In order to make any sense of what’s going on at the CFPB, we need to start at the beginning — in this case, the 2008 financial crisis and its aftermath. While economists may argue over specifics, the conventional wisdom explains the financial meltdown as a result of aggressive lending in the subprime mortgage market. When the balloons came due on those mortgages, the homeowners couldn’t make their payments and defaults became widespread.
In a new wrinkle, subprime mortgages were bundled, securitized, derivatized, and traded. Major investment banks that should haveknown better — think Lehman Brothers and Bear Stearns — were overexposed to these securities and collapsed. When Lehman Brothers filed for bankruptcy in September of 2008, worldwide markets tumbled and took years to recover.
Note one thing: Retail automotive and its finance function are not in the chain of events brining about the crisis. That’s for one obvious reason: No one buys a retail installment sale contract thinking the value of its collateral — a car — is going to keep rising over time. Yet car dealers felt the brunt of the crisis, as retail sales dropped like a stone. What came to be called “The Great Recession” for the rest of the economy was a true depression in the automotive market. About one in five dealerships closed their doors in the two years following the collapse of Lehman Brothers.
Insult to Injury
Never one to let a good crisis go to waste, our government enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Despite the term “Wall Street Reform” in its title, Dodd-Frank was far broader than its title suggested. Amongst other goals, the bill promised to “protect consumers from abusive financial services practices,” and those practices weren’t limited to subprime mortgages.
Senator Sam Brownback of Kansas succeeded in inserting what came to be known as the Brownback Amendment to the Dodd-Frank bill, exempting retail automobile dealerships from its scope. The industry heaved a great sigh of relief. But, to quote Lee Corso, “Not so fast, my friend.”
Although the Brownback Amendment legally took retail automotive outside the scope of Dodd-Frank, the devil is in the details. Even the bill’s co-sponsor, former Sen. Christopher Dodd (D-Conn.), admitted the American people were essentially buying the proverbial car without a test drive when he said, “No one will know until this is actually in place, how it works.” There was room for things to change, and they did.
One of the things Dodd-Frank did was establish the Consumer Financial Protection Bureau, or CFPB. And while the CFPB did not have the legal right to oversee and regulate indirect automotive financing, it certainly had the right to regulate the banks and captive finance companies that bought installment sale contracts and lease contracts from dealers.
The initial head of the CFPB, Richard Cordray, soon proved he was willing to do indirectly what his agency was prohibited from doing directly, namely, tell dealerships what to do.
In 2013, the CFPB issued its Automobile Dealer Participation Guidance. In that short document, the CFPB alleged that bank policies that allowed dealerships to mark-up interest rates above the buy rate resulted in discrimination against women and minorities. Please note that there has never been any credible evidence presented to prove this allegation.
To prove the folly of the CFPB’s approach, consider these two transactions involving the exact same vehicle and MSRP.
In the first deal, the dealership discounted the MSRP by $2,000 and offered a trade allowance of $8,000, for a total amount financed of $18,000. Assume for the purposes of this exercise that the buy rate was 4%; the dealership marked it up by 175 basis points for a retail APR of 5.75%. On a 60-month note, that works out to a monthly payment of $346.
In the second deal, the dealership discounted the MSRP by $1,500 and offered a trade allowance of $6,500, for a total amount financed of $20,000. The dealership marked up the buy rate by only 150 basis points for a retail APR of 5.50%. On a 60-month note, that works out to a monthly payment of $382. Which is the better deal?
That’s right — the first one, with a higher APR. And yet the CFPB believed the first example demonstrates discrimination and should not be allowed. That’s because the CFPB only saw one variable — interest rate — when real automobile finance transactions have numerous variables: discount, trade allowance, term, down payment, APR, F&I products, rebates, and so on. Regulations that are divorced from reality rarely work out well. This one did not.
The Move Toward Flats
The CFPB suggested three solutions to this perceived problem. One was to prohibit dealer participation entirely and require banks to offer uniform compensation, commonly called “flats.” Another was to limit dealerships to a uniform — and modest — markup. And door number three was to adopt internal policies that would prevent discrimination in the F&I box.
