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The FTC works for the consumer to prevent fraudulent, deceptive, and unfair business practices in the marketplace and to provide information to help consumers spot, stop, and avoid them. To file a complaint or to get free information on consumer issues, visit ftc.gov or call toll-free, 1-877-FTC-HELP (1-877-382-4357); TTY: 1-866-653-4261. The FTC enters consumer complaints into the Consumer Sentinel Network, a secure online database and investigative tool used by hundreds of civil and criminal law enforcement agencies in the U.S. and abroad.



Predatory Lending Practice

Do you feel that you have been taken advantage of by a mortgage lender involved in a predatory lending practice? Have you been pressured into accepting mortgage terms, or for that matter, have you been cornered into applying for a mortgage against your best interest or wishes? If you answered yes to any of the above questions then you are a victim of predatory lending.

Immediately contact a Real Estate Lawyer if you suspect being a victim of any predatory lending practice. Predatory lending practice is illegal, contact a Real Estate Lawyer now, to find out what your rights are.

A Predatory Lending Practice is any unfair and abusive practice whereby a mortgage broker or a mortgage lender uses any type of information about the borrower, to the borrower’s disadvantage, and then proceeds to convince the borrower to accept loan programs and or loan terms that were not in the best interest of the borrower. This practice also includes imposing higher interest rates, cost and fees, along with pre-payment penalties when more favorable terms could have been offered.

In response to the escalating trend in foreclosures Shelia Blair, Chairman of the Federal Deposit Insurance Corporation, recently expressed to the House of Representatives, “The time has come for national anti-predatory lending standards applicable to all mortgage lenders”. Furthermore, Blair indicated that regulations be imposed upon lenders to determine a borrower’s ability to repay a loan at its true cost, rather than on artificially low rates offered through aggressive advertising campaigns. Other areas needing immediate improvement include, Loan Flipping, Pre-Payment Penalties, Escrow of Taxes, and Fiduciary Obligations of Mortgage Originators.

Common Predatory Lending Practice Violations:

  • Foreclosure: Homeowners should not be misled about their rights and remedies when facing foreclosure.
  • Loan Flipping: Mortgage companies should not be engaged in the practice of persuading homeowners to refinancing their homes with little or no apparent significant improvement of the homeowner’s situation.
  • Red Lining: This would involve imposing higher interest rates and or steeper prepayment penalties in areas of a city considered to be less desirable.
  • Adjustable Rate Mortgages: Some lenders have steered homeowners into adjustable rate mortgages with low teaser rates without considering the borrowers capacity to reasonably meet future increases in the monthly payments.
  • Failure to Disclose: Each and every lender has the legal responsibility to fully disclose and completely explain each and every aspect of the mortgage for which you are applying.
  • Housing Discrimination: If you feel that your race, creed, religion, national origin, marital status, health status, sex or sexual orientation may have impacted your mortgage terms, your rights may have been violated.

The House of Representatives Financial Services Committee is facing estimates that 2.2 million homeowners are currently at risk of losing their homes. The subcommittee reviewed “predatory lenders” that gave loans to people who were either unaware or unable to repay the loans. The common concern is that this may be the most devastating real estate disaster since the Great Depression. Lenders are not allowed to take advantage of a homeowner’s circumstances to make excessive profits on a loan application. The law also precludes lenders from exploiting to their own advantage, the consumer’s lack of knowledge on various mortgage programs, offerings and qualifying guidelines. You do not have to settle for less than what you are entitled to. Do not allow any lender to take advantage of you or your situation.

See Also:

Immediately contact a Real Estate Lawyer if you suspect being a victim of any predatory lending practice. Predatory lending practice is illegal, contact a Real Estate Lawyer now, to find out what your rights are.

Content Related to Topic



Ex-Citigroup worker alleges illegal lending norms
15 June 2001
By F. Brinley Bruton

A Citigroup Inc. unit deliberately targeted low-income, uneducated borrowers for loans and insurance they did not need or understand, a former employee alleged in a government lawsuit. The financial services giant has consistently denied such practices.

The charges, filed in an affidavit by part-time branch assistant manager Gail Kubiniec of Citigroup unit CitiFinancial, are part of the lawsuit filed by the Federal Trade Commission (FTC) against Associates First Capital Corp., a consumer lending unit that is part of CitiFinancial. The suit alleges predatory lending and deceptive marketing.

