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COPYRIGHT 2007 Harvard Society for Law and Public Policy, Inc.
INTRODUCTION
I. NATIONALIZATION OF BANKING MARKETS AND FEDERAL PREEMPTION OF STATE LAWS A. State Usury Statutes B. Preemption Rulings of the Comptroller of the Currency C. The Dilemma for States and the Appeal of Consumer Education D. A Model Act II. THE TAXING POWER OF STATES A. History of 12 U.S.C. [section] 548 B. Plain Meaning of the Statute C. Judicial Precedents in Analogous Contexts D. The Regulatory Dimension of State Taxation E. The Role of Federal Banking Agencies in Interpreting 12 U.S.C. [section] 548 F. Judicial Review of the Model Act 1. Does the Act Discriminate Between National Banks and State Institutions? 2. Is the Act a Reasonable Exercise of State Taxing Powers? III. LEGAL BARRIERS TO THE TAXATION OF OUT-OF-STATE BANKS A. Statutory Challenge to Economic Nexus. B. Constitutional Challenges to Economic Nexus C. Constitutional Challenges to the Model Act. IV. CONCLUSION APPENDIX: A MODEL ACT FOR THE PROVISION AND PUBLIC FINANCING OF CONSUMER FINANCIAL EDUCATION
Over the past quarter-century, consumer lending markets in the United States have become increasingly national in scope, with large national banks and other federally chartered institutions playing an ever more important role in many sectors, including credit card lending and home mortgages. At the same time, in a series of judicial decisions, courts have ruled that a wide range of state laws regulating abusive credit card and predatory mortgage lending practices are preempted, at least as applied to national banks and other federally-chartered institutions. Given the dominant role of such institutions in U.S. lending markets, these rulings have narrowed the capacity of states to police local lending transactions. As an alternative to direct regulation, the California Assembly recently considered legislation designed to improve consumer understanding of financial transactions through educational efforts. The measure would be financed by a new state tax on income from certain problematic loans made to California residents by financial institutions, including national banks and other federally-chartered institutions. This Article considers whether a tax of the sort proposed in California could survive a preemption challenge under recent court rulings, as well as other potential constitutional attacks. Although the States have quite limited powers to regulate federally chartered financial institutions, Congress explicitly authorizes states to tax national banks in 12 U.S.C. [section] 548. This Article explores the scope of state taxing authority that [section] 548 confers and the relationship between that authority and recent preemption rulings. After reviewing a range of legal precedent, the Article concludes that a state tax of the sort considered in California--imposing modest levies on federally chartered entities but not preventing them from engaging in otherwise authorized activities--should qualify as a legitimate exercise of state taxing power under [section] 548 and should withstand scrutiny both under the Due Process and Commerce Clauses to the extent the tax is imposed on out-of-state banks.
INTRODUCTION
In February 2005, California Assemblyman Joe Nation introduced a bill proposing a novel approach to consumer protection in the financial services industry. A.B. 1375, the Consumer Protection and Anti-Interest Rate Manipulation Act, (1) would have imposed a supplemental tax on lenders, including national banks, that include in their credit card agreements with California residents a controversial interest rate repricing mechanism known as a universal default provision. (2) Proceeds from the levy were to be dedicated to "educating consumers regarding predatory lending practices." (3) Although the measure has yet to be reported out of committee, the legislation raises a number of important and unresolved questions regarding the authority of states to finance consumer education efforts through the imposition of taxes on national and out-of-state banks.
For the past several years, federal courts have faced a series of cases challenging the authority of state officials to impose a variety of consumer protection laws on national banks and other federally chartered institutions. With the Supreme Court's recent decision in Watters v. Wachovia Bank, N.A., (4) the battle has been resolved largely in favor of federal preemption, at least with respect to state laws purporting to regulate the manner in which national banks and other federal instrumentalities extend credit to their customers. As these federally-chartered entities play an increasingly dominant role in the nation's lending market, the capacity of states to engage in direct regulation of the financial activities of their residents has been curtailed dramatically. The decline in direct state power over consumer finance is the impetus behind proposals, such as Assemblyman Nation's, seeking to enhance the capacity of state residents to deal with an increasingly complex array of lending opportunities through state education efforts financed with funds raised from those lending institutions deriving revenues from state residents through potentially problematic classes of lending transactions.
