Consumer Law & Policy Blog

American Banker Piece on Truth in Lending

by Jeff Sovern

The American Banker ran a piece I wrote in their Viewpoints section today titled "Borrowers Must Understand Their Obligations" (the American Banker's content is available only to subscribers but they offer a free two-week trial subscription if you want to read the piece).  The essay argues that Truth in Lending failed to convey to too many consumers what their payment obligations would be, thereby leading consumers to take out loans they didn't understand they would not be able to repay.  Here's how it ends:

What should we do? Policymakers have already begun revising disclosure forms to increase the likelihood that those who can learn from written disclosures will be able to determine whether a particular loan is right for them. This process should continue. But we should also recognize that some consumers are unlikely to learn from written disclosures and adopt measures that will communicate to them what they need to know. Such borrowers may need a disinterested counselor - not a mortgage broker who will profit if the loan is made - to walk them through loan terms and explain what they need to know. Perhaps we should administer tests to loan applicants to see whether they understand their loan terms; those who fail should not be permitted to borrow unless a neutral counselor certifies that they understand the terms. And it may be that some loan terms should be outlawed because they are too confusing. We need to install additional checks on lending, and one way to do this is to insure that borrowers understand their loan obligations.

More on the Credit Card Holders' Bill of Rights

We reported yesterday on the House's overwhelming passage of this legislation. Read the statment of Rep. Carolyn Maloney (D - NY), the principal sponsor of the legislation. Another note: While there was substantial difference of opinion among Republicans (voting in favor by 105 to 69), there was almost none among Democrats (voting in favor by 252 to 1).

New Proposed Credit Card Regulations

The Fed, OTS, and NCUA today announced proposed changes to their credit card regulations.  The press release is as follows:

The Federal Reserve Board, the Office of Thrift Supervision, and the National Credit Union Administration today proposed clarifications to aspects of their December 2008 final rules under the Federal Trade Commission Act (FTC Act) prohibiting certain unfair credit card practices. The Federal Reserve Board also proposed clarifications to its December 2008 final rule under the Truth in Lending Act (TILA) amending Regulation Z to improve the disclosures consumers receive in connection with credit card accounts and other revolving credit plans.

The proposals are intended to facilitate compliance with the December 2008 final rules without reducing protections for consumers. They would resolve areas of uncertainty and make technical corrections to ensure that institutions are able to come into compliance with the rules on or before the July 1, 2010 effective date. In particular, the proposals would clarify that:

• The key protections in the final rules would continue to apply to balances on a consumer credit card account when the account is closed or acquired by a different institution or when the balances are transferred to another account issued by the same institution. For example, an institution would not be permitted to increase the rate on a credit card balance because the account has been closed.
•  Institutions and retailers may continue to offer deferred interest and similar programs, but these programs are subject to all of the protections in the final rules. For example, if a consumer makes a purchase under this type of program, the terms governing interest charges on that purchase cannot be changed through a “hair trigger” or “universal default” rate increase. In addition, institutions and retailers must comply with enhanced disclosure requirements.

Links to the Federal Register notice and model forms can be found here.  Comments will be due within thirty days after publication of the notice in the Federal Register.

Skiba and Tobacman on Patterns of Borrowing, Repayment, and Default in Payday Loans

Paige Marta Skiba of Vanderbilt and Jeremy Tobacman of Penn have co-authored Payday Loans, Uncertainty and Discounting: Explaining Patterns of Borrowing, Repayment, and Default.  Here's the abstract:

Ten million American households borrowed on payday loans in 2002. Typically, to receive two weeks of liquidity from these loans households paid annualized (compounded) interest rates over 7000%. Using an administrative dataset from a payday lender, we seek to explain demand-side behavior in the payday loan market. We estimate a structural dynamic programming model that includes standard features like liquidity constraints and stochastic income, and we also incorporate institutionally realistic payday loans, default opportunities, and generalizations of the discount function. Method of Simulated Moments estimates of the key parameters are identified by two novel pieces of evidence. First, over half of payday borrowers default on a payday loan within one year of their first loans. Second, defaulting borrowers have on average already repaid or serviced five payday loans, making interest payments of 90% of their original loan's principal. Such costly delay of default, we find, is most consistent with partially naive quasi-hyperbolic discounting, and we statistically reject nested benchmark alternatives.