“I and other employees would often determine how much insurance could be sold to a borrower based on the borrower’s occupation, race, age, and education level,” Kubiniec said in the affidavit, a copy of which was provided to Reuters by a New York-based consumer advocacy group.

“If someone appeared uneducated, inarticulate, was a minority, or was particularity young or old, I would try to include all the coverages CitiFinancial offered,” she said in reference to insurance and other products often tied to real estate or personal loans.

Citigroup has not admitted to predatory lending, but said in March it had dealt with the FTC’s concerns by putting into place a program that addresses lending practices at Associates First, which Citigroup bought last year.


Citigroup on Thursday denied alleged abuses at CitiFinancial, a longtime Travelers Group unit known as Commercial Credit until 1999. The unit changed its name shortly after financial services group Travelers merged with global bank Citicorp to form Citigroup.

The company said the allegations are against Citigroup policy.

“Ms. Kubiniec’s allegations are an affront to the tens of thousands of CitiFinancial employees who strive every day to act in their customers’ best interest,” Citigroup spokeswoman Leah Johnson said. “If true, the unethical sales tactics she describes would constitute serious violations of the company’s policies and standards.”

Kubiniec’s affidavit was filed on May 16 in a case brought by the FTC against Associates First in federal court in Atlanta. The FTC has charged Associates First with systematic and widespread abusive loan practices, often described as predatory lending. They include deceptive marketing to induce consumers to refinance existing debts into home loans with high interest rates, costs and fees.

The suit, which also names Citigroup and CitiFinancial as successors to Associates First, seeks redress for all borrowers who were harmed as a result of the alleged practices.

Federal Trade Commission officials could not immediately be reached.

Citigroup merged Associates First into CitiFinancial in March, but Kubiniec’s affidavit covers practices at CitiFinancial before the two units were combined.

“As soon as we learned of her allegations, we commenced a thorough review that has reassured us that these alleged practices are in no way characteristic of how CitiFinancial employees treat their customers and sell products,” Citigroup’s Johnson said.

Last year, Citigroup said it would take steps to improve the consumer lending practices at Associates First.


The affidavit was provided to Reuters by Inner City Press/Community on the Move and Inner City Public Interest Law Center, which is campaigning against Citigroup over its takeover plans and lending practices.

Kubiniec, who could not be reached for comment on the affidavit, alleges that she saw CitiFinancial employees “harass and intimidate borrowers” who were behind with payments. “Managers condoned whatever tactics an employee used, as long as he obtained payment,” she said.

“Typically, employees would only state the total monthly payment amount in selling a proposed loan. Additional information, such as the interest rate, and the financed points and fees, closing costs, and ‘add-ons’ like credit insurance, were only disclosed when demanded by the borrower,” she said. “It was also common practice to try to sell borrowers the largest possible loan.”

Kubiniec worked for CitiFinancial and its predecessor from 1995 until February in Lansing, Michigan and the New York towns of Tonawanda and Depew.



The phrase “loan shark” came into usage in the United States late in the nineteenth century to describe a certain type of predatory lender. Earlier variations of this vernacularism include “land shark” and “money shark.” The lenders to whom these epithets were applied charged high rates of interest and designed their credit products in such a way as to make orderly retirement of the debt difficult. Borrowers became trapped by their loans and were unable to pay off the principal. The interest payments dragged on and many borrowers became virtual debt peons. As Cobleigh explains, “The real aim of loan sharks is to keep their customers eternally in debt so that interest (for the sharks) becomes almost an annuity.”[1]


There are many registered and legal lenders that lend to people who cannot get loans from the most mainstream lenders such as large banks. They often operate in cash, whereas mainstream lenders increasingly operate only electronically, which means that they will not deal with people who do not have a bank account. Terms such as subprime lending and “non-standard consumer credit” are used for this type of lender. Payday loans are one example of this type of consumer finance. The availability of these products has made true loan sharks rarer, though some legal lenders have been accused of behaving in an exploitative manner.

Payday loan operations have also come under fire for charging inflated “service charges” for the service of cashing a “payday advance” — effectively a short-term (no more than one or two weeks) loan for which charges may run 3-5% of the principal amount. By claiming to be charging for the ‘service’ of cashing a paycheck, instead of merely charging interest for a short-term loan, laws which strictly regulate moneylending costs can be effectively bypassed.

