks. There is no “double insulation.” The CFPB’s funding arrangement is indistinguishable from that of the board.

There is no escaping the logic of its appropriations clause argument: If the CFPB is unconstitutional, so too is the Fed and other self-funded federal financial regulators. Consider the havoc that will unleash on the economy if there is no agency allowed to regulate the U.S. banking or housing finance system or undertake monetary policy. There’s no way to strike down the CFPB’s funding without destroying the entire U.S. bank regulatory system.

Even if the CFPB could somehow be distinguished from these other agencies, declaring it unconstitutional still hazards chaos, as it would void all of the bureau’s rulemakings from the past dozen years. That does not mean that there’s no regulation. Instead, it means that there’s unclear regulation, which is the worst possible outcome for the consumer finance industry because it poses enormous litigation risk.

Consider a mortgage lender that needs to make disclosures when making a loan. For years that lender has been using the disclosure forms promulgated by the CFPB, knowing that using them shields it from liability. If the agency is unconstitutional, the use of those forms ceases to provide any legal protection.

Likewise, the CFPB’s Qualified Mortgage safe harbor from the Dodd-Frank Act’s ability-to-repay requirement will disappear if the CFPB is unconstitutional, triggering immediate liability on lenders’ warranties to investors that the mortgages they sold them were qualified mortgages. Every bank that charges an overdraft fee will suddenly be breaking the law, because overdraft fees are exempted from cost of credit disclosures by virtue of CFPB regulation.

And without the exemption created by CFPB regulation, every college and university in the country will suddenly be deemed a student lender and face class actions for failing to provide appropriate disclosures for installment tuition repayment plans.

CFPB opponents are playing with fire. Like the agency or not, regulated entities rely on its regulations to provide the rules of the road. The bureau is too integral to the smooth operation of the consumer finance industry to be eliminated without causing serious disruption to the economy.

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