Senate Banking Committee Passes Credit Card Bill

Here's the Committee's Statement:

Senator Chris Dodd (D-CT), Chairman of the Senate Committee on Banking, Housing, and Urban Affairs, announced today that the Committee passed comprehensive legislation he authored to protect consumers from confusing, misleading and predatory practices by credit card companies.  Having fought to reform the credit card industry for over two decades, Dodd wrote the Credit Card Accountability, Responsibility and Disclosure Act, a version of which he introduced in 2004, to provide tough new protections for consumers who are treated unfairly by their credit card companies, some of whom are encountering financial ruin as a result.
 
“Millions of Americans are being laid off, our economy is in crisis, and the need to modernize our financial system is clear.  With this perfect storm of challenges, this is the moment to stand up for consumers in every corner of America who are struggling through this recession,” said Dodd.  “Economic recovery will only come when we put an end to the abusive practices that continue to drive so many Americans deeper and deeper into debt.  It is the right thing to do for our families, and the right thing to do for our economy. Seizing that moment starts today - and it starts with reforming credit card practices.  I commend the Banking Committee for passing this legislation, and am determined to see this bill pass the United States Senate and become law.”

The Credit CARD Act will help protect American consumers by bringing an end to wrongful credit card practices.  Among other provisions, the legislation will:
 

• Protect consumers from “any time, any reason” interest rate increases and account changes;
• Prohibit unfair application of card payments;
• Protect cardholders who pay on time;
• Limit abusive fees and penalties;
• Prohibit issuers from using a consumer’s card history with another creditor to raise interest rates (“universal default” ban);
• Prohibit issuers from charging interest on debt that has already been repaid;
• Ensure that cardholders are informed of the terms of their account; and
• Protect young consumers from aggressive credit card solicitations.

Phony Consumer Protection?

by Jeff Sovern 

In a 1973 article, William Whitford raised the possibility that some consumer protection legislation is enacted not to protect consumers, but to create the illusion of that protection.  Legislators thus appear to satisfy the demands of consumers, while in reality serving business interests.  See William Whitford, The Functions of Disclosure Regulation in Consumer Transactions, 1973 Wisconsin Law Review 400.  Some aspects of the New York rent-to-own statute, N.Y. Personal Property Law § 500 et. seq. seem to fit that description. 

First, some background: Rent-to-own transactions are transactions in which consumers pay rent on an item until they have purchased it.  The transactions typically provide that the consumer may return the item without incurring further obligations after the first week.  An FTC study some years back found that RTO customers tend to be poorly-educated and have low-incomes.  Remco Enterprises, Inc. v. Houston, 677 P.2d 567 (Kan. App. 1984) (which appears in our casebook), may present a standard RTO transaction: the customer was described as “a 20-year-old single mother of three who had completed only the ninth grade in school and was dependent upon aid to dependent children welfare payments of $320 per month.”  One of the RTO transactions she had entered into was for a TV set; if she made 104 weekly payments of $17 each, she would own the TV.  That works out to a total of payments of $1,768, for a TV said to have a retail value of $850.  If that $918 markup was treated as a finance charge, she would be paying an APR of 85%. 

RTO transactions are not subject to either the Truth-in-Lending Act or the Consumer Leasing Act; indeed, they are largely unregulated by the federal government, except to the extent that RTO businesses engage in unfair or deceptive practices.  So their regulation has fallen to the states.  It seems to me that state regulation could have several goals.  One would be to help RTO customers understand that the rates they are paying are very high.  For example, state RTO statutes could require RTO businesses to quote customers an APR.  The New York statute does not, however, so require.  See Colon v. Rent-A-Center, Inc., 276 A.D.2d 58, 716 N.Y.S.2d 7 (1st Dept. 2000). 