A loan shark is a person or body that offers illegal unsecured loans at high interest rates to individuals, often backed by blackmail or threats of violence. They provide credit to those who are unwilling or unable to obtain it from more respectable sources, usually because interest rates commensurate with the perceived risk are illegal.

Today loansharking tends to be associated in the popular mind with organized crime. The stereotypical loan shark is thought to be a gangster who extorts repayment of the debt with threats of physical brutality. Such loan sharks do exist, but the first loan sharks were not linked to crime families and they did not beat delinquent debtors. The phrase was originally applied to salary and chattel mortgage lenders who operated at the turn of the twentieth century. These creditors dealt in small sums (most loans were less than $100) and they charged high rates of interest (between 10% and 20% a month, and sometimes more). Many of these cash advances were interest-only and required a lump-sum payment to retire the principal. As a result, loans that were supposed to be short term often dragged on for months and years. To pay one lender the debtor often took out another loan in a process that was called “pyramiding.” The loan sharks frequently colluded in encouraging this expanding chain of debt.[2]


Usury (pronounced /ˈjuːʒəri/, comes from the Medieval Latin usuria, “interest” or “excessive interest”, from the Latin usura “interest”) originally meant the charging of interest on loans. This would have included charging a fee for the use of money, such as at a bureau de change. After countries legislated to limit the rate of interest on loans, usury came to mean the interest above the lawful rate. In common usage today, the word means the charging of unreasonable or relatively high rates of interest. As such, the term is largely derived from Abrahamic religious principles and Riba is the corresponding Islamic term. The primary focus in this article is on the Christian tradition.

The pivotal change in the English-speaking world seems to have come with the permission to charge interest on lent money: particularly the Act ‘In restraint of usury’ of Henry VIII in England in 1545 (see book references).


Usury and the law

“When money is lent on a contract to receive not only the principal sum again, but also an increase by way of compensation for the use, the increase is called interest by those who think it lawful, and usury by those who do not.” (Blackstone’s Commentaries on the Laws of England, p. 1336).

In the United States, usury laws are state laws that specify the maximum legal interest rate at which loans can be made. Congress has opted not to regulate interest rates on purely private transactions, although it arguably has the power to do so under the interstate commerce clause of Article I of the Constitution.

Congress has opted to put a federal criminal limit on interest rates by the RICO definitions of “unlawful debt” which make it a federal felony to lend money at an interest rate more than two times the local state usury rate and then try to collect that “unlawful debt”.[17]

It is a federal offense to use violence or threats to collect usurious interest (or any other sort). Such activity is referred to as loan sharking, although that term is also applied to non-coercive usurious lending, or even to the practice of making consumer loans without a license in jurisdictions that require licenses.

Usury statutes in the United States

Each U.S. state has its own statute which dictates how much interest can be charged before it is considered usurious or unlawful.

If a lender charges above the lawful interest rate, a court will not allow the lender to sue to recover the debt because the interest rate was illegal anyway. In some states (such as New York) such loans are voided ab-initio[18]

However, there are separate rules applied to most banks. The U.S. Supreme Court held unanimously in the 1978 Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp. case that the National Banking Act of 1863 allowed nationally-chartered banks to charge the legal rate of interest in their state regardless of the borrower’s state of residence.[19] In 1980, due to inflation, Congress passed the Depository Institutions Deregulation and Monetary Control Act exempting federally chartered savings banks, installment plan sellers and chartered loan companies from state usury limits . This effectively overrode all state and local usury laws.[20][21] The 1968 Truth in Lending Act does not regulate rates, except in the cases of some mortgages, but it does require uniform or standardized disclosure of costs and charges.[22]




Definition: Usury is defined as the act of lending money at an unreasonably high interest rate, this rate is defined at the state level. Repayment of loans at a usurious rate makes repayment excessively difficult to impossible for borrowers. This is also called “loan sharking” or “predatory lending”.

Usury has recently come back into legal conversations due to the emergence of payday loans and sub-prime lending. These types of loans are aimed at those who are at greater risk of defaulting, those with lower incomes. Payday loans are supposed to be used as short term loan to help people make it to their next paychecks by paying bills that are due before they receive it. Unfortunately these get abused and the lendees can get into further financial trouble.

