March 3 (Bloomberg) -- For consumer advocates, housing a new agency to protect Americans from financial-product abuse within the Federal Reserve would be a defeat after lobbying for
an independent body. For banks, it would represent a victory.

Barney Frank, Chairman of the House Financial Services Committee, called a Senate plan to house the proposed Consumer Financial Protection Agency at the Fed “a joke.” Shielding
consumers from harmful financial products is “the most
conspicuous failure by the Fed,” Frank said in an interview
yesterday.

Banks say placing the agency with the Fed alleviates their concern that an independent entity would ignore the health of the financial system. Consumer advocates say it’s a mistake
because the Fed didn’t succeed in curbing abuses during the
subprime lending boom that contributed to the worst financial
crisis since the Great Depression.

“We have all sorts of individual agencies that protect Americans, and none of them is subservient to the regulator that is in charge of looking out for the industry,” said Lauren
Saunders, managing attorney at the National Consumer Law Center
in Washington. “This agency has to be independent so that it
can fix the problems the banking regulators failed to fix.”

The Obama administration’s proposal for a consumer protection agency is part of the biggest overhaul of financial regulation since the 1930s. Putting it inside the Fed, instead
of creating a standalone bureau, was a compromise proposed by
Senator Bob Corker, a Tennessee Republican, and Banking
Committee Chairman Christopher Dodd, a Connecticut Democrat.

Joining in Criticism

Frank, who oversaw legislation passed by the House in December that would create an independent agency, said the chamber wouldn’t accept the proposed deal. Senators joined in
the criticism yesterday.

Jeff Merkley of Oregon said the Fed had an “abysmal” record on consumer protection. Richard Shelby, the top Republican on the Banking Committee, said the entity shouldn’t
be autonomous within the Fed. “If you have something at the
Federal Reserve, the Board of Governors ought to have the
control,” he said.

Fed spokeswoman Susan Stawick declined to comment yesterday.

The Fed has an “innate conflict of interest” in trying to protect consumers while fulfilling its mission of safeguarding the rest of the financial system, billionaire George Soros said
at a conference in New York today. “When Barney Frank called it
a joke, I think he’s right,” Soros said.

Banking Knowledge

Banking lobbyists say the Fed’s knowledge of the banking system makes it well-suited to coordinate rules on credit cards and other consumer financial products.

“Regulation of the products should be connected to the regulation of the bank,” said Scott Talbott, senior vice president of government relations for the Financial Services
Roundtable, which represents the largest financial institutions.

The financial-services industry has lobbied lawmakers to defeat the plan for a consumer agency. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon called the agency “just a
whole new bureaucracy” on a December conference call with
analysts.

The American Bankers Association, the largest trade group representing banks, organized hundreds of meetings with its members and Congressmen and spearheaded a campaign that
encouraged almost 300,000 letters to be sent to Capitol Hill,
all in opposition to the CFPA. ABA spokesman John Hall said the
organization wouldn’t comment on the Fed idea until the proposal
became official.

Subprime Mortgages

Consumer advocates say the Fed didn’t use its authority to put in place stronger protections for home buyers as the subprime mortgage market began to expand earlier this decade.
The Fed has the broadest authority of any regulator to write
rules on lending practices and disclosure.

The Fed’s specific enforcement authority is limited to 800 state member banks. It wields much more clout as the supervisor of bank holding companies, such as Bank of America Corp., some
of which had subprime mortgage lending subsidiaries.

Some $600 billion in subprime mortgages were originated in 2006, up from $310 billion in 2003, according to Inside Mortgage Finance, a trade publication. The Fed began to hold hearings
around the country in 2006, and consumer advocates provided
details of abuse, transcripts from the meetings show.

‘Yelling at Them’

“We were yelling at them in 2001 and 2002” to use their authority, says Michael Calhoun, president of the Center for Responsible Lending in Durham, North Carolina, and the current
chairman of the Fed Board’s Consumer Advisory Council. “It
wasn’t like people didn’t know this stuff was going on.”

Edward Gramlich, a Fed Governor from 1997 to 2005, proposed that the Fed use its bank holding company authority to examine subprime lending subsidiaries. The proposal was opposed by then-
Chairman Alan Greenspan, he said, and never went to the Board of
Governors. Gramlich died in September 2007. Greenspan in the
past has declined to comment.

Among the subprime casualties on Wall Street: Bear Stearns Cos., acquired by JPMorgan Chase & Co. with help from the Fed, Merrill Lynch & Co., taken over by Bank of America, and Lehman
Brothers Holdings Inc., which went bankrupt.

Fed Chairman Ben S. Bernanke began to step up restrictions on subprime lending only after Congress threatened to strip the Fed of its authority. In a June 2007 hearing, Frank told then-
governor Randall Kroszner: “Use it or lose it.”

Using Authority

“If the Fed doesn’t start to use that authority to roll out the rules, then we’ll give it to somebody who will,” Frank said.

The Fed drafted tougher mortgage lending rules in 2007 and completed them in 2008. The rules prevented mortgages for borrowers with no documented income, required lenders to write
loans borrowers could repay and made escrow accounts mandatory
for high-cost mortgages. The Fed also toughened restrictions on
prepayment penalties.

Separately, the Fed has forced credit-card companies to improve disclosure and has increased its scrutiny of possible discrimination in lending. The central bank referred 17 cases to
the Justice Department in the three-year period ending 2009, up
from nine the prior three years.

The Fed’s actions came too late, consumer advocates say.

Subprime mortgage delinquencies rose to 25 percent of the total at the end of 2009, from 10 percent at the end of 2004, according to Mortgage Bankers Association data. Total home loans
in foreclosure rose to 4.6 percent from 1.2 percent.

Track Record

“We have the track record of them failing to take action when they should have and potentially could have averted this foreclosure crisis,” said John Taylor, president and chief
executive officer of the National Community Reinvestment
Coalition in Washington, a group of 600 organizations promoting
fair lending.

The action the Fed does take against banks is often kept secret.

“When examiners identify banks with weak and ineffective compliance programs, they document the weaknesses in the examination report and take appropriate supervisory action,”
Fed governor Elizabeth Duke, who served as chairman of the
American Bankers Association from 2004 to 2005, testified before
the House Financial Services Committee last March.

Because “most banks voluntarily address any violations and weaknesses,” she said, “we find public formal actions are not typically necessary.”