Some would argue that RTO legislation should limit RTO charges—sort of a usury statute.  Many economists argue that price limits are undesirable as a general matter.  But the New York statute appears to have rejected that position, at least at first glance.  That is, it does seem to impose a price limit.  Section 503 limits the total RTO charge to twice the cash price of the merchandise.  So, in the Remco case, where the cash price of the TV was $850, the total price would be limited to $1,700, saving the customer $68. 

The statute even defines “cash price” in § 500.2 as “the price at which a merchant, in the ordinary course of business, would offer to sell the merchandise to the consumer for cash . . . .”  So it looks like the RTO business can’t just raise its cash price to permit higher RTO charges.  But not so fast.  “Merchant” is defined in § 500.5 as “a person who, in the ordinary course of business, regularly leases, offers to lease, or acts as an agent for the leasing of merchandise under a rental-purchase agreement.”  In other words, an RTO business.  So it doesn’t matter what a normal appliance retailer charges; the limit is twice what an RTO business would charge in cash.  And since RTO businesses have an incentive to inflate their cash prices to collect more in RTO charges, the result is that the limit is an illusion.  If my impression is correct that RTO businesses normally do the vast bulk of their business in RTO transactions rather than cash sales, it means that the possibility of a cash sale wouldn’t restrain RTO businesses from having high cash prices—because they seldom make cash sales.  That’s not their business.  So the New York statute creates the illusion of a limit, but not much of a reality.  You could argue that such limits are bad policy, but setting an illusory limit seems to be even worse policy. 

I also love § 502, which requires rental purchase agreements to state that the consumer has the option of reviewing the completed form for up to 24 hours—upon written request.  First of all, how many times have you heard of a consumer making a written request of any kind at an appliance store?  But maybe that doesn’t matter since the right to make the request is on the form itself.  Except that § 502’s notice is not required to be conspicuous, while other disclosures—see § 501.7—are.  So this notice is likely to be obscured by the provisions that, under the statute itself, are required to be conspicuous. Maybe other provisions of the RTO statute are helpful to consumers.  But the sections I’ve just described are either designed to create the illusion but not the reality of consumer protection, or else were poorly done.  You be the judge.

Insult to Injury

The AP reports on a new trend: states making deals with banks to impose fees for access to unemployment benefits.

A Comment on the New Credit Card Solicitation Disclosures

by Jeff Sovern

I have commented before on the December amendments to the credit card provisions of Regulation Z (here and here) but I find that as I prepare to teach them, I have a bit more to say.  You can see the new model form for the "Schumer Box," that is, the box that is to appear on credit card applications and solicitations and that is intended to provide consumers with the information they need to decide whether a particular credit card is for them here.  A model for the current form appears in our casebook at page 142. One change that I very much like: while the old form places the method of computing the balance for purchases (such as "Average Daily Balance (including new purchases)") inside the box, the new form places it less noticeably--and therefore, less distractingly--underneath the box.  Because, as the Fed observes in its accompanying statement, this disclosure is meaningless to most consumers, consumers are unlikely to take it into account in making a decision whether to apply for a particular card, and so it makes sense to make it less noticeable.  Another positive change: the old "Grace period for repayment of the balance for purchases" has been replaced with the more meaningful "How to avoid paying interest on purchases."  And another: fees have been collected together to make for easier comparison.  The new form also has a new item: "Penalty APR and When It Applies" in which applicants are told that the penalty APR might apply if the consumer makes a late payment, makes a payment that is returned, etc.  That seems like a positive change.  But I would have combined this last with two more.  First, the disclosures don't take into account the optimism bias: the tendency of consumers to overoptimistically assume that they won't default, etc. (you can find lots of discussion of the optimism bias if you look; I wrote about it in the text accompanying notes 145-150 of my article Towards a New Model of Consumer Protection: The Problem of Inflated Transaction Costs, 47 Wm. & Mary L. Rev. 1635 (2006)).  Thus, I suspect many consumers won't pay attention to that disclosure on the theory that it won't apply to them.  The disclosure could be made more effective if the lender is required to state also something like "In a recent year, X% of our credit card holders were obliged to pay the penalty APR."  (and wouldn't that be an interesting statistic?).  Second, the penalty APR disclosure is separated from the penalty fee disclosures, and so consumers might not realize that late payments trigger both a penalty fee and a penalty APR.  I think I would have inserted a very brief cross-reference to the penalty fees in the penalty APR box.  But despite these quibbles, I continue to believe that the new forms are a significant improvement over the old ones.