Sub-prime loans, again, are for lower income individuals that are more at risk of not being able to fulfill their obligation in payments. These loans have higher rates, but obviously fall just below their state’s usury level to be legal.

Many are now asking for changes in how we define usury to eliminate these types of loans.

The usury laws, predatory lending, and loan sharking rules apply more to local banks. Since the passing of a federal law stating that the state usury laws do not apply to banks that label themselves with the words “national”, these banks have been able to offer loans above the state usury limit. These “national” banks are allowed to apply interest rates a number of points higher than the Federal Reserve Discount Rate. The Federal Reserve Discount Rate is the rate banks get when borrowing directly from the Federal Reserve Bank for short term funds.

However, at the Federal level, there is a criminal limit, as defined by Congress, for interest rates. This rate is twice the amount of the particular state’s usury limit.

here are a number of different lending tactics that are considered predatory lending. Some lenders dispute whether these are unethical, often citing that consumers have choices of who they get their loans from. Below are the most common practices labeled “predatory”.

Fees & APR. Common compaints on predatory lending involve fees incurred which are not included in the APR. Borrowers may not know they have a no-fee line of credit, or may not be able to get a no-fee line of credit. Lenders may take advantage of this by offering a reasonable interest rate, but tacking on a fee. The APR may appear attractive, but the fee is not considered in the APR, if it were the rate would appear significantly higher.

Risk-based lending. This is the practice of charging higher interest rates to the consumers who are labeled as high-risk, meaning there is a higher risk that the consumer will not be able to pay back the loan and thus default. Lenders argue they need the higher interest rates in order to offset the losses from those that default. Consumer groups, however, counter that the higher interest rates themselves make it more difficult for the individuals to pay back the loan, and the lenders are simply price-gouging.

Credit Insurance. Lenders will push single premium credit insurance stating that the insurance will pay off the loan if the homebuyer passes away. The cost of the insurance is often added to the loan, making it more appealing since it does not have to be paid in one lump sum. This makes the loan more expensive, and compounds the interest of the insurance over the life of the loan.

Interest Negotiation. Lenders often do not tell consumers that they may be able to negotiate the interest rate of the loan. By not communicating this to the consumer, the lending company increases profits.


State Usury Laws

New Hampshire
New Jersey
New Mexico
New York
North Carolina
North Dakota
Rhode Island
South Carolina
South Dakota
Washington, DC
West Virginia







Competition law, known in the United States as antitrust law, has three main elements:

  • prohibiting agreements or practices that restrict free trading and competition between business entities. This includes in particular the repression of cartels.
  • banning abusive behaviour by a firm dominating a market, or anti-competitive practices that tend to lead to such a dominant position. Practices controlled in this way may include predatory pricing, tying, price gouging, refusal to deal, and many others.
  • supervising the mergers and acquisitions of large corporations, including some joint ventures. Transactions that are considered to threaten the competitive process can be prohibited altogether, or approved subject to “remedies” such as an obligation to divest part of the merged business or to offer licences or access to facilities to enable other businesses to continue competing.

The substance and produce of competition Acts vary from jurisdiction to jurisdiction. Protecting the interests of consumers (consumer welfare) and ensuring that entrepreneurs have an opportunity to compete in the market economy are often treated as important objectives. Competition law is closely connected with law on deregulation of access to markets, state aids and subsidies, the privatisation of state owned assets and the establishment of independent sector regulators. In recent decades, competition law has been viewed as a way to provide better public services.[1]



“The fact that secrets do not remain guarded
forever is the weakness of the secret society.”
-Georg Simmel, The Secret Society
“Free enterprise,” “open markets,” and
similar expressions are standard business
rhetoric, but in practice economic organizations
strive to limit, curtail, and restrict the
operation of competitive markets. Their tactics
include planning (Galbraith 1967), entry barriers
(Baker 1984; Porter 1980c), joint ventures,
mergers, director interlocks, political activity

(Pfeffer 1987; Pfeffer and Salancik 1978; Burt
1983), direct manipulation of market ties
(Baker 1990), and embeddeding business decisions
in social relationships (Granovetter
1985). These market-restricting tactics are legal,
but business organizations also indulge in
practices proscribed by law that flagrantly subvert
the market mechanism.

