> Posted by Nadia van de Walle, Senior Africa Specialist, the Smart Campaign
The risks associated with the recent U.S. boom in subprime auto loans for the working poor are compounding, a series of articles recently published by The New York Times indicates. The articles report on the Times’ extensive investigation on the subject, which included the examination of over 100 bankruptcy cases, dozens of civil lawsuits against lenders, and hundreds of loan documents. The series draws attention to companies lending to those on the financial margins who often have questionable or missing credit histories and who are purchasing typically pretty old, low-quality cars. Lenders have lowered credit standards to widen their pool of borrowers, a risky practice incentivized by an influx of money from investors looking for a hot market and keen to securitize. Subprime auto loans have increased by 130 percent in recent years, and in 2014 they accounted for one in four auto loans.
In addition to viewing this through our did-we-learn-nothing-from-the-subprime-mortgage-crisis?! glasses and seeing potential systemic repercussions, one can take the consumer rights vantage point and see the scary picture of a world in which the underbanked or financially excluded are given two kinds of options: bad and really bad. We decided to score the features of this market against the seven Client Protection Principles of the Smart Campaign. Since the Client Protection Principles are a do-no-harm standard, we expect markets to meet seven out of seven principles to earn our endorsement. Let’s see how subprime auto loans stack up.
First, as the articles highlight, customers in this market often find themselves very quickly, severely in debt and thus the principle of Prevention of Over-Indebtedness is not being met. These lenders bypass even basic repayment capacity analysis, and apply lax credit standards. In some cases, consumers who are bankrupt, without jobs, and even living on social welfare programs receive loans they cannot afford– as their employment information is falsified by car salesmen. Score: standard not met.
The principle of Appropriate Product Design and Delivery Channels is also missing in action. Some of these loan products are designed such that the loan size for a run-down used car – whose defects are also not adequately disclosed to the consumer – is greater than the value of the car. In The New York Times’ examination, it was found that the size of the loan was typically more than twice the value of the car. Buyers drive off the lot and straight underwater. In the case of the title loan market, used by 1.1 million households in 2013 to obtain fast cash in exchange for their car titles, inability to keep up with repayments, quickly leads to repossession of the car. Because the cars resell for an amount smaller than the loan principal, the now carless borrower may still be paying off the debt years later. Score: standard not met.
Recent press describes many cases where the principle of Transparency in this subprime auto loan market is not being met. I’m curious to see a deeper exploration of disclosure mechanisms, but the Times’ series documents instances of purposefully murky communication, linguistic barriers, misunderstood contracts, and customers who do not feel comfortable asking questions. With these auto loans, car dealers are in effect the agents of the finance company that extends the loans. Given their incentives – to sell more cars – and their training – focused on automobiles, not financial services – they are not reliable sources of information. Score: standard not met.
On Responsible Pricing, the series devotes an article to the high interest rates charged. For some of the loans inspected, interest rates were as high as 29 percent, with the occasional incidence of excessive fees and add-on products required for loan purchase such as high-cost insurance policies. Score: we can’t judge without knowing more about the costs of making such loans, but we do know that prime customers receive significantly lower rates.
The series’ articles also expose how the principle of Fair and Respectful Treatment of Clients is infringed by lenders using devices that can remotely disable a car’s ignition the minute a borrower misses a payment. One of the articles quotes Robert Swearingen, a lawyer with Legal Services of Eastern Missouri, in St. Louis, who says: “No middle-class person would ever be hounded for being a day late. But for poor people, there is a debt collector right there in the car with them.”
Along with falsifying employment activity, lenders and car dealers in this market have been found to use aggressive sales techniques and poorly treat desperate clients who absolutely need cars to get to their jobs. For instance, the Times recounts lenders misleading borrowers on their loan qualification such that they will jump on whatever is offered, even if the terms are contrary to their interests. Score: below standard.
With tie-ins to the Campaign’s Client Protection Principle of Privacy of Client Data, these devices point to the double-edged sword of big data. While such surveillance and personal data gathering can be troubling, lenders are also framing such technologies as a way of understanding and evaluating customers who have no credit history, thus allowing them to serve the underserved. Score: questionable.
