Unlike other areas of consumer finance, auto lending has largely escaped tighter regulation in the wake of the financial crisis. This could soon change.
Auto lenders have long been able to reclaim their collateral from defaulting borrowers without getting the law involved. Known as "self-help" repossession, the process is much simpler than home foreclosures, for instance, which are conducted either through a court or county sheriff's office, depending on the state.
Car repossession is more loosely governed by a patchwork of state laws — a hodgepodge that many consumer advocates find inadequate. Given heightened awareness of consumer protection issues, many experts believe more oversight of the auto industry and its repossession practices is sure to take hold, possibly via regulatory reform.
Though the Senate passed a motion urging that auto dealers be excluded from the oversight of a proposed independent consumer protection agency as part of the financial reform bill, the final word on the legislation has yet to come down. And there's likely to be increased scrutiny on auto finance in general.
"I'm quite certain that if there is an integrated consumer finance regulator, I have no doubt that auto finance, broadly speaking, would be an important area for it to focus its agenda," said Raj Date, the chairman and executive director of the Cambridge Winter Center for Financial Institutions Policy.
Ultimately, it may be a matter that is left up to the states, experts said. But any additional oversight could make it more difficult for lenders to reclaim their collateral, which is vital to the industry. "Repossession kind of has to exist," Date said. "There is no way, no how, that subprime auto finance can take place absent the ability to get the vehicle back."
According to a recent study from the National Consumer Law Center, there were nearly 2 million self-help repossessions in 2009. Most were conducted by unlicensed individuals, even some convicted criminals, the study found. In the past three years, repossessions have resulted in: "Six deaths. Dozens of injuries and arrests. Pistols, rifles, shotguns, knives, fists and automobiles wielded as weapons. And, in at least three cases, repo agents towed away automobiles with children under the age of 9 inside," said the report, written by John Van Alst and Rick Jurgens.
Though the instances of injury or death make up a small percentage of the total repossessions that occur each year, one incident is one too many, Van Alst said in an interview. "When you step back and look at them in the aggregate, it really does call out that there is a problem," he said.
Some in the industry say that a reasonable requirement would be to have repossession agents go through a standard licensing process — something that is required in only a handful of states. The National Consumer Law Center, meanwhile, has proposed that states do away with self-help repossession, and that law enforcement be involved in the process. "Just a hundred years ago, a car was a luxury item," Van Alst said. "It certainly wasn't a necessity for folks as it is now. There wasn't as much concern about protecting the rights of the car owner."
Today, there is no "need for lenders to protect their own rights and take the law into their own hands," he said.
Lenders and other industry participants, of course, disagree. "Law enforcement oversight can't happen," said Joe Taylor, vice president of Recovery Industry Services Co., which sells insurance to repossession companies. "This is a private transaction." However, requiring repossession agents to obtain a standard license "would get the criminal element out," he said.
No special license is required to carry out repossessions in 33 of 50 states, according to the NCLC.
States regulate repossessions under the Uniform Commercial Code, which addresses most aspects of commercial transactions, including sales, leases and collections. All 50 states and the District of Columbia have enacted some version of the code.
Article 9 of the code deals with the rights of debtors and creditors in a secured transaction. The code states: "in taking possession, a secured party may proceed without judicial process if this can be done without breach of the peace and may proceed by action."
"What that means is if you can take the car without putting people in danger, without violating another law, if you can do it in sort of ordinary course, then all that's OK," said Michael Benoit, a partner at the law firm Hudson Cook LLP in Washington who represents financial services firms. "But you can't, for example, pull a gun on an owner and take their car. You couldn't break into a locked garage on a debtor's property and take it out of there."
There is no textbook definition of what breach of peace is, though, Benoit said. The concept has been defined over the years through litigation.
"From a lender's perspective, it's really quite black and white," said Chris Choate, the chief financial officer of AmeriCredit Corp., a Fort Worth auto finance company, of the repossession process. "If there's a default, then the lender has the right to self help to the collateral as long as it can be done in a reasonable and peaceable fashion."
Roughly half the states have expanded on Article 9, Benoit said, adding additional repossession procedures. About 10 states require that borrowers be given notice of their right to pay off the delinquent balance prior to repossession. Others require that notice be given after the repossession with details on how the vehicle can be reinstated.
Though it's difficult to determine exactly how often repossessions result in harm, anecdotal evidence suggests that standards have been on the decline.
One reason, some say, is the rise of "buy here, pay here" auto dealers. They "have a very different business model," Jurgens said. Sales representatives are paid "based not on how many cars they sell but on the payments that come in," he said.
"Buy here, pay here" dealers have flourished in part because of the financial meltdown and the freezing up of the secondary market, which many lenders rely on for financing. The dealers use their own balance sheets to finance loans. As traditional lenders shut the door on subprime borrowers, "buy here, pay here" dealers have become the only option for some.
Subprime lending has become less of a traditional bank business, Date said. "Asset-backed markets shut down, so if that is where you got your credit, you were stuck."
Meanwhile, the prime area has largely been dominated by "captive" finance companies like Ally Financial Inc., formerly known as General Motors Acceptance Corp., that have historically been owned by the car manufacturers.
"Over time, banks have gotten out of the prime auto lending business," Date said. "If you're a finance company that is not a captive, it's real tough to compete in prime. And if you're not in prime, it's hard to compete because the finance markets aren't working still," he said. Based on 2007 data, Cambridge Winter estimated that "direct" auto lenders, those that negotiate directly with borrowers, made up about 21% of the market, while "indirect" lenders, like dealers, which serve as middlemen, made up 79% of the market.
Another controversial trend is the rise in the past few years of "forwarding" companies, businesses that outsource repossession services to contractors. Some repossession agencies claim these companies have effectively lowered the going rate for their work, and in turn opened the door to disreputable businesses and hurt the industry's image.
"Let's say my rate for repossession is $400," Taylor said. "The forwarding companies have gone to the lender and said 'we will do your work for $400 and we'll take all your business.' Then they offer repossession agencies $200 to do the same work."
"There's such a proliferation of uninsured, underinsured, unqualified people that these forwarding companies are hiring because they'll work for nothing," he said. "It's a real issue."
It is standard for payment to be contingent on reclaiming the vehicle, but that has only exacerbated the problem. "You can't survive on contingency," Taylor said. "I'm going to take some chances to get that car so I can get paid. Contingency will get you killed."
With lax rules around licensing, "anybody with a tow truck and the ability to have a business card made up can call themselves repossession agencies," said Max Pineiro, the president and chief executive of Elite Collateral Recovery Inc., in Elizabeth, N.J.
On the flip side, some just don't see how more oversight of the industry is practical. "It's bound by contractual law," said Bobby Lazenby, the president of Navigator Acceptance, an auto finance company in Atlanta. "All lenders want consumers to pay their bills. When one party stops performing in a two-party relationship, it's no longer a good deal, especially if they are still driving our vehicle."
Les McCook, executive director of American Recovery Association Inc., a trade group in Irving, Texas, said requiring all repossessions to go through judicial review is not feasible. "Can you imagine 2 million more cases in our court systems right now?" he asked. "If every repossession or every delinquent car loan had to go through a court to be processed, lending would end. It's too onerous on the system."