A decade ago, the world of financial services saw what was perhaps its greatest sea change in a generation — in 2007, two separate, unconnected and epoch-making things happened at the same time.
The first was that the iPhone hit the market, igniting the mobile phase of the digital era. That year, the iPhone opened the door to the blending of the online and offline worlds that now defines commerce as we know it.
The second was that the economy detonated worldwide. The financial crisis that followed was ignited by sloppy underwriting en masse (with a massive assist from credit-default swaps) that successfully blew up the U.S. real estate market into a bubble, and nearly leveled the entire global economy when it popped a decade ago. If extending credit to the unworthy had created the problem, regulators reasoned, then never – or at least rarely – extending it must be the solution.
In the years that followed, consumer lending contracted sharply for all but super-prime customers. Bank-based SMB lending contracted even more sharply, and still hasn’t recovered to pre-2007 levels.
However, like nature, financial services ecosystems abhor a vacuum, and consumers and SMBs didn’t stop needing access to credit just because banks suddenly lost their appetite for extending it. Over the last decade, a giant unanswered demand — and a newly emerging mobile ecosystem — created the conditions that moved dozens of firms to set their homesteads on the digital frontier and set their sights on disruption. Lending Club, OnDeck Capital, Kabbage, Prosper, LendUp, Affirm, SoFi, Even Financial, Quick and LendingPoint are just some of the many payments companies that have been part of this digital wave.
But as 2017 pulled into the station, it became clear that a decade-long era in financial services was officially drawing to a close, other than this transitional year between what was and what’s next. Because, in the electoral surprise of the century, Donald Trump won the presidency — and came in ready to roll back the Dodd-Frank regulations that have guided so much of the segment’s destiny for the last decade.
It became clear that Act I of digital era financial services was drawing to a close — and that Act II is getting warmed up backstage.
And 2017 — the performance at intermission where all the parts and players began changing places — well, in many ways, that turned out to be the greatest show on Earth.
So, which players most deserved your attention?
The CFPB has spent a year generating surprising questions — with even more surprising answers.
The consumer watchdog agency came into the year under a cloud of uncertainty, as the new administration and its allies in Congress made it clear that their intention was to first attempt to remove the CFPB’s executive director, Richard Cordray, and to scale back the power of a governmental institution that various legislators referred to as “undemocratic” and “tyrannical” at times.
Not surprisingly, that tipped off a fight with Democrats and consumer advocates, who became passionate believers in the #SaveCordray movement. Efforts at removing the CFPB head quickly stalled because Dodd-Frank, by design, makes the director’s six-year term hard for a president to end without being able to show cause. This frustrated President Trump and his Congressional allies, who believed they had cause. Ultimately, though, it became clear that a legal battle around removing Cordray might be more trouble than it was worth, given that his term was set to expire in July of 2019. The year also kicked off with prominent rumors that he would be leaving his post early to prepare a run for governor of Ohio, a move presaged by the CFPB’s wave of mass resignations.
Moreover, there was some thought that the federal courts might render much of the discussion moot by ruling that the CFPB’s independent structure rendered it unconstitutional in the CFPB v. PHH case.
The first ruling in that case found that the CFPB’s single director makeup was unconstitutional, as was the provision in the Dodd-Frank Act that the director of the CFPB could only be fired if cause was found. That ruling was thrown out by a three-judge panel of the D.C. Circuit court of appeals, and a final ruling is still awaited. Foes of the federal consumer watchdog spent much of the first half of 2017 hoping they would be saved by the gavel, so to speak, and that the courts would order a full restructuring of the regulatory agency.
That case is still pending — and, as it turns out, the outcome will likely never impact Richard Cordray all that directly.
Why? That aforementioned speculation that the CFPB’s executive director intended to leave his post early and pursue political office turned out to be at least half true. Cordray did step down from his post in late November, without confirming his plans regarding the Ohio governor’s seat, which will open up (thanks to term limits) next year.
And then things really got crazy.
Because in Cordray’s wake, the CFPB didn’t end up with one new leader, but two.
A few days after Cordray announced his intent to leave his post early, President Trump signaled his plans to place current OMB head Mick Mulvaney in the role on an interim basis until a long-term head could be found and approved by Congress, citing the Federal Vacancies Reform Act as empowering him to do so. Mulvaney was considered a controversial choice, given his public description of the CFPB as “one of the most offensive concepts” in the U.S. government, as well as his commitment to his earlier statement calling the CFPB a “sad, sick joke.”
But in his last few days as director, Cordray announced that the agency’s chief of staff, Leandra English, would become the agency’s deputy director on Friday (Nov. 24). He then noted that her appointment as the interim executive director would take effect as of Nov. 27.