Whether Assemblyman Nation's bill would survive a preemption challenge is an interesting, important, and unresolved question of law. On the one hand, the national bank activities on which the California tax would be imposed are similar to activities that the States have been denied the power to regulate directly. Taxation, however, is not the same as regulation, and--critically--Congress in [section] 548 expressly authorized states to impose taxes on national banks. (5) Although in past preemption cases involving national bank activities the courts have had little guidance on the topic of congressional intent regarding state authority, Congress has spoken clearly with respect to taxes: States have the unambiguous authority to tax national banks. To be sure, the existence of [section] 548 does not wholly resolve the matter: if state taxes were blatantly designed to circumvent restrictions on direct regulation of national banks, the enactment of such taxes would raise difficult legal questions. But modest taxes imposed to finance legitimate consumer education goals--that is, taxes of the sort proposed in Assemblyman Nation's bill--are a legitimate exercise of state authority under [section] 548 and should survive a federal preemption challenge, even one advanced by the Office of the Comptroller of the Currency (OCC) (6) or other federal regulators under the color of Chevron deference. (7)
A separate, unresolved legal issue raised by Assemblyman Nation's proposed legislation concerns the authority of states to impose income and other taxes on out-of-state banks that do not maintain a physical presence within the taxing jurisdiction. Judicial decisions are currently divided on whether alternative theories of jurisdictions--especially theories of state taxing power based on economic nexus rather than physical presence--satisfy constitutional requirements under the Due Process and Commerce Clauses. Although this aspect of the analysis turns on unresolved issues of constitutional law, this Article argues that states should be permitted to rely on an economic nexus theory of jurisdiction at least with respect to financial institutions that increasingly base their operations in a few remote jurisdictions and conduct their operations to reach borrowers throughout the nation.
This Article explores how other states might expand upon Assemblyman Nation's original bill to establish a more comprehensive system of state consumer education financed with taxes imposed on both problematic credit card agreements and potentially predatory home mortgage transactions. The Article begins with an overview of the nationalization of U.S. lending markets in the past quarter-century and the contemporaneous legal battles over state efforts to regulate consumer lending transactions that increasingly involve national banks located in other jurisdictions. After reviewing the series of federal court cases largely curtailing the power of states to regulate in the areas of consumer credit and home mortgages, the Article considers the advantages of consumer education at the state level as an alternative to the direct regulation states can no longer effectively impose. The Article next presents a Model Act based on Assemblyman Nation's original bill but with a number of refinements that clarify the legislation's educational purposes, reform the terms of its tax provisions, and expand the base on which state taxes are levied to include potentially predatory home mortgages and problematic credit card arrangements. The Article then considers whether the Model Act would be authorized under 12 U.S.C. [section] 548, and whether the Act could withstand Due Process and Commerce Clause challenges if imposed on out-of-state financial institutions without a physical presence in the state.
I. NATIONALIZATION OF BANKING MARKETS AND FEDERAL PREEMPTION OF STATE LAWS
Over the last quarter-century, banking markets in the United States have undergone a dramatic transformation. Although banking markets were traditionally served through local institutions and segmented by legal restrictions on interstate branching and even interstate bank holding companies, the American banking industry has become increasingly national in scope. This trend is most pronounced in the credit card industry, where a substantial proportion of credit cards are now issued by a handful of major firms located principally in South Dakota and Delaware. (8) Home mortgage financing is also no longer a local business. Major mortgage lenders and brokers advertise nationally, and the vast majority of home mortgages originated in the United States today are immediately resold into mortgage pools financed by national and international investors. (9) Although the U.S. banking industry still remains one of the most fragmented in the world, the trend toward consolidation is pronounced, particularly in the area of credit card lending and home mortgage finance. (10)
The nationalization of consumer lending markets has imposed considerable pressure on the traditional structure of consumer protection laws in the United States, most significantly in the application of these laws to national banks. In the past, there was relatively little conflict between state consumer protection laws and national bank powers. Consumer protection was generally understood to be the province of state governments, and national banks routinely complied with local consumer protection rules. (11) Indeed, federal laws often specified that national banks would be subject to local rules governing such issues as usury and bank branching. (12)
Starting in the 1970s, however, a series of legal battles forced the courts to reconsider the application of local consumer protection requirements. The disputes initially arose with respect to national banks doing business across state lines when consumer protection requirements in the states where the banks' customers were located differed in some way from the requirements where the national bank was based. Typically, these controversies were framed as issues of federal preemption: whether the National Bank Act preempts the arguably conflicting provision of state law. (13) Often acting at the instigation of the OCC, courts generally found local state consumer protection laws were preempted with respect to national banks. National banks supported preemption findings because such findings permitted national operations under a consistent set of regulatory requirements. (14)
