Consumer Law & Policy Blog

Elizabeth Renuart and Diane Thomspon Paper on APR Disclosure

Elizabeth Renuart and Diane E. Thompson of NCLC have written The Truth, the Whole Truth, and Nothing But the Truth:  Fulfilling the Promise of Truth in Lending, available at  http://ssrn.com/abstract=1021318. Here's the abstract:

Evaluating the cost of credit and comparison shopping in the modern credit environment can be a daunting task, even for the most sophisticated shoppers. Lenders increasingly unbundle the costs of their loans from the interest rate into an array of fees, outsource their overhead to third parties who add to the consumer's cost, and unveil amazingly complex loan products that dazzle and confuse borrowers.

At the same time, the preemption of state usury and consumer protection laws by Congress and the federal banking agencies spurred deregulation at the state level. Today, the consumer credit marketplace is governed almost exclusively by disclosure rules. The subprime mortgage crisis of 2007 resulted from allowing the market to police itself and from the failure of disclosure to curb abuses.

Nearly forty years ago, Congress addressed the problems caused by lack of transparency in credit pricing when it enacted the Truth in Lending Act (TILA). Congress intended to promote informed consumer shopping and a level playing field for lenders by requiring standard disclosure of the cost of credit, most simply through the annual percentage rate (APR) and the finance charges upon which the APR is based. The value of the APR disclosure has deteriorated since 1968 due to exclusions from the finance charge definition created primarily by the Federal Reserve Board.

The article documents the history of this decline for the first time and describes the consequences of an APR disclosure that has become incrementally weaker as an indicator of the true cost of the credit. This article draws upon financial literacy, cognitive psychology, and behavioral economics literature to justify the need for a more effective APR.

The authors posit a simple litmus test for the finance charge that creates a more effective APR. They discuss why this test is superior to other proposed definitions of the finance charge and respond to arguments that a fee-inclusive APR is unhelpful to consumers and harms the industry.

This article is particularly timely because the Federal Reserve Board is currently undertaking a sweeping overhaul of TILA disclosure regulations, including the finance charge definition. Given the state of the credit marketplace, the authors conclude that a robust APR is more critical now than it was in 1968.

It's Time for Another National Commission on Consumer Finance

Back in 1968, Congress created a bipartisan National Commission on Consumer Finance.  See Pub. L. No. 90-321. The Commission reported and went out of business.  It's probably fair to say that the Consumer Credit Protection Act would be a very different statute had the Commission not existed, though of course it's impossible to know. 

We need such a commission now.  The truth is there's a lot we don't understand about the subprime meltdown specifically and the consumer credit system generally.  We need to know more about what caused borrowers to take out these loans, and what caused lenders to make them.  We need to know more about whether disclosures can prevent this type of crisis, and if so, what kind of disclosures, and if not, what alternatives we have.  Plenty of solutions to the problem have been suggested, and we might solve the problem by happenstance, but then again, we might not.  A long careful look at the problem would be more likely to prevent recurrences than a rush to action in the heat of the moment.

It's clear that the marketplace, existing laws, and existing regulatory structures were not up to preventing the crisis.  In that light, it seems unwise to depend solely on the marketplace or existing regulatory structure to prevent the crisis from happening again. 

Of course appointing a commission is sometimes a substitute for taking action.  I'm not suggesting a commission should be used to create the illusion of action: the members of the commission should be chosen to represent all the various constituencies and should be committed to working hard on the business of the commission.  The commission should also have subpoena power and enough financing to conduct a serious investigation.  We need a body that can cut across jurisdictional lines while giving us an overview of what happened and what to do.

Such a commission should not confine its acts to investigating the subprime crisis.  It should also take a long look at other ills affecting the consumer credit system.  Can more be done about identity theft?  What about predatory credit cards?  Is our structure for regulating consumer credit transactions the best we can do?  I'm sure readers of this blog can come up with plenty of other things for the commission to explore.

We face probably the worst consumer credit crisis in decades. It's been forty years since we stepped back to see how we could do better.  Now it's time to do it again.

Huge Upswing in Credit Card Borrowing

by Christopher Peterson

New fed numbers are out showing Americans sucked down 6.9 billion dollars in new credit card debt, increasing outstanding consumer credit to $2.52 trillion during the month of January. This increase was double the $3.7 billion increase in the previous month of December--despite holiday sales.

This seems like a very ominous development to me. One suspects that this increase in borrowing is causally related to credit tightening in mortgage and home equity lending, and also that consumers facing foreclosure are turning to credit cards to stave off financial collapes. Distressed debtors that are shifting their living expenses into credit card borrowing are going to face high default interest rates and could be setting themselves up for a harder fall.

