Should new consumer agency govern car dealers?

In the final deal between House and Senate negotiators announced this morning, auto dealers won the exemption they sought from oversight by the new consumer-protection agency - a carve-out the Obama administration had opposed.

Will consumers be harmed by the exemption? Georgetown law professor Adam Levitin thinks so, and details his concerns in a blog entry titled "The CFPB Auto Dealer Exemption--A Reminder of the Why We Should be Worried." Click here to read it.

Levitin's main point is that particular features about auto purchases - aside from real estate, generally the largest purchases consumers ever make - make that fertile ground for what he calls "sharp practices":

First, there are high transaction costs in purchasing a car. The consumer has to figure out the type of car they want and then locate a dealer, and then physically go to the dealer and haggle over price (yes, I know there are some Internet options now, and maybe that will improve things). By the time the deal is closed, the consumer has spent a fair amount of effort. This makes consumers reluctant to walk away when confronted with an abusive practice, not least because they fear that the next dealership will be even worse.

Second, a typical auto purchase transaction involves multiple components (sale, trade-in, warranties, financing, and add-ons). These components are all governed by different regulatory regimes, and the consumer cannot know the total cost of the purchase until at the very end of the deal. Meaningful comparison shopping--on the total cost--is therefore frustrated, and that allows lots of predatory, rent-seeking practices. (Sound familiar? It should be. The fundamental move of frustrating total cost comparison shopping is the same as in credit cards and lots of areas of consumer finance.)

Levitin invited responses, and got an interesting one from a fellow blogger, Jon Klippel, who says he's a finance manager in the auto industry. Click here to see Klippel's entire blog, but it's really the dialogue that's most interesting.  Here are Klippel's initial response and Levitin's reply.

Klippel's comment:


I've been employed as a finance manager in the auto industry for over twenty five years. I've probably placed over 15,000 auto loans or leases for consumers over that time. I cringe when I hear people make statements regarding regulation. Yes auto dealers are in the business to make money. Yes we may earn income from placing loans for our customers. For some reason you believe this is evil. Have you ever spent any time in a automobile agency and walked through the sales process? I pride myself on offering more competitive loan rates then my clients can obtain through their own financial institutions. I do it on a daily basis. I may save them money. I definitely save them time and make the sales process easier.

What scares me is when "experts" make statements like "we don't know what type of regulations to instill, but we know the industry needs regulation", or your take that subsidized low interest rates lead to dumb choices by consumers. Your twisted way of thinking and proposed solutions will eventuality lead us to bigger government, less choices, and higher costs to consumers. You state that consumers may obtain their own loan, but doubt that many do. So am I to believe that your opinion is factual? Why didn't you back up your spiel with some data?

The examples you used as the dealers way of doing business are probably illegal. Loan packing, already illegal. Hidden fees? The only fee I've ever charged is a dealer document fee which is already capped by regulation at $55. Every client pays the same document fee. Bait and switch? Never happens in the agency I work for. That type of behavior is unethical. Shame on anyone guilty of that practice. Consumers should walk away if they find themselves exposed to that situation. You want to regulate the practice. I know of no dealers that offer credit life insurance. I doubt that many offer rustproofing. I work and live in California. Rust isn't an issue for most people.

Why didn't you mention the current Regulation Z. This "truth in lending" regulation requires the complete disclosure of every penny spent on an automobile purchases? All loan contracts already are under this regulation. Did you conveniently overlook the regulation or intentionally fail to explain it on the radio broadcast.

I could go on further but I have to sign up a client for his new .9 APR auto loan.

Levitin's response:


Let me be clear about the point of my post. I am certainly not alleging that every auto lender engages in sharp practices. Rather, I am merely noting that sharp practices do exist in the auto lending industry, which calls into question whether auto dealers should be exempt from the CFPB's regulatory authority, or whether they should be covered, just like an auto finance company.

Jon Klippel suggests that most of the shady practices I detailed are "probably illegal." But are they? There might be specific state statutes I don't know, but there's little in the way of protection on the federal level. Some states cap, like California, things like dealer document fees, but that's not uniform, and there are plenty of unregulated fees; a creative lender can easily come up with new junk fees. And just because something is illegal doesn't mean it doesn't happen. There are laws against murder, after all.

Mr. Klippel also mentions Reg Z as if it is some talismanic proof of industry good behavior. Let's recall that Reg Z covers credit card and mortgage and payday lending too. How much good does that do? Reg Z requires disclosure of the finance charges, the sales amount (itemized), and who besides the lender is getting paid on the deal. There are a few problems with this.

First, the consumer only sees this disclosure right at the end of the negotiations, after the consumer has put in considerable transaction costs. Are you really going to walk away at that point over an extra $100, when you know the next dealer will do just the same thing and might not give you as good of a price? It's hard to walk away once you've sunk in major transaction costs. (This is also a problem with mortgage lending, when additional fees get added on at closing.)

Second, the disclosure isn't necessarily very meaningful. How many consumers have any idea what it means if they see a "dealer reserve fee" disclosed? How many are going to ask or realize that it could be negotiated?

And third, there isn't very much enforcement of Reg Z for non-banks. The FTC is the agency responsible for Reg Z enforcement for non-banks, but the FTC does not conduct regular examinations of auto dealers, the way banks are examined. And private enforcement--just not worthwhile. How often is a consumer going to bring suit over a few hundred or few thousand dollars? Not worth it. And for a single dealership, it's probably not even worth a class action.

This all goes to the Klippel's "show me the data" point. I would love to show some data on the auto lending industry. Unfortunately, I don't know of any data sources, and would be very happy if someone could point me to some data. The Fed tracks auto lending rates, but that's just the APR, and doesn't tell you much of anything. The absence of data is itself a problem--there's plenty of anecdotal evidence of abuses in auto credit sales, but because no one keeps track of the terms of the transactions, it's hard to make an informed policy judgment.

Mr. Klippel launches a generally salvo against "experts" who think they know better than industry and big government. Did he sleep through the mortgage crisis? It seems we know pretty well what happens when consumers are given artificially low teaser rates--a lot (but not all) get in over their heads. As for the silly big government is bad meme, consider quality of life in countries with lots of government (US, Europe, Canada, Japan, e.g.) vs. countries with minimal government (Iraq, Afghanistan, Haiti, e.g.). Where would you rather live? The issue can't be a matter of "big" government. It's really a question of effective government. And let's not make the foolish assumption that more regulation leads to higher prices and less choice. The impact of increased regulation is, in the abstract, indeterminate. The issue isn't the amount of regulation, but whether it is smart regulation. Smart regulation should enhance competition by eliminating rent-seeking opportunities. The result should be lower prices and increased pressure to innovate products (not just pricing), which means more (meaningful) choices for consumers.

Mr. Klippel challenges me on a factual assertion, that consumers may obtain their own direct auto loan. Check out Capital One's Auto Finance website: I don't know how many consumers get this sort of direct loan; I suspect it is a small minority, but I know it helped me get a much better rate out of my dealer.

Finally, how is Mr. Klippel going to make money on a .9% APR loan? It sure isn't on the interest. If he's willing to lose money on the loan, he's got to be making it up elsewhere.

What we do know for now is that auto dealers put on a full-court press to win this exemption, and appear to have succeeded. That may be good for their bottom lines - clearly a big part of their argument to Congress in the middle of a deep recession - and it may be of minimal impact on car buyers who deal only with the most scrupulously honest dealers. But if Levitin is right, it's bad news for consumers.