* Order of authorship is alphabetical to indicate
equal contributions. Direct correspondence to
Wayne E. Baker, Graduate School of Business,
University of Chicago, 1101 E. 58th Street, Chicago,
IL 60637. Funding was provided in part by
the Graduate School of Business, University of Chicago.
We benefited from the insightful and thorough
reviews provided by anonymous ASR reviewers.
We are grateful for comments received during
presentations at the 1992 annual meeting of the International
Sunbelt Social Network Conference
(San Diego, CA), the Decision Research Workshop
at the University of Chicago, and seminars at the

University of Michigan, Northwestern University,
and the Stanford Center for Organization Research.
We especially thank Elizabeth Knier, J.D., for meticulous
and diligent research assistance, and our
informants in the heavy electrical equipment industry
for sharing their insights and knowledge with
us. We thank Michele Companion and Timothy
Harrington for additional research assistance. We
appreciate the helpful comments provided by Gene
Fisher, Andy Anderson, Anthony Harris, Gerald
Platt, Doug Wholey, David Sally, and Paul Cowan.


University of Chicago University of Massachusetts
We analyze the social organization of three well-known price-fixing conspiracies in the
heavy electrical equipment industry. Although aspects of collusion have been studied by
industrial organization economists and organizational criminologists, the organization
of conspiracies has remained virtually unexplored. Using archival data, we reconstruct
the actual communication networks involved in conspiracies in switchgeal; transformers,
and turbines. We find that the structure of illegal networks is driven primarily by the
need to maximize concealment, rather than the need to maximize efficiency. Howevel;
network structure is also contingent on information-processing requirements imposed by
product and market characteristics. Our i’ndividual-level model predicts verdict (guilt or
innocence), sentence, and fine as functions of personal centrality in the illegal network,
network structure, management level, and company size.

Collusive agreements in the heavy electrical
equipment industry go back to the 1880s, but
the price-fixing “schemes of the 1950s were
given special impetus when repeated episodes
of price warfare proved incompatible with top
management demands for higher profits”
(Scherer 1980, p. 170). Top executives imposed
unrealistic profit objectives in an industry
characterized by chronic overcapacity, increasing
foreign competition, and stagnating
demand (Ohio Valley 1965, p. 939). To cope,
managers decided to conspire rather than compete.
Their elaborate conspiracy involved as
many as 40 manufacturers and included more
than 20 product lines, with total annual sales
over $2 billion. The conspiracy was pervasive
and long-lasting; it became, insiders said, a
“way of life” (U.S. Senate Committee on the
Judiciary 1961, pp. 16879-84 [henceforward
Kefauver Committee]).


The study of the organization of conspiracy
is important for both theory and policy. We
contribute to research on organizations by
studying illegal networks involving companies
and their agents (employees). Most knowledge
about interorganizational networks is based on
studies of legal practices. Interorganizational
conspiracies, however, are a perduring feature
of capitalist societies. Our study explores the
extent to which theories based on legal networks
can be generalized to illegal networks.
Most sociological knowledge about organizational
crime is based on studies of corporate
offenders and their offenses (Shapiro 1980, p.
29). We move beyond this focus by analyzing
the organization of criminal activity, as well as
its effect on outcomes.
Studies of the social organization of conspiracy
also provide new insights relevant to
public policy, especially regarding the investigation
of antitrust violations and the enforcement
of antitrust laws. The anticompetitive activity
we study here is so common that uncovering
it is a chief purpose of major “guardians
of trust” (Shapiro 1987) like the U.S. Department
of Justice. Price-fixing and other
anticompetitive practices reduce consumer and
societal welfare (Scherer 1980). Successful
conspiracies artificially raise prices above the
competitive norm (Lean et al. 1982; Scherer

1980; Ohio Valley Electric Corp. v. General
Electric Co. and Westinghouse 1965, p. 915
[henceforward Ohio Valley 19651).

+++    ++++   +++

The Tennessee Valley Authority’s (TVA)
planning in 1958 for the Colbert Steam Plant
exposed the conspiracy. The TVA complained
about possible bid rigging to the U.S. Justice
Department because it had received identical
or nearly identical bids for electrical equipment,
ranging from $3 for insulators to
$17,402,300 for a 500,000 kilowatt steam turbine
generator (Walton and Cleveland 1964,
pp. 24-29). The Justice Department’s investigation
in 1959 revealed extensive collusion and
grand jury indictments followed in 1960.