I hope the credit card lenders have their models figured out. As financial refugees from the mortgage market flee into the waiting arms of credit card lenders, it seems like there is the potential for subprime securitization problems to echo into credit card receivables. January's increase in credit card borrowing makes me wonder if the normally sophisticated credit card lenders' underwriting may finally come up short. Just a tip to all those Norwegian villagers, hedge fund managers, and investment bankers hoping to not look like Bear Sterns: Post-bubble vintage credit card recievable backed securities are a sucker bet.

Check out Patrick Deneen's interesting blog post for more thoughts.

We Need a Single Agency to Regulate Consumer Credit Transactions

by Jeff Sovern

Today's edition of the Pittsburgh Post-Gazette has an essay I wrote which they gave the headline "The Private Sector: U.S. Needs Agency to Watch Consumer Credit."  It appears below.  In the version below, I reinserted, in brackets, a sentence that the paper deleted (which may be more meaningful to readers of this Blog than the general public anyway).

As proposals proliferate to address the subprime mortgage crisis, and as the crisis itself spreads beyond subprime loans, it may help to step back and ask a fundamental question: What government agency is responsible for regulating consumer credit transactions?

The answer, unfortunately, is almost as complicated as the mortgage crisis itself -- and that in turn has contributed to the problem.

At the head of the list is the Federal Reserve Board, which has the power to bar some predatory lending practices and also fashions rules governing what lenders have to tell borrowers about loan terms. The theory is that these disclosures will enable consumers to avoid unwise borrowing (worked well, didn't they?).

These disclosure rules are enforced by the Office of the Comptroller of the Currency (OCC), the Fed itself, the Federal Deposit Insurance Corp. (FDIC), the Office of Thrift Supervision (OTS), the National Credit Union Administration Board (NCUA) and the Federal Trade Commission (FTC), among others. The OCC also claims the power to prohibit some lenders from engaging in predatory lending. The FDIC originated the Bush administration plan to freeze so-called "teaser rates," while the Treasury Department shepherded the plan through.

Confused yet? It gets worse. When states attempted to prohibit predatory lending, the OCC, OTS and NCUA all ruled that the state laws did not apply to federal lenders. Federal courts have upheld this position, while state lenders, which preferred to be free of the state laws, surrendered their state charters and became federal lenders, immunizing them from state law. [Georgia, not to be outdone, provided that its own state predatory lending statute was preempted as to Georgia lenders as well.]

From the Consumerist: "Credit Card Victims Muzzled"

On Friday, Alan White posted here about Congress's unusual demand that four consumers waive their rights to privacy in their financial histories before being allowed to testify before the House Financial Services Committee on the abusive credit card practices that they experienced. The testimony was to be given in conjunction with Congress's consideration of pending legislation known as the the Credit Cardholders' Bill of Rights. The consumers were not willing to sign the waiver and so did not testify. The Consumerist now has posted this discussion of the topic, including the written testimony that one of the consumers would have given had he not declined to testify. The post also includes a synopsis of the pending legislation.

Angela Littwin Paper on How Low-Income Borrowers Respond to Restraints on Credit Card Use

Angela K. Littwin of Harvard has written a  paper, Testing the Substitution Hypothesis: Would Credit Card Regulation Force Low-Income Borrowers Into Less Desirable Lending Alternatives?, available at http://ssrn.com/abstract=1014460.  Here's the abstract:

One of the strongest arguments against regulating credit cards is the substitution hypothesis, which states that if a restriction on one form of credit decreases access, borrowers will respond by using other, less desirable forms of credit. For low-income consumers, the argument is more powerful still, because their other options are high-cost lenders such as pawn shops and rent-to-own stores. But the substitution hypothesis has been more frequently assumed than investigated, and the empirical research that has taken place does not support the theory as strongly as has been supposed. The theory is based on a naïve presumption about the constancy of demand for consumer credit and a failure to account for a more nuanced view of the role of credit supply. This Article presents original data from a study of low-income women. The findings suggest that lenders such as pawn shops and rent-to-own stores may function as complements more than substitutes. In addition, the research uncovered another form of credit that low-income families routinely use and participants evaluated favorably, but that has never been discussed in the academic literature. These findings suggest a more nuanced formulation of the hypothesis that better predicts the consequences of credit card regulation.

