In March 2013, the Consumer Financial Protection Bureau (CFPB) issued guidance stating that auto finance sources would be held accountable for discriminatory pricing resulting from the indirect financing practice known as dealer reserve.  This attack on a longstanding and previously unquestioned industry standard was amped up on September 17, 2014, when the CFPB proposed expanding its oversight to non-bank auto lenders, such as Ford Motor Credit Co. and Toyota Financial Services.  Although the agency contends that its regulations are necessary to fight discrimination in lending practices and protect consumers, the CFPB has not produced reliable evidence to support its claims.

Dealer reserve is a common auto industry practice in which dealerships, as compensation for securing a bank loan for customers, charge a discretionary fee on top of the interest rate secured from the bank.  As described in a September 17, 2014 Detroit News article, “Dealers routinely arrange financing for customers.  They are often allowed by lenders to mark up the interest rate charged to consumers, allowing them to keep the difference.  The CFPB wants to make sure dealers aren’t charging minority buyers a higher rate than white buyers.”

Although the CFPB has produced statistics regarding the number of minority auto buyers that have been discriminated against, the agency has not disclosed its methods for determining that discrimination has occurred.  This is one of the major arguments that the National Automobile Dealers Association (NADA), the primary trade association for auto dealers, has used in arguing against the policy.  NADA further explained its position in the Detroit News article, “There are legitimate, market-based reasons for disparities in interest rates — from monthly budget constraints, to the presence of more competitive offers, to inventory reduction considerations — all of which are nondiscriminatory and all of which can be documented in the transaction.  A better solution would be for lenders to adopt a robust retail compliance program that documents the basis of the pricing decision to effectively reduce the risk of discrimination in the purchasing process.”

Additionally, the markup charged by dealerships is limited by many lenders to a few additional percentage points.  According to a September 29, 2014 Forbes article, “Most lenders impose caps of 2 or 3 percentage points on dealer markup, on top of the bank’s wholesale rate, the so-called ‘buy rate.’  Below those caps, dealers can typically set their own amount.”

One of the most concerning aspects of the CFPB’s actions is the lack of input from impacted parties.  The agency did not obtain prior public comment or analyze the potential impact that its guidance would have on consumers. 

In order to help remedy what pro-taxpayer groups view as an abuse of regulatory authority, the Council for Citizens Against Government Waste has endorsed H.R. 5403, the Reforming CFPB Indirect Auto Financing Guidance Act.  As stated in CCAGW’s letter, “the legislation would rescind the CFPB’s 2013 guidance and require public comment prior to the issuance of any future guidance.  Additionally, the legislation would require the agency to conduct a study on the impact to consumers, women-owned, minority-owned, and small businesses.”

Instead of unilaterally flexing its regulatory muscle, the CFPB should work with dealers to improve transparency and accountability to ensure that discriminatory lending is not occurring.  Eliminating discretionary interest rates and moving to a flat fee would prevent dealers from being able to “meet or beat” competitors rates, and would ultimately hurt consumers’ ability to negotiate a better rate.  In this instance, as with many others, heavy-handed, uninformed, and arbitrary regulation is not the answer to a perceived problem.

  -- P.J. Austin