Friday, April 02, 2010

The Supreme Court’s Role in the Financial Meltdown

Rick Pildes

Of all the public and private institutions whose role in the financial crisis has been scrutinized, the one institution about which almost nothing has been said is the Supreme Court. Were the Court irrelevant to the story, that would hardly be surprising; not every major policy crisis or issue is one in which the Court plays a role. Unfortunately for those of us who care about the Court, however, the Court turns out to have played a part in the regulatory missteps that contributed to the financial crisis. And there is evidence that the Court itself has recognized that fact.

A recent, lengthy NY Times story provides the background for this point, though the story does not mention the Court’s role. As the Times story documents, in the years leading up to the financial meltdown, state attorney generals had begun using state consumer-protection laws to go after practices, like subprime mortgage lending, engaged in by subsidiaries of national banks. At that point, the federal regulator of national banks, the Office of the Comptroller of the Currency, stepped in and argued that the states had no power to act in this area, because the OCC’s regulations preempted application of these states laws. As the Times story indicates, many consumer advocates view the OCC as far more responsive to the interests of the national banks than consumers, and they view the OCC’s effort to take the states out of any oversight role to be evidence of agency capture – that is, evidence of the OCC being controlled by the interests of those it was designed to regulate. In the spring of 2007, the Supreme Court, in a 5-3 decision called Watters v. Wachovia Bank, N.A., held that OCC did have the power, and did act lawfully, when OCC took the states out of the business of enforcing their consumer-protection laws against practices like subprime lending by the banks that OCC regulated. We will never know what might have happened had the Court not been so deferential to OCC. Would the efforts of state attorney generals to stop and expose these practices have provided enough of an early warning signal to have triggered earlier, more effective regulatory responses by other actors?

In the wake of the financial meltdown, the Court seems to have recognized that Watters was a mistake. In June of 2009, after the meltdown, the Court decided another case about OCC’s power to preempt state oversight of national banks. This time, in Cuomo v. Clearing House Ass’n, L.L.C.¸the Court was presented with amicus briefs, including from state attorney generals, that explained how Watters had devastated state efforts to protect consumers against certain lending practices, like the most extreme of the subprime mortgages. Once again, in Cuomo, OCC regulations attempted to prohibit states from enforcing certain of their laws against national banks. This time, though, the Court in a 5-4 decision rejected OCC’s efforts to oust the states. Three Justices who had recognized OCC’s powers to preempt in Watters now rejected OCC’s efforts to shut down state enforcement (Justices Ginsburg, Souter, and Breyer). Moreover, the questions of these Justices at oral argument in the later case strongly suggested that the financial meltdown, which had occurred between Watters and Cuomo, had led them to a far more skeptical attitude toward OCC and its efforts to eliminate state enforcement.

The full story is documented in articles by Professor Arthur Wilmarth, of George Washington University Law School. Of course, there are arguable legal distinctions between the cases, but it is hard to escape the conclusion that at least three of the Justices concluded that they contributed to the financial meltdown by being so accepting of OCC’s aim of monopolizing regulatory oversight.

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