The United Nations Guidelines for Consumer Protection, revised and adopted by the General Assembly in resolution 70/186 of December 22, 2015, provide useful principles and guidance as we consider the auto loan market. The guidelines alert us to be mindful of the imbalance between the consumer and the dealer as to economic terms, educational levels, and bargaining power. Specifically, as part of good general business practices, consumers should not be subject to unethical, discriminatory, or deceptive practices. There should be fair and equitable treatment with consumers, particularly with respect to vulnerable and disadvantaged consumers. United Nations Guidelines for Consumer Protection (July 2016). These aspirations embedded in the UN principles of consumer protection had its genesis in a landmark speech on March 15, 1962, by President John F. Kennedy, in his “special message to the United States Congress of America on protecting the consumer interest.”
In America, we rely today on the federal Equal Credit Opportunity Act (ECOA), state fair credit laws, and the Unfair and Deceptive Acts and Practices (UDAP) federal and state statutes to enforce the aspirations and principles set forth in the UN Guidelines. In practice on everyday main street, the economic terms and conditions received by many low-income consumers in auto deals raises serious questions as to whether our current fair lending and UDAP laws are effectively protecting our most vulnerable citizens.
An example is the risk of discrimination in auto lending through dealer markups (also called dealer participation or dealer reserve) on the minimum loan rate provided by indirect lenders in arranging dealer financing for the borrower. Dealers have an incentive to find the sweet spot or increasing the loan rate to the highest amount possible, without losing the sale, as it will increase their profits. The impact of this practice, however, for an African American or Latino borrower, with a similar or more favorable credit worthiness history as compared to a white borrower, is the heightened risk that they will pay a higher dealer markup on the auto loan.
This has been borne out in expansive studies by Yale Law Professor Ian Ayres and Vanderbilt Business Professor Mark A. Cohen, as well as a more recent study by the National Fair Housing Alliance, that documents consistent and pervasive evidence that the color of your skin can result in your incurring hundreds to thousands of extra dollars in costs for financing cars. The general premise is that auto dealers and lenders want to serve all consumers fairly as a matter of ethics, respect for the law, and good business practice. Yet, the research studies have raised meritorious issues of potential disparate impact claims that may warrant consideration based on the impact of the structural issues and practices prevalent in the auto buying experience today.
The threshold challenge exists from the inability to obtain the data necessary to meet the evidentiary burden to file a lending discrimination suit under a disparate treatment or disparate impact claim. Regulation B, which implements the ECOA, generally prohibits nonmortgage lenders from asking about or documenting characteristics such as a consumer’s race or national origin (12 C.F.R. Sections 1002.5(a)(2) and 1002.13). Although the rationale for the prohibition is the collection of the data may enhance discrimination, a growing band of advocates and legislators believe reporting such data may in fact assist in stopping discrimination. Without the data, consumer advocates and legislators argue it’s very difficult or expensive to prove a discrimination claim.
In the absence of data, proxy methodologies for race and/or ethnic origin have been implemented and used by federal agencies in other contexts, such as by the Federal Reserve Bank for fair lending exams. An example is the Bayesian Improved Surname Geocoding (BISG) proxy methodology, whereby researchers substitute surname and place of residence variables as proxies for race and ethnic origin. Yet, politicians and lobbying groups for the auto industry in Congress have vigorously opposed this reasonable alternative. The CFPB utilized such BISG methodology for their support in issuing CFPB 2013-02, a supervisory bulletin providing guidance that the CFPB intended to hold indirect auto lenders accountable for discriminatory markups. CFPB Bulletin 2013-02 received fierce resistance relative to questions of whether the bulletin represented covert rulemaking and thus an abuse of the agency’s authority, as well as substantive questions regarding the data collection methodology and the manner in handling dealer markups. Without addressing the heart of the issue of discriminatory markups, Congress determined in spring 2018 that the guidance did qualify as a rule, rather than guidance, and hence CFPB Bulletin 2013-02 was rescinded under the little-used Congressional Review Act.