The situation is now to be decided by a judge. Mulvaney is working the role for now, as various legal proceedings are filtering through the courts; he won the first round to stop a temporary injunction that would have kept him out of the position. It could be a while – the Game of Thrones will likely persist until a new permanent head is named and confirmed.
But acting director (1) Mulvaney is certainly keeping himself busy in the role. The CFPB has temporarily suspended an investigation into a bail bond company called Nexus and halted data collection at the agency as a whole, citing “cybersecurity” fears.
Mulvaney has also named Rep. Jeb Hensarling, R-Texas — perhaps the CFPB’s biggest foe in Congress — to a senior advisory role within the consumer watchdog. Earlier this month, Reuters reported that the multi-million dollar Wells Fargo settlement might also be under review due to the change in leadership. And just a few days ago, he granted the prepaid rules a stay of execution in order to examine them more critically in the new year.
However, some changes Mulvaney has sought to make have not gone through. He initially froze all payments to fraud victims, but beat a hasty retreat on that two days later when public outcry became loud and pressing. Mulvaney has also allowed some internal promotions and personnel transfers, despite a hiring freeze.
However, he does not seem to have successfully endeared himself to the staff — which, according to some reports, has formed a resistance movement called “Dumbledore’s Army.”
The Congressional Review Act (And The Fate Of The Old Rules)
It’s not easy for a piece of legislation to follow Dumbledore’s Army’s opening act — particularly a piece of legislation that, until very recently, was extremely obscure and almost never used.
But in the age of Trump, the Congressional Review Act (CRA) is enjoying something of a renaissance. The 20-year-old law, which had only been used once before 2017, has been used 15 times since January of last year to undo Obama-era rules.
The CRA allows Congress to review new federal regulations issued by government agencies and overturn them with a majority vote. Not only does the legislation stop rules from going into effect, but it also prevents agencies from issuing “substantially similar” regulations for the next five years. The window to use it, however, is narrow – legislators have 60 days between when the rule is passed and when it goes into effect to block it with the CRA.
And CFPB rules have been a favored target of the CRA.
The law was effectively used to bounce the CFPB’s arbitration rule from going into effect. That rule would have made it illegal for financial services companies to insert mandatory arbitration clauses into consumer contracts, thus forcing consumers to surrender their right to form class-action lawsuits.
Briefly, it seemed as though the Equifax hack — and an extremely ill-timed arbitration clause insertion — might have ended up creating the public outcry necessary to save the rule, but ultimately both the House and Senate were able to muster the majority votes they needed for appeal.
A similar maneuver was attempted to block controversial rules the CFPB passed regarding the regulation of prepaid cards. The House approved the CRA resolution, but the bill was unable to garner majority support in the Senate. That means going forward, prepaid cards that offer overdraft protection will be regulated as though they are credit cards, as opposed to debit cards.
And there was one more big bite out of the CRA apple this year: payday lending regulations.
After an intensive year of debate, the CFPB dropped its final rules for the industry in October. Though they didn’t generate the same level of outcry that draft regulations incited when they hit the wires at the beginning of the year – as consumer advocates and industry representatives shockingly agreed that the first run at the rules would poorly serve consumers – they were certainly controversial.
Advocates argued that the rules would protect consumers from the predation of the short-term, small dollar loan industry and the triple-digit interest debt cycles. Detractors noted that cutting off consumers’ access to funds in times of need is not protecting them – and the CFPB’s rule would force that situation by closing the doors of 80 percent of the nation’s small-dollar lenders.
Death by the CRA has been one hypothesized method of terminating the rule – but one that is considered unlikely, since it will not attract a single Democratic vote in the Senate, and Republicans only have a two-vote margin to lose to make it pass. The payday lending industry has vowed to fight the rules in court, arguing that they illegally restrict consumer choice.
But, even if the rule survives, its enforcement future at the new CFPB is unclear. Interim director Mulvaney has publicly stated that he does not like the rule and would see it rolled back if he could, and already announced his intention to delay it from going into effect while he reviews its possible consequences.
Stay tuned – this conversation will be ongoing.
The Future Of Innovation Instead Of Regulation
The goal of alternative financial services – broadly – is to bring people into financial markets who have been left out by choice or by structure from the mainstream, in a way that helps consumers instead of hurting them.
The ongoing series of fistfights, legal battles, ad hominem attacks and Twitter wars among those in charge of ensuring that financial services are available to anyone who wants and needs them might indicate that this effort is in trouble.
