Meltdown 101: Reform plan’s impact on consumers

American consumers have fallen victim to one financial scandal after another in the past decade, from accounting fraud at Enron to illegal late trading by mutual funds to the subprime mortgage meltdown.

President Barack Obama hopes to put the brakes on that trend with a series of regulatory reforms that his administration says will guard the nation’s financial system against its own excess. The formal announcement comes Wednesday, but much of the substance was disclosed by the administration on Tuesday.

The centerpiece of the package is the creation of a new agency, and there also are proposals to protect people who have mortgages or use credit cards.

Here are some questions and answers about the proposed reforms and their likely impact on consumers.

Q: What’s being created and why?

A: The Consumer Financial Protection Agency, if approved by Congress, will have broad authority to protect consumers of credit, savings, payment and other consumer financial products and services. It would be independent of agencies that now share those oversight duties and take away some power from some, most notably the Federal Reserve.

It’s being proposed in response to widespread criticism that banks, lenders and credit card companies have used unfair and deceptive practices to dupe consumers and saddle them with debt.

Q: What exactly would the new agency be able to do?

A: It could write rules, reform mortgage laws, examine financial institutions’ practices, enforce compliance through penalties, ban unfair practices and require that companies be “clear and conspicuous” in informing consumers of costs, penalties and risks. It also would allow states to pass laws that are stricter than the federal standards.

One signal that administration officials are determined not to let this be just another layer of bureaucracy and complexity: their use of the term “plain vanilla.” The agency would require banks and other financial institutions to offer a basic, “plain vanilla” mortgage product with straightforward terms — such as a 30-year, fixed-rate mortgage loan.

Consumers could still opt for more complicated products, though they would be subject to more stringent rules and disclosures than they are now.

Q: Will these reforms help people stay out of trouble with their mortgages?

A: They should help avoid future troubles. It would set guidelines for mortgages, and certain subprime mortgages clearly would be banned. Mortgage companies and banks would not be able to issue mortgages “or other credit products” that they knew consumers would not be able to pay back.

The reforms also would ban unfair practices such as “yield spread premiums” — side payments from lenders that encourage mortgage brokers to push consumers into higher-priced loans than they should qualify for. And they would require that brokers be paid over time based on people’s continued loan performance, rather than in a lump sum at closing.

Prepayment penalties, which can lock borrowers into bad loans, also would be banned.

Q: What if I’m already facing foreclosure? Is this going to help me?

A: Perhaps not immediately. But the summary being circulated by administration officials makes it sound as if the new agency would have the authority to order institutions to negotiate fairly with consumers facing foreclosure.

Q: Could the new agency have prevented the subprime mortgage mess?

A: It’s conceivable. Data surfaced as early as 2001 about subprime mortgage loans, yet despite all the warning bells going off it wasn’t until fairly recently that firm action was taken to try to halt aggressive lending practices and improper underwriting.

Consumer advocates in particular say a lot of trouble could have been prevented if reforms had been put in place earlier.

“The Fed slept for 10 years after Congress gave it authority over predatory mortgage lending and did not issue rules till after the crisis had peaked two years ago,” said Ed Mierzwinski, senior fellow on consumer issues at the Washington-based Public Interest Research Group.

Q: Will this stop credit card companies from raising rates and fees?

A: It won’t automatically ban all rate increases, but the new agency could have the power to set a maximum interest rate and maximum fees. It could also limit the amount interest could be increased at any one time and penalize companies that don’t do what it says.

Q: What about all the fine print in credit card statements — is that going to go away?

A: It won’t go away entirely. But the insistence on transparency and understandable communications — with the threat of penalties for companies that don’t comply — should improve things.

Q: What obstacles does the Obama administration face in trying to get the reforms approved?

A: The package of proposals is certain to face stiff opposition on Capitol Hill. Big banks and industry groups oppose the consumer protection plan. They argue that empowering a new agency with sweeping authority could actually lessen consumer access to loans and other products. And Republicans and some others have questioned the proposal to give the Fed expanded powers to supervise “too big to fail” institutions, as well as the additional spending the reforms entail.