Criticism of Bush Administration Plans for Addressing the Subprime Mortgage Crisis

The Times editorial page continues to monitor proposals for addressing the subprime mortgage meltdown.  The most recent editorial, "Lifeline for Whom?," appeared yesterday.  Here's an excerpt:

In May last year, Senator Christopher Dodd, chairman of the Senate Banking Committee, convened a group of major banks and loan servicers that promised to “create a permanent solution,” wherever possible, for troubled subprime borrowers. Then there was Hope Now, created last October and, now, as of Tuesday, Project Lifeline, both created at the urging of the Bush administration and both involving mortgage industry honchos promising to help hard-pressed borrowers.

If the industry had kept the promises they made last May, the other two efforts might not have been needed. So it’s unclear why the administration continues to believe that urging the industry to do more is the most effective way to cope with the foreclosure crisis. The industry, for its part, has earned the skepticism that has greeted its serial promises.

The Business section also included an article about Project Lifeline.  Headlined "Plan to Aid Borrowers is Greeted by Criticism," the article included the following:

“These policies make nice politics because it says our politicians care about us and don’t want the impersonal market forces to hurt the innocent,” said Marc Chandler, the top currency strategist for Brown Brothers Harriman. “They don’t seem to address the real underlying cause of the angst in the market.”

And Senator Charles E. Schumer, chairman of the Joint Economic Committee in Congress, said in a statement that the plan failed to offer enough help.

“It is encouraging that lenders and servicers are willing to temporarily pause foreclosures, but only meaningful and long-term loan modifications will help keep people in their homes,” Mr. Schumer, Democrat of New York, said.

And here's a link to an article from December 30 in which local officials complained that they were not included in the Hope Now program:

[B]anking regulators in New York, New Jersey and Connecticut said the alliance was missing some important pieces: namely, them. The lack of a coordinated local response, they said, could hinder the financial recovery of thousands of struggling homeowners.

''Ignoring the complexities, differences and commonalities of state laws and regulations is a big miss for the Hope Now alliance,'' said Richard H. Neiman, New York's superintendent of banks. The omission, he added, ''exposes the alliance to proposing unrealistic plans without consideration for the complete picture.''

I should note that for all I know, local regulators have since become involved.

New Study Shows Disproportionate Numbers of Payday Lenders in Bible Belt and Mormon West

by Christopher Peterson

A new study, conducted by Steven Graves and myself, finds a surprising relationship between populations of conservative Christian Americans and the proliferation of payday lenders. A draft of the study can be downloaded from SSRN, free of charge.

The natural hypothesis is to assume that given strenuous Biblical condemnation  of usury there would be more aggressive regulation and less demand for payday loans in these states, but ironically, the numbers show the opposite is true. 

The study is based on the largest and most comprehensive database of payday lender locations yet created. We developed an index that measures the density of payday lender locations based on the number of lenders within a geographic area, the number of payday lenders relative to population, and the number of payday lenders relative to bank branches. We also developed an index that measures the political power of conservative Christians within a state. This index has three components. First it is based on voting scores given to a state’s Congressional delegation by a panel of three leading Christian Faith based advocacy organizations including the Christian Coalition, the Family Research Council, and the Christian Action Network. Second, the Christian power index also included Congressional delegation scores compiled by Poole and Rosenthal, two widely respected political scientists that study these issues. And finally the index was also based on the percent of a state’s Evangelical or Mormon population. Our results are based on a simple correlation coefficient test comparing the payday lending density index to the Christian power index. Our hope was to create transparent results, that simply describe a commercial and spatial pattern of high cost lending that exists in our society.

One thing our data does not show is a causal relationship between faith and payday lending. For example, we believe there are many other variables that help explain why this pattern has emerged, in addition to faith. Nonetheless, our findings should serve as a wake up call to pastors, religious leaders, and people of faith that usurious lenders are thriving in their neighborhoods, communities, and states. Given the Bible’s injunction against usury, Christ’s example of expelling usurious money changers, and the ancient Christian tradition of sound financial stewardship, our study suggests that Christian Americans may want to pressure their political leaders to better effectuate Biblical values on consumer finance.

We believe it is sad that states with a pious and honorable religious heritage now disproportionately host predatory lenders.

Credit Card Practices Bill Introduced in House of Representatives

Thanks to Ed Mierzwinski over at U.S. PIRG's Consumer Blog for this excellent post on the introduction last Thursday of the Credit Cardholders Bill of Rights Act, H.R. 5244. The bill addresses a number of credit card company practices, including imposition of certain interest rate and fee hikes and charging interest on already-paid-off balances. Ed's post has a number of useful links about the bill. The text of the legislation is here.

The "New Redlining"

The Washington Post reported this weekend on mortgage lenders imposing loan restrictions on entire counties or zip codes considered to be "soft markets."

[via Consumerist]