Changing the way auto loans get priced at thousands of car dealers across the country is proving a tall task for the federal government.
The Consumer Financial Protection Bureau and the Justice Department for well over a year have locked horns with lenders and dealerships over the discretionary markups that auto salesmen add to the price of loans. At issue is the effect of the pricing system on minorities.
The CFPB in December reached a $98 million settlement with Ally Financial, one of the nation's largest automobile lenders, in a deal that offered incentives for the company to switch to a flat-fee pricing model.
Under a flat-fee system, auto dealers would receive a fixed amount of compensation for each loan, rather than a sum that varies depending on the outcome of their negotiation with each car buyer.
But despite the pressure to switch to flat fees, Ally Chief Executive Michael Carpenter made clear this week that his company will stick with the industry's longstanding way of doing business.
"We are not going to be the Trojan horse for driving industry change," Carpenter said in strongly worded remarks to Automotive News.
"That is obviously not what the CFPB wanted to hear. They thought we were going to cave," he was quoted as saying.
CFPB officials say their goal is not to end the markup system, which is sometimes called dealer rate participation.
The CFPB and Justice have been investigating instances where legally protected classes of borrowers, such as racial minorities, may have paidlarger markups than other consumers with a similar credit profile.
The average African-American car buyer who received an Ally loan paid more than $300 in additional interest over the course of the loan's term than a similarly situated white borrower, according to the December consent order. Ally maintains that it does not engage in discriminatory practices.
Auto dealers and their allies on Capitol Hill have blasted the CFPB, but agency officials deny that they are insisting on lenders switching to a flat-fee system. The CFPB has suggested other options that would also remove discretion from the auto dealers.
Still, the CFPB's statements and recent actions suggest that the agency is trying to upend the status quo.
"What we think is problematic is when, if creditworthy determination has been made and there's a rate that is gauged, that somehow that rate will be pushed up because of financial incentives for people to push that up higher at the expense of the consumer," CFPB Director Richard Cordray said during congressional testimony last month.
The Ally consent order gave the Detroit lender an unpalatable choice. The company could either switch to a system that takes pricing discretion away from the auto dealers, or it could implement a monitoring program that may require Ally to write checks on a rolling basis to any minority borrowers who are deemed to have paid too much.
Ally is choosing the latter option.
Its reason? "Ally does not believe that there is measurable discrimination by auto dealers, and we believe dealer finance income can be an important tool for dealers to run strong businesses and offer consumers competitive annual percentage rates," an Ally spokeswoman said in an email.
Other banks in the auto lending business might like to see an end to dealer markups, according to industry sources.
But no lender wants to be the first mover, and with good reason. That's because any lender that opts to end dealer markups unilaterally risks being abandoned by dealers in favor of other financing sources, observers say.
This dynamic is partly a product of competition; no single auto lender has more than about 7% market share.
"So there's a reluctance to change a successful model, and to jeopardize your market share, without knowing what the implications are," said Bill Himpler, executive vice president at the American Financial Services Association, which represents auto lenders.
The same point was made by John Van Alst, a staff attorney at the National Consumer Law Center, which has been pushing for an end to dealer markups. "I do think it's a real uphill battle," he said. "Because you can't do it alone."
Lawyers who represent auto lenders offered diverging views about the long-term prospects for dealer markups in the face of pressure from regulators and prosecutors.
Ally's decision to dig in its heels sends a message to the rest of the industry, said Kenneth Rojc, managing partner of the auto finance group at Nisen & Elliott.
"Other lenders were trying to determine just how the winds are blowing," Rojc said. "They're clearly blowing in the direction of rate participation."
Ally is the first auto lender to reach a settlement with the federal government, but other companies remain the subject of CFPB scrutiny. And it's possible that a number of large lenders will decide to switch to a flat-fee system at around the same time, said Christopher Willis, a partner at Ballard Spahr.
That kind of collective approach could protect any one lender against a sudden loss of business.
"I continue to believe that the market is headed away from dealer participation," Willis said. "I just don't think that the conditions for that to occur have coalesced yet."
Leonard Chanin, a former assistant director of regulations at the CFPB who is now a partner at Morrison Foerster, offered a murkier assessment of where the market is headed. "My sense is that a lot of institutions are still trying to figure out the best approach," he said.