And yet …
While we can’t deny that the regulatory forecast for the last year has mostly been “cloudy with a chance of crazy,” conditions on the ground are probably a bit more hopeful than the preceding passages might have implied.
Regulators are finding it very hard to legislate a fair deal for consumers without a fight breaking out – but in 2017, innovators found that it is actually much less difficult to build one.
Affirm, founded by PayPal’s Max Levchin, built a POS financing product dedicated to offering consumers an honest, transparent way to pay for items on installment.
“We tell merchants that we will never charge any late fees or retroactive fees; these gimmicks aren’t okay with us, and shouldn’t be okay with you, either,” Levchin told Karen Webster in a recent interview.
Affirm’s mission to expand consumer access to honest financing will rev into high gear next year, on the heels of a $200 million capital raise on an estimated $1.6 billion valuation, and now with the ability for any consumer to take advantage of its credit option at any merchant.
LendUp wants to calibrate financial services to what it calls “the new average consumer” or the “emerging middle class.”
“This is the 50 percent of the population that reports volatile income. This is a new customer segment that we used to think of as working class, but it’s now creeping up the socioeconomic ladder,” LendUp CEO and co-founder Sasha Orloff told PYMNTS. “This is a consumer who works and lives on their phone, and many have moved from drawing salaries from a career to an economy where they are paid for doing tasks.”
LendUp builds financial products for those emerging middle-class consumers, with an eye toward helping them better their situations, improve their credit scores and move into the world of mainstream financial services. They’re also focused on education: Early this year, LendUp and the Aspen Institute’s EPIC are launching Finance Forward, a national discussion of the issue from the perspective of individuals, local government, non-profits, for-profits, employers, tech and anyone else with an ability to lend or take action.
EVEN’s new partnership with Walmart is a new tool to help smooth the income volatility for its workers by allowing them to be paid in real time for the hours they have already worked, instead of having to wait for the traditional payday.
“This isn’t that people just don’t have the money to pay their bills in general, but that they are forced to make bad decisions because the money they have already earned by working is not available to them at the right time,” EVEN CEO Jon Schlossberg told Karen Webster. “That adds up to a $100 billion industry a year in payday loans and late fees. That’s crazy; we can fix that and we should fix that.”
So EVEN – now with Walmart as a partner – is fixing it, both by giving customers access to their funds early, but also by providing access to financial management software so they can better control their money.
“It’s really when you combine those two aspects that you get a whole greater than the sum of its parts,” noted Schlossberg. “Because the system can start to tell you how to use it better, we can proactively suggest an InstaPay because our system can see an expense is going to hit you and you are going to run out of money. The system, in fact, will probably know that before the user does.”
It is almost impossible to hazard a guess for what will happen in alternative financial services in the next 12 months. While some of this year’s developments could have been foreseen from the vantage point of late December 2016, the election of Donald Trump more or less guaranteed that it would be an adventurous year in regulation.
But anyone who tells you that they foresaw all of it – the court battles, the regulatory switchbacks, two CFPB directors for the price of one, the avalanche of innovations aimed at the underserved – well, that person is either the world’s greatest psychic or the world’s boldest liar.
We can guess at some of the things coming. For example, payday lending will likely be an ongoing conversation, as it has been for the last half decade or so.
And we imagine regulators will do a lot of conversing. And studying – they surely like the studies. Perhaps in 2018, they will even find ways to write studies that use terms properly and do not directly contradict the research of other regulators.
That might be a bit of a tall order. Maybe we can just hope that they move on to studying bitcoin – something complicated, but without a big impact on the lives of normal, everyday, working humans: in other words, the emerging middle class.
What we hope to see in 2018 is more of an instinct to view the future of financial services as the future of the development of the American middle class.
A middle class that includes gig workers who will need the architecture of payments upgraded, and a solid set of innovations to smooth out complicated income. Because gig workers aren’t just cab drivers anymore, as the team at Fiverr‘s global head of community noted. Gig workers are also lawyers, doctors, computer programmers and a host of other highly skilled workers who are working outside the traditional payroll system.
It’s a middle class that includes millennials, America’s largest class of workers, who are now aging into the credit-requiring years of their life.
“When you enter the system and you have no track record or a poor one, you are going to get the highest price and lowest-term credit in the system,” said Beneficial State Bank co-CEO Kat Taylor. “That isn’t just expensive for the individual consumer; it’s bad for society.”
Millennials, she noted, tend to enter the credit system with a bang once they start having families.
“We have to get more people into the tent, and we have to make the tent a better fit … that is where FinTech comes in,” Taylor said. “We have to change this entire system.”