The Sherman Act defines neither the practices that constitute restraints of trade nor monopolization. The second important antitrust statute, the Clayton Act, passed in 1914, is somewhat more specific. It outlaws, for example, certain types of price discrimination (charging different prices to different buyers), “tying” (making someone who wants to buy good A buy good B as well), and mergers—but only when the effects of these practices “may be substantially to lessen competition or to tend to create a monopoly.” The Clayton Act also authorizes private antitrust suits and triple damages, and exempts labor organizations from the antitrust laws.


Anticompetitive Practices

In referring to contracts “in restraint of trade,” or to arrangements whose effects “may be substantially to lessen competition or to tend to create a monopoly,” the principal antitrust statutes are relatively vague. There is little statutory guidance for distinguishing benign from malign practices. Thus, judges have been left to decide which practices run afoul of the antitrust laws.

An important judicial question has been whether a practice should be treated as “per se illegal” (i.e., devoid of redeeming justification, and thus automatically outlawed) or whether it should be judged by a “rule of reason” (its legality depends on how it is used and on its effects in particular situations).

To answer such questions, judges sometimes have turned to economists for guidance. In the early years of antitrust, though, economists were of little help. They had not extensively analyzed arrangements such as tying, information sharing, resale price maintenance, and other commercial practices challenged in antitrust suits. But as the cases exposed areas of economic ignorance or confusion about different commercial arrangements, economists turned to solving the various puzzles.

[ . . . ]

The recent era of antitrust reassessment has resulted in general agreement among economists that the most successful instances of cartelization and monopoly pricing have involved companies that enjoy the protection of government regulation of prices and government control of entry by new competitors. Occupational licensing and trucking regulation, for example, have allowed competitors to alter terms of competition and legally prevent entry into the market. Unfortunately, monopolies created by the federal government are almost always exempt from antitrust laws, and those created by state governments frequently are exempt as well. Municipal monopolies (e.g., taxicabs, utilities) may be subject to antitrust action but often are protected by statute.

About the Author –

Fred S. McChesney is the Class of 1967 James B. Haddad Professor of Law at Northwestern University School of Law and a professor in the Kellogg School of Management at Northwestern.



The basic goal of safety-and-soundness regulation is to protect “fixed-amount creditors” from losses arising from the insolvency of financial institutions owing those amounts, while ensuring stability within the financial system. Fixed-amount creditors are bank depositors, beneficiaries and claimants of insurance companies, and account holders at brokerage firms who are owed fixed amounts of money. Investors in a stock or bond mutual fund are not fixed-amount creditors because the value of their investments is determined solely by the market value of the fund’s investments. Financial institutions with fixed-amount creditors include banks, S&Ls, credit unions, insurance companies, stockbrokers, and money-market mutual funds (MMMF). Compliance regulation broadly seeks to protect individuals from “unfair” dealing by financial institutions and in the financial markets and to impede such crimes as “money laundering,” although this crime is hard to define.


Financial regulation in the United States is carried out by an alphabet soup of federal and state agencies. The federal bank regulators include the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the National Credit Union Administration. The Securities and Exchange Commission (SEC) regulates stockbrokers, MMMFs, stock and bond mutual funds, stock trading—including the stock exchanges—and financial disclosures by publicly traded corporations. State regulators oversee state-chartered banks, savings institutions, and credit unions as well as all insurance companies. State securities regulators are a junior partner to the SEC in that field.

Safety-and-Soundness Regulation

Safety-and-soundness, or solvency, regulation seeks to prevent financial institutions with fixed-amount creditors from becoming insolvent. Because government regulation cannot prevent all insolvencies, however, governments have created mechanisms to protect at least small fixed-amount creditors from any loss when a depository institution, insurance company, or brokerage firm has become insolvent—that is, has “failed.” These mechanisms, such as deposit insurance, insurance guaranty funds, and investor protection funds, can properly be viewed as a product warranty for solvency regulation. That is, they protect fixed-amount creditors against losses when the “product,” regulation, which is supposed to protect fixed-amount creditors, fails to prevent a financial institution’s insolvency.