Gail Hillebrand of Consumers Union on Payments Law

Gail Hillebrand of Consumers Union has written Before the Grand Rethinking: Five Things to Do Today with Payments Law and Ten Principles to Guide New Payments Products and New Payments Law, 82 Chicago-Kent Law Review 769 (2008).  Here's the abstract:

U.S. consumers today have a broad range of choices about how to make payments. In addition to checks, credit cards and traditional debit cards, consumers may be offered prepaid cards, contactless cards, mobile payment devices, online payment sites, online credit payments, and other new ways to pay.

Federal payments law was developed before many of these methods existed, so it is no surprise that it has gaps in coverage. The variations in the law underlying the different payments methods place consumers in very different legal positions when something goes wrong. The gaps in the law mean that the particular payment method used, and how the payment is processed, can affect the consumer's ability to get his or her money back if the goods are not delivered as ordered, the payment information is stolen and misused, the payment was unauthorized, or the payment is processed for the wrong amount.

This article, first published at 83 Chicago-Kent Law Review, No. 2, 769 (2008), describes the current state of confusion and gaps in the payments law; outlines a set of five immediate changes to current law that would address major problems and ambiguities in payment law; and offers ten principles to evaluate existing and future payments methods, regulations and laws.

First, the article describes the current state of the law as applied to some of the new payments methods in terms of the questions consumers might ask: Is my money safe? Will it disappear in fees before I have a chance to spend it? Will I get my money back if someone else makes a mistake? Can I stop or reverse payment if I do not get the goods? This section describes the different answers to these questions depending on which payment product is used.

Second, the article describes how many of these problems could be eliminated and greater consumer protection in the non-cash payment marketplace could be accomplished with a handful of changes to the Electronic Fund Transfer Act, the Fair Credit Billing Act, and the Expedited Funds Availability Act, plus more vigorous regulatory use of the power to prohibit unfair practices. These changes could provide a baseline set of consumer protections, built from the strongest elements of current federal consumer protections in payments law. Finally, the article recommends ten principles for evaluating new payments products and new payments law.

Simkovic Study Finds 2005 Bankruptcy Act Profits Credit Card Companies at Consumers' Expense

Michael Simkovic of Harvard's Olin Center for Law and Economics has written The Effect of 2005 Bankruptcy Reforms on Credit Card Industry Profits and Prices.  Here's the abstract:

The U.S. Bankruptcy code changed dramatically with the passage of The Bankruptcy Abuse Prevention and Consumer Protection Act Of 2005. This act increased the costs and decreased the benefits of bankruptcy to consumers. Supporters of the law claimed that it would benefit consumers as well as creditors, because reducing the losses faced by creditors would lower the cost of credit to consumers. Critics of the law depicted it as special interest legislation designed to profit credit card companies at the expense of consumers. This study tests whether the 2005 Bankruptcy Reform: (1) reduced the number of bankruptcies; (2) reduced credit card company losses; (3) lowered the cost to consumers of credit card debt; and (4) increased credit card company profits. The data suggests that although bankruptcies and credit card company losses decreased, and credit card companies achieved record profits, the cost to consumers of credit card debt actually increased. In other words the 2005 bankruptcy reforms profited credit card companies at consumers' expense.