These options were not warmly received by the dealership community, who uniformly rejected the notion that discrimination was widespread in the industry. And given that car dealers legitimately try to maximize their return on every single transaction, regardless of the race or sex or the customer, that’s easy to believe.
In response to the CFPB’s Automobile Dealer Participation Guidance, the National Automobile Dealers Association issued its Fair Credit Compliance Policy and Program in 2013, in conjunction with the National Association of Minority Automobile Dealers and American International Automobile Dealers. Under this policy, which many dealers adopted, dealers would establish a single “Standard Dealer Participation Rate” by which it would mark up all buy rates. That Standard Dealer Participation Rate would be applied to every deal, except when it wasn’t. When it wasn’t, the dealer had to document the precise non-discriminatory reason why the Standard Dealer Participation Rate was reduced in that particular deal. The Standard Dealer Participation Rate could not be increased.
Every single deal had to be audited within two days of the sale to ensure that the policy had been properly followed. No one really appreciated the extra paperwork and, if anecdotal evidence is believed, most dealers did nothing and hoped for the best.
The Automobile Dealer Participation Guidance was in the nature of a federal rule, and federal rulemaking has to follow a consistent and transparent process. A rule is proposed, and then there is a 60-day comment period where interested parties can file their comments or proposed changes. Then a final proposed rule is issued, which itself can be stopped under certain circumstances. The process can be lengthy and involved, but it is transparent and democratic.
What the CFPB did with respect to the Automobile Dealer Participation Guidance was to issue it without notice or the opportunity to comment, effectively removing it from the democratic process. The Guidance came on the heels of the CFPB’s enforcement action against Ally Financial, in which the CFPB alleged Ally permitted discrimination by the dealerships from which it purchased paper. This process is called “regulation by enforcement.” For its own reasons, Ally settled and paid a hefty fine. The result of the process was the <ital>de facto<ital> establishment of a rule that prohibited dealership discretion in the markup of buy rates.
A Bureau by Any Other Name
This brings us — finally! — to the topic of this article, the repeal of the CFPB’s dealer participation guidance. The Senate voted to repeal the Guidance on April 18, 2018, and the House followed suit in May. On May 21, 2018 President Trump signed the resolution and the guidance was officially revoked. What does that mean for dealers?
A couple things, all-important. The first is, literally, symbolic, but important all the same. The CFPB got a new name and a new official seal. Actually, the new name — the Bureau of Consumer Financial Protect — is the name designated in the Dodd-Frank Act that established the bureau in the first place.
In addition to the new name is the new official seal. Most official seals of federal agencies display only one year: the year the agency was established. This seal, however, has three: 1776, the year the United States declared its independence from Great Britain; 2010, the year the agency was established; and 1787, the year the United States Constitution was drafted.
Taken together, the new bureau name and the new seal, stressing the importance of the Constitution, tell the world that there is a new sheriff in town with a new attitude.
But that does not mean that dealers are now free to discriminate, in finance or anything else. Attorneys General from several states have declared they intend to continue to enforce the dealer participation guidance. Dodd-Frank specifically allows state attorneys general to enforce the terms of the Dodd-Frank Act. But because the Automobile Dealer Participation Guidance has been repealed, there is technically no guidance to enforce.
State attorneys general are free to enforce anti-discrimination laws — they always have been — and they are certainly welcome to do so. Discrimination is a bad thing and should be prohibited. But repeal of the dealer guidance means they must actually <ital>prove<ital> discrimination rather than merely allege it. This is progress.
And then there’s the Federal Trade Commission. The FTC had, and has, enforcement authority with respect to interstate commerce, which covers the activities of car dealerships. Any unfair or deceptive acts or practices (UDAP) that involve the automotive finance function remain illegal, and subject to FTC enforcement action.
The Equal Credit Opportunity Act remains the law of the land. In other words, UDAP and ECOA violations, which involve actual discrimination in the dealership environment, are still illegal, as they should be.
Sage advice to dealerships is what it always has been: Do the right thing. Treat everyone fairly. Don’t gouge on rate. Do the right thing and you don’t need to worry about state attorneys general, or the FTC, or the local plaintiff’s bar. Or a government agency focused on consumer financial protection, by whatever name.