Should auto dealers avoid new regulation?

Time Magazine

(May 2010) When Brandon Moushey and Anna Kreutz bought a Suzuki motorcycle three years ago, the young husband and wife asked for an installment loan that would allow them to pay off the $15,000 bike purchase in five years. Instead, a salesperson at Quinsey Powersports El Cajon in San Diego, Calif. got Moushey and Kruetz to finance the purchase on a private-label credit card, according to a lawsuit the couple has filed against Quinsey and bank HSBC.

The contract Moushey and Kreutz signed said the loan had a 0% interest rate, but the rate quickly jumped to 20%. Three years later, the couple is no closer to playing off their bike than when they bought it. The high-interest credit card loan has already added thousands of dollars to their motorcycle purchase. What's more, the $214-a- month payment the salesperson told Moushey and Kreutz to make not only won't pay off the loan in five years, it doesn't even cover the interest.

"When they bought the bike they were told they got a five-year loan," says the couple's lawyer Hal Rosner of San Diego firm Rosner, Barry & Babbit. "Instead, if they spent the rest of their life making the payment they were told to make, this loan would still never be paid off." (See the 50 worst cars of all time.)

Moushey and Kreutz are not alone. Rosner, an expert in auto finance fraud, says dealers routinely use tricky finance arrangements to get consumers to spend more than they have to when buying a motorcycle or car. He says private-label credit cards, which are currently subject to few regulations, are a increasingly popular way auto dealerships get around state and federal regulations meant to curb abusive lending practices.

In the next few days, the Senate is expected to vote on a bill to reform the financial services industry. Among the many aspects of the bill is a proposal to form a Consumer Financial Protection Bureau. Auto dealers have argued that they should be exempt from the new organization that is focused on the lending industry. A broad coalition of consumer advocates, economic policy experts, financial industry players and top U.S. military officials, though, disagree.

Surprisingly, whether or not to subject auto dealers to new consumer protections has become one of the mostly hotly contested issues of the financial reform bill debate. The House of Representative financial reform bill includes a so-called carve-out that shields auto dealers from the new consumer protection bureau. A amendment to do the same is pending in the Senate. Many have called the vote on that amendment of the bill alone too close to call. (See the most exciting cars of 2010.)

"We think consumers should get the same level of protection at a car dealership that they get at a bank," says Steve Verdier, who heads up government affairs at the Independent Community Bankers Association. His organization, which represents small banks, is against the carve-out amendment for auto dealers. Verdier says that, unlike banks, auto dealers are not subject to regular audits of their business practices. "No one really knows what goes on in the back rooms of auto dealers."

Auto dealers argue that they didn't cause the financial crisis. They say they are merely the middlemen in the auto lending industry, helping consumers choose between the best loans. They say new regulations will push up costs for consumers and make it tougher for individuals to get car loans. This week, 150 auto dealers planned to travel to Washington to make their case to lawmakers.

"The government already has the ability to regulate auto dealers' lending practices," says David Hyatt, a spokesperson for the National Automotive Dealers Association. "Dealers create capacity in the auto lending market. The new reforms would increase the cost of credit to the consumer."

But it's not clear that the new regulations would make car loans more expensive for consumers to get or dealers to make. AutoNation, one of the largest publicly traded auto dealer chains, decided not to include the possibility of being regulated by the new Consumer Financial Protection Bureau among a number of risks it noted to its business in a recent financial filling. A company spokesperson says while AutoNation does oppose including auto dealers in new financial protection rules, the company thinks it is too early to say that the regulations, should they happen, would hurt the company's earnings.

Raj Date, a former Wall Streeter who now heads up non-partisan think tank Cambridge Winter, says there is little evidence that regulating auto dealers' lending practices would restrict credit. He says as middlemen auto dealers don't decide who gets or who doesn't get a loan. That's up to the banks. In fact, Date says if anything dealers drive up the cost of auto lending, making it more difficult for people to afford car loans. A November study by the Center for Responsible Lending found that auto dealers regularly charge consumers higher interest rates than they would get if the same customer went directly to a bank. CRL estimates that the auto dealer lending "markups" cost consumers $20 billion a year. (See the best business deals of 2009.)

"There tends to be a race to the bottom in the auto lending business," says Date. "It's very hard to be ethical."

Consumer advocates say auto dealers are regularly the focus of consumer complaints. In 2009, the Better Business Bureau received 26,019 complaints about new car dealerships, ranking them fourth among industries consumers filed grievances about, behind cellular phone service providers, cable televisions operators and banks. Used-car dealers got an additional 13,235 complaints. Military officials contend their rank and file regularly run into problems with abusive auto financing.

Jim Pair, who is the president of the National Association of Mortgage Brokers, says if the new financial consumer protection bureau is going to regulate his profession, auto dealers should be regulated as well. He says there is nothing different between what auto dealers and mortgage brokers do.

"We don't create the product. We don't fund the product. And we don't close the loans," says Pair. "So just because they don't fund the loans doesn't mean they should be exempt if mortgage brokers aren't. We all should have to operate under the same standards."