Two examples illustrate the trend toward preemption of the authority of states to protect consumers from abuses of nationally chartered banks: (1) the substantial erosion of state usury ceilings following the Supreme Court's 1978 decision in Marquette National Bank of Minneapolis v. First of Omaha Service Corp.; (15) and (2) more recent OCC rulemakings that have had the effect of preempting a broad range of state laws, including a number designed specifically to address problems of predatory mortgage lending regulations. (16)
A. State Usury Statutes
In Marquette, the Supreme Court faced the question of which usury rules apply when a national bank based in Nebraska makes a loan to a customer who resides in Minnesota. The case called for an interpretation of section 85 of the National Bank Act, which provides that a bank may charge interest "at the rate allowed by the laws of the State, Territory, or District where the bank is located...." (17) The Court ruled in favor of the laws of the bank's home state on the theory that the statute specified the location of the bank and not that of the customer. (18) As a result of the Marquette ruling, national banks in one state could "export" their interest ceilings (or lack thereof) to other states, effectively overriding the usury limits of other jurisdictions. A number of smaller jurisdictions-notably South Dakota and Delaware--capitalized on the Marquette decision by relaxing or even eliminating their interest rate regulations and thereby encouraging national banks to locate their credit card businesses in those jurisdictions. (19) In a national banking system where credit is increasingly extended across state lines, the Marquette decision, coupled with the cooperation of several state legislatures, effectively ended interest rate regulation for certain kinds of consumer credit in the United States.
Over the years, the Marquette holding has been expanded to cover other aspects of credit card operations. Not only are local interest rate ceilings preempted, but so too are restrictions on late fees and other financing charges, on the grounds-endorsed by the OCC and accepted by the Supreme Court in Smiley v. Citibank (20)--that late fees are an element of interest for purposes of section 85. (21) More recently, state attempts to protect consumers by regulating disclosures in credit agreements have also been preempted with respect to national banks. (22) Even claims only indirectly related to usury violations by national banks have been held to arise exclusively under federal law. (23)
B. Preemption Rulings of the Comptroller of the Currency
Over the past few years, controversies over the preemption of state consumer protection laws typically have involved preemption decisions, including a number of rulings designed to restrict the application of state predatory lending legislation to national banks. The OCC's actions prompted much academic criticism and a series of court cases. (24) Responding in part to concerns about a Georgia statute designed to prevent predatory lending practices against residents of that state, the Comptroller in early 2004 adopted a series of regulations defining the application of state laws to national banks. (25) The rules cover a number of specific areas including real estate lending, (26) deposit taking, (27) non-interest charges and fees, (28) and general bank operations. (29) In addition to identifying specific state laws preempted in certain areas, (30) the regulations include the following general formulation: "Except where made applicable by Federal law, state laws that obstruct, impair, or condition a national bank's ability to fully exercise its powers to conduct activities authorized under Federal law do not apply to national banks." (31) The preemption provisions are supplemented with a further "visitorial powers" provision that severely constrains the authority of a state official to examine, investigate, or impose licensing requirements on the activities of national banks. (32)
The overwhelming weight of judicial authority to date has affirmed the broad scope of the OCC's preemption rules. Federal district court decisions have accepted preemption of additional state disclosure requirements on national bank lending practices, (33) state rules assigning liability on loans sold by national banks into secondary mortgage markets, (34) and even state tort claims that turn on fees charged on national bank loans. (35) Furthermore, a string of federal appellate courts have affirmed the OCC's visitorial-powers regulation denying state officials any supervisory functions with respect to most activities of national banks. (36) And, in its recent decision in Watters, the Supreme Court endorsed the OCC's extension of it visitorial powers to operating subdivisions of national banks. (37)
In light of these precedents, the only open question remaining is the residual scope of state authority to maintain local rules that have some indirect impact on the operations of national banks. Once again, OCC regulations include a standard formulation:
State laws on the following subjects are not inconsistent with the powers of national banks and apply to national banks to the extent that they only incidentally affect the exercise of national bank powers: (i) Contracts; (ii) Torts; (iii) Criminal law; (iv) Rights to collect debts; (v) Acquisition and transfer of property; (vi) Taxation; (vii) Zoning; and (viii) Any other law the effect of which the OCC determines to be incidental to the exercise of national bank powers or otherwise consistent with the powers set out in ... this section. (38)
Although the courts have not yet had an opportunity to provide definitive interpretations of this formulation, (39) the OCC position does seem to suggest that national banks are subject to some state law requirements in areas traditionally left to local control: those that are "not inconsistent" with national bank powers. Part II of this Article considers, in some detail, the authority of state governments to impose taxes on national banks, an area that is addressed specifically in a federal statute and not just in the OCC's standard formulation above. A key question will be whether the OCC's "not inconsistent" standard is appropriate in the area of state taxation where Congress has expressly authorized states to tax national banks.
