Financial Reform: Five Reasons Why We Need Protection From Car Dealers

Auto dealers have a simple request for consumers: Trust us. That's the upshot of car vendors seeking exemption from oversight by the proposed Consumer Financial Protection Agency.

Anyone up for some rust-proofing? Me neither. For a few simple reasons, sheltering dealerships from new regulations against predatory lending is a lousy idea:

Car loans are big business. After mortgages, auto finance is the second-biggest area of lending in the U.S., with roughly $850 billion in outstanding balances. That's bigger than the credit card industry. Although dealers didn't experience the same loss rates on subprime loans during the credit bubble as mortgage firms, they did lower their underwriting standards (see below chart).
Car buyers often get ripped off. Surprise! The Better Business Bureau and state regulatory authorities get more complaints about auto dealers, including their financing practices, than any other industry, according to the National Consumer Law Center. Common tactics include tacking "yo-yo sales," in which dealers change financing terms after the customer has bought a car; tacking on unnecessary fees; and steering buyers to higher-cost loans.
Excluding certain classes of lenders distorts competition. With community banks and credit unions set to be regulated by the CFPA, shielding car vendors from government scrutiny would give them an unfair advantage over lenders with less exploitative business models. Allowing dealers to operate under different rules would also invite abuses.
When dealerships close, customers are often left holding the wheel. Vendors that are going out of business commonly violate agreements with customers, such as failing to pay off existing loans on a trade-in. That's of particular concern given the thousands of dealers that have shut down since 2007.
Current consumer protections are insufficient. Oversight by the FTC and other government agencies hasn't deterred car dealers from engaging in a range of dubious financing practices. Loopholes in federal law, such as the Truth in Lending Act, also exempt dealers from lending standards.

Dealers say they should escape new federal regulations because they don't really make loans, only arrange them with third-party lenders. Not so. Dealers are at the center of auto financing in the U.S., with enormous power to dictate lending terms. Write the authors of a report by the non-partisan Cambridge Winter Center for Financial Institutions Policy:

Auto dealers are the dominant distribution channel in auto finance, and auto finance is the largest category of consumer credit outside of mortgage. Far from being passive administrators with respect to auto finance, auto dealers actively market and price borrowers' loans....
Even by the low analytical standards applied to hastily arranged, crisis-driven corporate welfare initiatives, the exemption of auto dealers from the CFPA is ill-conceived.

Slam dunk, right? Wrong. It's unclear if House and Senate lawmakers negotiating over financial reform will succumb to pressure from dealers and cut them out of the final bill. For now, though, the signs are inauspicious. More than 60 Democratic lawmakers recently called on Rep. Barney Frank, D-Mass., who's helping to lead reconciliation of the measures, to comply with dealer demands over the new consumer rules.

Perhaps not coincidentally, a congressional ethics panel is now investigating whether certain House lawmakers let their financial ties to big banks, which are major suppliers of car loans, influence their decision to exempt dealers from regulation by the CFPA.

Two words jump to mind when car dealers, Wall Street and Congress agree on something: caveat emptor.

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Alain Sherter

Alain Sherter covers business and economic affairs for CBSNews.com.

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