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CFPB's Auto Finance Push Hurts Consumers

The way the Consumer Financial Protection Bureau is regulating the auto finance industry's relationships with dealers is simply wrong — both legally and ethically. It's also directly counterproductive to its goal of protecting consumers.

Congress, in its occasional wisdom and, in no small part, as the result of lobbying by the nation's auto dealers, specifically carved dealers out of the CFPB's scope of oversight. This apparently did not sit well with the CFPB — which, in a thinly veiled end-around move, attempts to supervise auto dealers through the banks and nonbanks that offer financing to dealers. In effect, since it does not have the statutory authority to do so itself, the CFPB is forcing auto lenders to police dealers. The lenders must oversee how dealers mark up loans and assess whether there is any discrimination.

It seems to me that it would have been much more evenhanded, and potentially better received by the industry, for the agency to have simply engaged in rulemaking for auto dealers by going through proper channels. Instead, the CFPB's regulation of auto finance is an unfair, improper and potentially illegal attempt to control what lenders and dealers charge for their services.

The legal authority of any CFPB rulemaking directly or indirectly impacting auto dealers is dubious given the carve-out by Congress. Furthermore, the agency admits that it has not found actual discrimination. Instead, it says there is implied discrimination because some minorities reportedly received worse lending terms than nonminorities.

The CFPB announced its use of disparate impact methodology in March 2013. Now even a neutral policy that affects protected borrowers adversely can result in penalties for a lender — regardless of the lender's intent. The methodology is flawed, and the agency has acknowledged as much by saying that disparate impact could overestimate discrimination. Even so, the CFPB says it prefers this method to the alternative where bias might be underestimated. This parental-esque concern, however, fails to take into account the reputational harm to lenders that results from the CFPB basing damages on overestimated figures.

The agency's determination of whether borrowers are minorities by looking only at surnames, geographic location, or a combination of both, is misguided as well as being somewhat offensive. Moreover, it blatantly ignores business factors recognized by the Justice Department in other contexts as legitimate, including but not limited to credit scores; characteristics of vehicles; timing, location and structure of the deal; and whether the car is new or used. Use of these valid factors by the CFPB would undoubtedly show that fewer consumers are being harmed than is alleged.

A 2014 white paper in which the CFPB offers some details on its disparate impact methodology lacks sufficient detail in indicating how lenders should structure their compliance management systems to avoid being cited for discrimination. The result is a widespread, costly duplication of efforts since every lender must come up with its own methods to prevent and remedy potential disparities.

The agency's targeting of the auto finance industry is reportedly in response to allegations that dealers pump up interest rates, make too many risky subprime loans and discriminate by adding different markups to these loans. It is simply unrealistic for the CFPB to believe it can change dealers' entire market pricing theory through regulation of the lenders who serve them. Most lenders already have a 2.5 percent cap on dealers' price discretion, adopted as a result of settlements in the mid-2000s.

The CFPB's focus on dealer markups likely will raise financing costs. If markups were eliminated, as the agency suggests, dealers would try to replace that revenue, and the inescapable outcome is that consumers will continue to be the source of any new revenue. No doubt the increased cost of the aforementioned compliance programs will be passed on to consumers too. The CFPB estimates the labor costs of a compliance exam to be $28,000. Industry trade groups, however, estimate the cost at $75,000 to $100,000. In addition, the guidance recommending lenders adopt a flat-fee compensation model for dealers would hurt competition and undoubtedly boost car prices.

Frankly, the agency's actions assume ignorance on the part of consumers that is presumptuous and offensive. If the goal of the CFPB is indeed protection of consumers, it has failed miserably.

Blair Evans chairs the auto finance team at the law firm Baker Donelson and practices in the areas of creditors' rights, collections and business litigation. She can be reached at bevans@bakerdonelson.com.

