VIEWPOINT: Time to Fix Preemption, Not Abandon It

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Byline: Michael Roster

With statements from Congress and the administration and a Supreme Court case pending on preemption, it is a good time for the banking industry, consumer groups and policymakers alike to have a civil conversation.

I think we will quickly come to a consensus that preemption is both necessary and in need of repair.

It would be ironic if, just as Europe and other parts of the world eliminate national barriers to commerce, we in the United States re-create state barriers. And it is folly to think that we can have a patchwork where not only the states but also every city and county can adopt its own rules, on top of whatever the federal government enacts. The only people who will benefit are the lawyers, who on both sides will derive substantial incomes from endless litigation.

Take credit cards. If a cardholder moves from New York to Florida, are the old credit card balances subject to New York's protections and the new balances to Florida's? How do you allocate those balances if a portion is rolled over from one month to the next? What if there are joint account holders with different states of residence?

These are examples of the hundreds if not thousands of issues that will require rules ad nauseam. And for what purpose?

Similar issues would arise if we have a patchwork of rules governing mortgages and other consumer loans. And at least some readers will remember when we once spent huge amounts of time to determine the "choice of law" in multimillion-dollar commercial transactions, flew boards of directors to a designated state, required payments all to come to that state etc. Do we really want to go back to that Neanderthal era?

But preemption as it currently exists has serious shortcomings. The doctrine was largely developed in the 1970s in connection with the fixed-rate mortgage crisis of that period. About $1 trillion of the nation's $3 trillion of banking assets were insolvent, since institutions were holding mortgages yielding something like 4% but suddenly were paying 20% or more for funds. The preemption doctrine was developed as a way to address the havoc that existed in the nation's fixed-rate mortgage system, leading to a U.S. Supreme Court decision known as de la Cuesta that upheld the sweeping preemptive authority of the relevant federal regulator, the Federal Home Loan Bank Board, now known as the Office of Thrift Supervision.

The thrift regulator was created during the early years of the Depression. Because it was not clear then what powers would be needed, the legislation used few words but was sweeping in scope. It directed the FHLBB to adopt such rules and regulations as might be needed, "giving primary consideration to the best practices of local mutual thrift and home financing institutions" throughout the United States. In other words, the FHLBB could do pretty much anything it wanted in regulating federal thrifts but was to look at what was working at the state level and adopt federal rules based on these best practices.

In recent years we have been trying to graft preemption atop a deregulated system, and this will not work. It is like grafting a 100-foot tree atop a thinly rooted shrub. With the slightest wind, it will topple.

My mentor, Bill McKenna, largely invented the preemption doctrine, and before Bill would argue preemption in court, he insisted that there be a federal rule regarding whatever was at issue (due-on-sale clauses, late charges, prepayment fees etc.).

Bill understood that preemption was both a legal and a political matter. He did not think preemption would survive if a judge were to say, "I agree that the supremacy clause [in the Constitution] makes national law supreme. …