In Meltdown: The Financial Crisis, Consumer Protection and the Road Forward (Praeger, 2017), Larry Kirsch and Gregory Squires point out that in auto lending, the CFPB was handcuffed at its inception in any actions against the 65,000 auto dealers, the source of the third largest consumer debt market, because the auto industry successfully lobbied to carve out an exemption under the Dodd-Frank Act that exempts auto dealers from the rule-making, supervisory, and enforcement authority of the CFPB. To combat the issue of potential discrimination in dealer markups, the CFPB tactically chose to address the indirect lenders by asserting authority over the indirect auto lending industry with CFPB 2013-02. Unfortunately, the dealer lobbying attacks against the use of the BISG methodology seriously wounded the reputational authority of BISG as a viable proxy methodology to address issues in the auto market.
How do we solve the data collection problem? One approach is to explicitly allow a narrow exception for data collection for auto loans. This would treat auto loans like mortgage loans for data collection. Law Professor Winnie Taylor argues this can be justified by the extent of the problem and the difficult structural issues inherent in auto loans. (Winnie Taylor, Proving Racial Discrimination and Monitoring Fair Lending Compliance: The Missing Data Problem in Nonmortgage Credit, 31 Rev. Banking & Fin. L. 199, 205 (2012)). Another approach, suggested by Kirsch and Squires, is that reasonable minds among regulators, advocates, and industry players gather and arrive at a consensus to accept some research-focused proxy methodology for gathering information on auto vehicle lending that can be utilized for meeting the evidentiary burden in discrimination claims and can be relied on by regulators and advocates in enforcing reasonable consumer protections impacting low-income consumers of protected classes.
The goal in addressing unequal treatment in lending is agreeing on how we should handle dealer markups to be fair to all consumers. The Center for Responsible Lending found in a 2011 report that dealer markups cost consumers $25.8 billion over the life of the loans.
Before its revocation, CFPB 2013-02, and afterward, the New York State Department of Financial Services guidance issued in August 2018, under New York State’s Fair Lending Law (Section 296-a of the Executive Law), provided generally similar guidance to address unexplained pricing disparities on a prohibited basis. Collectively, they include reducing dealer discretion by placing limits on dealer markup or eliminating dealer discretion by using a different method, such as flat fees for each transaction that normally does not result in discrimination. Industry consultants have criticized the flat fee proposal, but a review by Delvin Davis and Chris Kukla from the Center for Responsible Lending noted that “if lenders did move to a flat rate compensation system, borrowers would overwhelmingly benefit.”
Another method to address fair credit is an enhanced nondiscrimination compliance system, a system agreed on in a 2013 Justice Department consent and thereafter supported by the National Association of Minority Automobile Dealers and other leading dealer associations. The proposed fair credit compliance policy and program may be an effective way to ensure a rigorous review of exceptions to a standard dealer rate to avoid credit discrimination. This system provides for a standard dealer rate with downward established deviations permissible for documented business reasons, such as competitive offers.
Issues on dealer markup proposals that need to be considered include whether the new systems are implemented by legislation or are voluntarily assumed broadly by the industry. If they are voluntary, transparency to the compliance systems to validate that it is being used broadly by dealers and that allowable deviations are substantive in nature should be mandated to address whether safe harbors are provided to dealers for their compliance systems and how best to structure fees on autos with varying prices so that it is equitable, such as a varying fee grid based on price of the auto.
In improving the continuum of consumer protection for disadvantaged consumers, we should continue to work together to advance solutions with regulators, advocates, and industry players. Various consent decrees were entered by the Department of Justice and financial lenders during the period 2013 to 2016 to address allegations of dealer discrimination on markups that included settlements of about $160 million. Consent decrees and settlements on selected lenders to enforce fair credit certainly benefit lenders of record and send a clear message to other market participants. However, consumer advocates should also pursue a more systemic approach across the industry through changes in compensation practices and compliance programs that provides greater uniformity in treatment for all consumers and raises the bar in consumer protection.
The goal in addressing unequal treatment in lending is agreeing on how we should handle dealer markups to be fair to all consumers.
Another critical aspect of the overall car-buying transaction that is fraught with consumer peril is that of add-on products. The problem is add-on products typically do not have a sticker price and are not introduced until a consumer has wrapped up the car purchase negotiation. An October 2017 report from the National Consumer Law Center (NCLC) highlights the abuses and inconsistencies based on a large data set of transactions for one major add-on provider that included “almost three million add-on products, spanning over 3,000 car dealers from every state and the District of Columbia” (Pg. 46).