For the more than three centuries that banks and insurance companies have been chartered by governments, notably with the founding of the Bank of England in 1694, governments have imposed regulations to ensure that these institutions remain both solvent (the value of their assets exceeds their liabilities) and liquid (they can meet payment requests, such as checks and insurance claims, when presented). The principal solvency regulation today centers on capital regulation; that is, the financial institution must maintain a positive capital position (its assets exceed its liabilities) equal to at least a certain portion of its assets. Other solvency regulations force asset diversity by limiting loan and investment concentrations among various classes of borrowers or the amount of credit extended to any one borrower.

[ . . . ]

Solvency regulations are enforced by examiners who assess the value of an institution’s assets and determine the scope of its liabilities, a particularly important function in property and casualty insurance companies. A financial institution can become insolvent (its liabilities exceed the value of its assets) if it suffers a large sudden loss or a sustained period of smaller losses. Likewise, a seemingly solvent bank or insurance company can turn out to be insolvent if examiners find hidden losses—assets have been overvalued or liabilities have not been recognized. Quite often, fraud is the underlying cause of those losses.

Compliance Regulation

Compliance regulation seeks to ensure “fair” and nondiscriminatory treatment for customers of financial institutions and to prevent financial institutions from being used for criminal or terrorist purposes. Compliance regulation has recently become a major responsibility for the regulators and a major cost burden for financial institutions.

Congress has enacted numerous protections for customers of federally regulated financial institutions; sometimes these protections extend to other types of financial firms, such as small-loan companies. These laws include the Truth in Lending Act, the Truth in Savings Act, the Fair Credit Reporting Act, the Real Estate Settlement Procedures Act, the Expedited Funds Availability Act, and various privacy protections, to name just a few. In recent decades, Congress also has enacted legislation barring discrimination in bank lending, including the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Consumer Credit Protection Act, and the Community Reinvestment Act. Each new law increases compliance costs for banks and other financial institutions.

Congress enacted the Bank Secrecy Act in 1970 not to enhance secrecy but to reduce it: the act’s intent was to prevent banks from being used as money-laundering conduits. Under this act, banks are required to submit Currency Transaction Reports to the Treasury Department for individual currency deposits and withdrawals exceeding ten thousand dollars unless the bank customer, such as a grocery store, regularly engages in large cash transactions with the bank. Banks also are required to submit Suspicious Activity Reports for any banking transaction that seems suspicious or out of the ordinary for that customer. According to Lawrence Lindsey, an economist and former governor of the Federal Reserve System, for the seventy-seven million currency-transaction reports filed between 1987 and 1995, the government was able to prosecute only three thousand money-laundering cases. The three thousand cases produced only 580 guilty verdicts. That amounts to more than 130,000 forms filed per conviction.

The USA PATRIOT Act, passed in the aftermath of the 2001 terrorist attacks, broadened the Bank Secrecy Act’s reach. Since then, the federal government has stepped up its enforcement of the Bank Secrecy Act, including the levying of multimillion-dollar fines against banks for violations. As a result, financial institutions of all types have increased their spending on compliance. Much of the cost of this spending is borne by customers of these institutions through higher fees and lower returns.


While financial institution regulation has changed dramatically over the centuries, its goal has not changed: to protect fixed-amount creditors against loss should their financial institution fail and to ensure timely payment of checks, insurance claims, and other obligations of these institutions as they come due. However, financial regulation has sometimes failed badly. Hence the need for a product warranty—in the form of deposit insurance, insurance guaranty funds, and the like—to protect depositors, insureds, and brokerage customers from regulatory failure.

About the Author –

Bert Ely, the principal in Ely & Company, Inc., is a financial institutions and monetary policy consultant in Alexandria, Virginia. In 1986, he was one of the first people to publicly predict the U.S. S&L crisis.



At an SEC roundtable that looked at lessons from the credit crisis, Chairman Cox discussed the need to give investors more useful, timely, and transparent information, and the need for Congress to fill a U.S. regulatory gap and provide statutory authority for government oversight of credit default swaps.

SEC Protecting Investors, Markets During Credit Crisis

During the current turmoil in the credit markets, the SEC has worked closely with other regulators in the U.S. and around the world to protect investors and the markets.

SEC Expands Sweeping Investigation of Market Manipulation

Work Begins on Congressionally Mandated Accounting Standards Study


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