C. The Dilemma for States and the Appeal of Consumer Education
Faced with a dramatic diminution of their traditional authority to protect their residents from financial abuses, the States today confront a serious dilemma. (40) Although recent developments in financial markets and judicial decisions have effectively limited the regulatory powers of states, problems of consumer protections have become more severe in many respects.
The rise of national consumer lending markets has undoubtedly expanded consumer access to credit. (41) Moreover, several authors have linked rapidly rising bankruptcy filings with the Marquette decision's deregulatory effect. (42) For example, Diane Ellis of the Federal Deposit Insurance Corporation (FDIC) argues that "deregulation altered the consumer credit markets and triggered a substantial increase in consumer credit availability, charge-off rates, and personal bankruptcies." (43) A recent study by Professor Ronald Mann corroborates the relationship between rising consumer debt and personal bankruptcies in the United States and the substantial costs that the financial distress imposes on families, local communities, and the public more generally. (44) Other analysts have explored the negative impact on consumers of particular lending practices, such as credit cards with the universal default provisions targeted in Assemblyman Nation's bill. (45)
Predatory lending practices impose similar social costs and are increasingly perceived as a major concern for state legislatures. (46) Although Congress has adopted some legislation designed to constrain predatory lending practices, lenders still have considerable latitude to structure home mortgages as they wish. There is also evidence that some lenders have exploited this latitude to induce consumers to enter into lending transactions that they will not be able to afford and that will ultimately cause them to lose their homes through foreclosure. (47) Elderly low-income borrowers are often the target of such abusive lending practices. (48) Although the Comptroller of the Currency has made some effort to police predatory lending activities of national banks, the agency has dedicated limited resources and brought only a handful of enforcement actions against national banks for such matters in recent years. (49)
In response to lending practices that states cannot directly regulate but that impose potentially substantial costs on state residents and state social welfare networks, consumer education initiatives of the sort proposed in Assemblyman Nation's bill have substantial appeal. A growing body of academic research suggests that Americans have a relatively low level of financial literacy. (50) Faced with a vast array of choices for consumer credit and home mortgages, many Americans are ill-equipped to determine which products provide the most advantageous terms and which include provisions, like a universal default clause, that many experts consider unfair and abusive. (51) More complicated questions, such as whether a borrower can afford to repay a high-cost home equity loan or an interest-only mortgage with monthly payments that may rise substantially in a few years, are also beyond the ken of many consumers. Viewed in this light, many of the problems associated with abusive credit card and predatory lending practices are simply a byproduct of financial illiteracy: if consumers had a better understanding of the consequences of certain financial transactions and the capacity to investigate more attractive alternative arrangements, the magnitude of the problems for consumers, and their communities and states, could be greatly reduced.
Although the Federal Reserve Board has researched the problem of consumer financial literacy in the United States, (52) federal banking authorities, unlike national regulators in some other countries, (53) have never viewed consumer financial education as a principal responsibility. Because education traditionally has been a core function of state and local governments,...
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