Finally, if a borrower wants to argue about falsified information, repossession, or another grievance, they by and large do not have any mechanisms for complaints resolution – the final Client Protection Principle. When a borrower goes to the bank for recourse, the reporting shows, the bank tells them this is a problem for the dealer, who then sends them back to the bank. Score: standard not met.
In summary, the U.S. subprime auto loan market fails to live up to every one of the Client Protection Principles. There is something seriously wrong here. It is no surprise that the auto loan industry negotiated an exception for itself from the consumer protection provisions of the Dodd-Frank reforms. Hopefully, these issues will continue to be examined in the news and by consumer advocates. In the meantime, these consumer violations of the Client Protection Principles provide another example of the high cost of being poor. Financial inclusion cannot be a matter of including the poor only in so far as they are willing to receive bad treatment, higher fees, and be left carless and in debt.
Have you read?
Book Review: ‘Stress Test’ by Timothy Geithner
‘Spent’ – Finding Change in the United States Financial System
eCPPs: How a Principles Approach to Client Protection is Built for the Digital Age
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February 5, 2015 at 11:26 am
Chris Linder
Please be careful of how you are couching this – it has very strong undertones of paternalism and that these loans should not happen at all – are we to say these people do not deserve a car or a loan? If you look at some of the check cashing outfits and other non-traditional financial service providers in the US, you will find very compelling stories around customer service and treating customers with respect and being welcoming. Please be careful on how far you take this without doing a lot of your own research and talking to clients themselves. I am not saying these outfits should not do better and that there are not problems – what I am saying though is that your definition of client advocacy may a bit too paternalistic and any recommendations that turn these options off will be just as much a disservice to poor clients as preying on them…
February 5, 2015 at 1:22 pm
John Gitau
The client protection principles have been very well contextually fitted and Nadia has done a good job here. I think it is safer for a consumer protection advocate to assume consumers gullible and service providers shrewd. Shrewdness easily transitions to craftiness as service providers perfect the art of framing and anchoring, of course capitalizing on consumers desperation and desire to own what they can hardly afford.
Every consumer feels clever in a buying process because desire based biases plays into information asymmetry. Consumer protection advocates, and Nadia is one, will want to warm consumers ” do not be duped” and they are aware that some gullible consumer will shout back ” leave me alone, I am not a kid, i know what I am doing, mind your own business” And such a response attests to the inherent naivety. But for sure, those who go through it and suffer, would regret when it is too late and consumer protection advocates wont tell them “I told you” since they know, real friends don’t tell friends “I told you”.
Nadia, I like your consumer protection tool. Continue to use it to stir every area that low income individuals are likely to suffer inducement related consumption. Ignore their protest of independence and ability to think for themselves. If the wisdom of hide sight is a perfect science, the low income people are better of daft.
That doesn’t mean Chris isn’t making an important point in a different style of advocacy. He is saying, “Nadia, don’t assume having less money means inability to think and evaluate choices or is evidence of daftness”. With that framing, he becomes an ardent grass-root advocate for the poor while branding you an elitist advocate. But that is normal. To service providers who want to make a quick kill out of the struggling workers, you are both obstructionist who have corns all over your toes.
But facts be told. If Chris and Nadia each leads a group of poor people to the rich territory of the king of Manna and it happens the King who did the invitation had laid a trap to capture the poor as slaves, majority of Chris group will be nabbed ( because he assumed his people can take care of themselves) while most in Nadia’s group would escape ( because she kept warning them never to trust strangers). But if it happens that the King indeed was genuine and kind, Chris’s poor would enjoy the Manna while Nadia’s would die of hunger. So, advocacy has its own risks and no one can ever be sure.
February 6, 2015 at 12:25 pm
erhyne
My husband, a person with 3 masters degrees from elite universities, just bought a used car for $14,000 which, as soon as he drove it off the lot turned out to need $10,000 in repairs before it could be used. He got sucked in by the huckster at the used car dealership in his desire to walk home that day with a car for our son. (No finance involved, but integrity deficits and customer gullibility demonstrated in action.)
A bit of paternalism may be in order.