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Confess that I have no experience as an indirect lender and the conversation about variability of the dealer markup is logical by still theoretical. Just trying to apply what fits my sense of who is drives the bargain and who has the leverage to control the transaction.

Curious -- what did Congress intend if not that auto dealers remain free to maximize their personal gain where their bargaining power was greater than the consumer?

Seems to me the rub is in the conflict between maximizing profit for the dealer but not discriminating on a prohibited basis. We in the mortgage business have been more or less finding that balance for at least the past 50 years. Why is it so problematical for auto dealers?
Posted by MildManneredRadical | Thursday, February 11 2016 at 1:36PM ET
Confess that I have no experience as an indirect lender and the conversation about variability of the dealer markup is logical by still theoretical. Just trying to apply what fits my sense of who is drives the bargain and who has the leverage to control the transaction.

Curious -- what did Congress intend if not that auto dealers remain free to maximize their personal gain where their bargaining power was greater than the consumer?

Seems to me the rub is in the conflict between maximizing profit for the dealer but not discriminating on a prohibited basis. We in the mortgage business have been more or less finding that balance for at least the past 50 years. Why is it so problematical for auto dealers?
Posted by MildManneredRadical | Wednesday, February 10 2016 at 6:38PM ET
How is it fair or right that auto dealers profit personally when they "sell" a higher interest rate to a less sophisticated consumer? In real life, these less sophisticated consumers are women, minorities and those in lower incomes.

That is discrimination in the purest sense. The dealer profits by 'sticking it to" people who least understand.

The fancy term is disparate impact. Yes, I understand that there is room for many to believe that the CFPB's chosen methodology to determine which consumers received refunds has plenty of room for error. That is statistics for ya! You may a mistake here and you make a mistake there and hope it all works out.

Why do you think it was that a powerful auto dealer lobby worked over Congress hard to get a carve out? Think it could be because they knew exactly what they were doing and wanted to protect their own self- interest? Caveat emptor rules, eh?

Why are auto dealers more special than a payday lender or a mortgage lender or anything else in the finance world?
Posted by MildManneredRadical | Wednesday, February 10 2016 at 3:18PM ET
No. In the hypothetical, the consumer could negotiate the rate down to 4%. Now it can only negotiate to 5% and will be declined if they qualify at 4% but not at 5%. The most needy consumers get the worst of this. Typical CFPB.
Posted by randyh44 | Tuesday, January 26 2016 at 7:27PM ET
Just playing devils advocate...the consumer was funding the difference between the buy rate and the the rate the consumer gets prior to the changes correct? Are they really any worse off? Arguably the new rules are better to neutral from the perspective of the consumer and their all in cost of ownership, correct?
Posted by HatrickSwayze | Tuesday, January 26 2016 at 5:14PM ET
Excellent points and easily shown by the CFPB's last tow consent decrees with auto finance companies in 2015. In both, the CFPB backed off elements of the 2013 Guidance by allowing for dealer rate participation (markup of lender's "buy rate") but limited to 125BP on credit of 60 months or less and 100 BP on credit of greater than 60 months. The orders also allowed the lenders to supplement the reduce rate participation with a flat payment to dealers. Reportedly, both lenders are doing so by adding a 1% of amount financed fee to remain competitive with other lenders who are not restricted in the dealer's rate participation.

Now who is paying that extra 1%. Not the dealer and not the lender. Assume previously the lenders had a buy rate of 4% but allowed dealer markups of 200-250BP. Consumers could negotiate rates down to the 4% figure or slightly above it. Now, to make up the 1% kicker they are paying the dealer, the lenders' buy rate goes up to 5%. Subprime customers who could qualify at 4$ may not qualify at 5% and all customers are hurt by the higher buy rate. This is the real world where the CFPB doesn't seem to operate. Helping consumers, especially needy consumers, seems to be antithetical to their mission of wanting to punish auto dealers. Not what Congress intended.
Posted by randyh44 | Tuesday, January 26 2016 at 8:17AM ET
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