These add-on “products” can be studied by looking specifically at (a) service contracts, (b) etching (security services), and (c) guaranteed asset protection (GAP) products. These three products collectively represent 50 percent of the NCLC data set and have a combined average markup of 170 percent (with markup defined as the ratio of gross profit to the wholesale price). Compare this with 2015 estimates by the National Automobile Dealers Association that found new cars had a markup of 3.4 percent in 2015 and used cars had a markup of 8.6 percent.
In looking closely at each, in 2012, the average dealer markup for etch sales (etching the vehicle ID number of one or more windows to deter theft or expedite recovery) was 325 percent (average markup of $189), GAP products had an average dealer markup of 151 percent (average markup of $378), and the average dealer markup for service contractors was 83 percent (an average markup of $859). For example, window etching was found in the study to be marked up over 300 percent and sometimes by over 1,000 percent. This poses great risk to low-income consumers about whether they are being discriminated against or whether they are receiving information timely and transparently to make an informed choice when car buying.
In fact, the NCLC report did find statistically significant markups for Hispanics as compared to non-Hispanics, using a simple proxy method of surnames alone to identify and code likely Hispanic consumers. This is a similar technique that the Federal Reserve Board uses in fair lending examinations to code for ethnicity. However, it is not as predictive for African Americans without geocoding, and thus the numbers likely underestimate the amount of discrimination as to non-Hispanic whites. A Center for Responsible Lending study has highlighted significant price disparities suffered by minorities in relation to auto add-on products. It found that African Americans and Latino consumers are about three times more likely to be told that add-ons are mandatory as compared to white consumers. Non-Negotiable: Negotiation Doesn’t Help African Americans and Latinos on Dealer-Financed Car Loans, Center for Responsible Lending, Delvin Davis, January 2014 (Pg. 12).
The crucial consumer issues at stake in add-on products are timely notice, disclosure of price, and the lack of consistency in pricing to consumers. Consumers need the ability to comparison shop among dealers and to have a better understanding before the final phases of car negotiations what the total cost will be and how much financing is required. In December 2018, the NCLC published the “Model Transparent and Consistent Pricing of Motor Vehicle Add-Ons Act,” which cites various state and local laws for support of various provisions, such as Connecticut, Maine, and New York City. The Model Act, which provides for advanced pricing that is transparent and consistent regarding add-on products, provides an important start to the dialogue consumer advocates should have in advancing consumer protection rights.
In protecting consumers, can we more effectively use the powers of Unfair and Deceptive Acts and Practices (UDAP) laws at the federal or state level to address the wrongs noted? Certainly, there were large monetary settlements by the Justice Department and CFPB in the 2013 to 2016 period, as well as some notable state attorney general actions, such as Massachusetts and Delaware in a $26 million settlement against Santander for issuing subprime auto loans to those who could not afford to pay them under an ability to repay claim. In an interesting analysis by Prentiss Cox, Amy Widman and Mark Totten, “Strategies of Public UDAP Enforcement,” Harvard Journal on Legislation, Vol. 55, 37 (2018), the authors lay out various strategies that state attorney generals have employed, including (a) outsourcing large settlements to outside counsel and (b) a street cop approach against individuals and small businesses within their jurisdictions, or some combination thereof on a continuum of other options. Yet, there are significant gaps in enforcement as well, with nine state enforcers making little use of their UDAP authority in the study period, and another nine states that resolved at least two but no more than five cases per the study criteria (Pg. 84). The authors offer that “While the United States disaggregated system of consumer protection allows for wide innovation, the laboratory of democracy only functions if other enforcers are watching and aware” (Pg. 102).
Finally, the legal profession and civil rights advocates must race to address new ways to help consumers improve their financial and consumer literacy in buying and arranging a car loan. Consumers need to understand the importance of comparison shopping, the benefit of financing the car independent of the dealer, the pitfalls and lack of disclosure on many add-on products, and the impact of high interest rates and long loans on the total cost of the car.
To balance the scales of economic justice, consumer advocates and civil rights advocates must come together to be equally proactive and united in asserting the economic rights of low-income consumers against a strong and united auto industry. The purchase and financing of a car is one of the most critical consumer transactions of their lives—let’s help our most vulnerable citizens keep their heads above water.
