The CFPB’s War On Car Loans

Most Americans need a car.

Some have recently opined that this trend may be coming to its end, pushed by the 80 million or so who reportedly prefer living in urban areas. According to Nielsen, 62 percent indicate they prefer to live in the type of mixed-use communities found in urban centers while 40 percent say they plan to stay in the city going forward. Those millennials are often singled out as the “post automobile” face of America — those who are more likely to rely on car/ride sharing services and public transportation than to shell out big bucks for a car.

But even that conventional wisdom is wobbling as of late, as urban millennials do what most people do when they get older: begin to resemble their demographic forebearers and do things like have kids, move to the burbs and require transportation to schlep them around.

According to data released by the National Association of Home Builders this spring, 66 percent of millennials want to live in the suburbs, 24 percent want to live in rural areas and 10 percent want to live in a city center. People over the age of 30, as it turns out, want living space — a commodity that has become a bit out of reach in cities.

Which means those millennials will be joining their boomer parents and Gen X older siblings, and buy a car.

A car that, statistically speaking, they will likely finance.

Auto loans are big business in the U.S. Over 80 percent of all car purchases are financed – and as of 2013 (the most current year data is available for) the average car loan was around $27,000. All in, there are roughly 30 million auto loan transactions per year in the U.S., which adds up to a market with a total worth of around $900 billion. That means car loans are America’s third largest source of debt for consumers – following mortgage loans and student loans.

And a lucrative lending business for those who provide such financing.

With car loans a ubiquitous and lucrative industry, it is unsurprising the area has caught the attention of one of the offspring of the Dodd-Frank Act, the Consumer Finance Protection Bureau (CFPB). Specifically, the CFPB is worried about discrimination in auto lending and is seeking to influence greater federal oversight in both bank- originated auto lending and now nonbank loans for car-seeking consumers.

“Many people depend on auto financing to pay for the car they need to get to work,” said CFPB Director Richard Cordray in a release last fall. “Nonbank auto finance companies extend hundreds of billions of dollars in credit to American consumers, yet they have never been supervised at the federal level. We took action after we uncovered auto-lending discrimination at banks we supervise. Today’s proposal would extend our oversight, allowing us to root out discrimination and ensure consumers are being treated fairly across this market.”

The CFPB brought complaints against two auto lenders, slapping Ally Bank with $98 million in fines and restitution in December 2013, as well as American Honda Finance Corp. with $24 million in penalties in restitution.

Now the CFPB wants to bring similar scrutiny to others playing in the space who aren’t officially banks. But they are running into some rather significant Congressional resistance, as both Republicans and Democrats have shared a rare moment of bipartisan agreement that the nation’s consumer watchdog may have overstepped its almost non-existent bounds.

So what’s the issue and why the revolt?

It’s all about the interest rates — who sets them, who pays them and if the CFPB can rationally claim a pattern of discrimination.

Need some more guidance without the spin?

PYMNTS has it all here.

The Dealer Reserve — AKA What All The Fuss Is About

When a consumer finances a car, they essentially have two options: They can apply for financing directly through a bank, or they can use the auto dealer as a loan broker.

In those indirect financing cases, auto dealers/brokers will get the loan back with a proposed interest rate. The dealer can then pass that rate along directly to the potential buyer, or they add to the interest rate with what is called a dealer reserve. The dealer then pockets the difference between what the bank offered and what the consumer paid. That uptick in interest, incidentally, can be very high. Some cases show dealers adding as much as 2.5 percent to the loan.

The CFPB alleges that auto dealers have essentially used the reserve to discriminate against classes of buyers  – white applicants do not often face the upcharge, but minority applicants do.

However, the CFPB can only intervene when the loan was created through a regular bank. When loans are financed by captive banks (lending entities controlled by car companies that only make auto loans) or alternative lenders, the CFPB does not have supervisory authority just yet – though late last year it claimed the necessity of claiming it, given what they see as discrimination on the basis of race in auto lending.

The problem is, no one is really all that sure about the CFPB’s claims.

It Matters How You Collect Data

The main complaint about the CFPB’s crusade against auto loans and the dealer reserve is that it is not entirely clear to some how good their data is on minority applicants is. Applicants for auto loans do not disclose their race or ethnicity because it is, in fact, illegal to ask for it under the provisions of the 1974 Equal Credit Opportunity Act (ECOA).

So — to figure out minority lending statistics where there is no specific demographic data available — the CFPB got a little creative.

“To proxy for race and national origin, exam teams rel[ied] on data associated with consumers’ last names and places of residence. Census Bureau Data is first used to calculate the probability that an individual belongs to a specific race and ethnicity based on their last name. Exam teams then update[d] that probability based on the demographics of the area in which the person resides again using Census Bureau data,” the agency noted.

So, the CFPB used last names and region of origin to make an educated guess about the race of auto loan borrowers.

Many have complained that, given that the CFPB has handed out over $100 million in fines to banks over similar discrimination-based claims, perhaps they need a better standard for proving it actually occurred than dealers and brokers “denied loans to people who we think were probably minorities because their last name was [fill in the blank] and they lived in [fill in the next blank].”

One editorialist from The Wall Street Journal put it more sharply: “The goal is to extract cash and get banks to agree to limit dealer discretion in offering different rates.”

Regulating the Regulators?

The House of Representatives is one body that is less than wholly impressed with how the CFPB gathered its data on discrimination – and is largely non-plussed by what some see as a power grab aimed at regulating auto dealers in a way that is specifically outlawed in Dodd-Frank (Dodd-Frank explicitly bars the CFPB from regulatory authority over auto dealers).

Last week, The U.S. House Financial Services Committee approved a bill that would significantly limit the Consumer Financial Protection Bureau’s guidance over auto lending.

“We want to ensure that the CFPB’s auto finance policy is based on accurate analysis and is based on the best interest of consumers,” noted Rep. Ed Perlmutter (D-Colo.), who introduced the bill with Rep. Frank Guinta (R-N.H.).

The bill is now on its way to the floor of the House – and, if passed, would revoke the CFPB’s auto lending guidance bulletin and require them to undertake a formal rulemaking process before pushing regulation.

The bill is unsurprisingly supported by Republicans, who have been generally suspicious about the CFPB – but is also being supported by some Democrats.

“So why are we in this situation?” asked Rep. David Scott (D-Ga.). “Hopefully this will send a very powerful message to the CFPB that we want you to do your job but not this job of manhandling [the auto industry].”

However, the bill has strong opposition from those who claim that now is precisely the wrong time to ramp back the CFPB’s power over auto loans.

“At a time when subprime auto lending is on the rise and major settlements against auto lending  companies are reached, we should be supporting the work of the CFPB,” noted California Rep. Maxine Waters.

Even if the House passes the bill, it is a long way from a sure thing. The Senate would have to pass it, which most political watchers think is unlikely (though possible). What most think is impossible, on the other hand, is that President Barack Obama will sign the law even if it does pass – and there are not enough votes in either House on this issue as of now to overturn a veto.

But it is interesting to note that the CFPB’s blank check is running out – at least in this instance – and questions about its lack of oversight are beginning to become more frequent and pointed.

Maybe, then, auto lending isn’t facing quite as big a change as the body that’s seeking to regulate it harder.