The CFPB Auto Dealer Exemption--A Reminder of the Why We Should be Worried
It looks like auto dealers are going to get their carve out from the CFPB. I can't think of a policy argument for exempting auto dealers; maybe someone will provide one in the comments. The used car dealer has long been the poster child for sharp dealing. But it's worth reviewing the consumer protection problems with auto dealers, so that we realize what practices are being exempted from potential future regulatory oversight.
Auto dealers sell a variety of products to consumers. They sell cars. They buy cars (trade-ins). They sell insurance products (warranties, rust proofing, GAP insurance, credit life, etc.). And they sell financing. They're not the only merchants that do a brisk business in both selling goods and financial products (electronics and furniture retailers do a fair amount of financing, for example, as do some retailers with private-label credit cards, like Target), but auto dealers are definitely combining sales and credit on a larger scale than any other type of merchant.
Auto loans themselves tend to be fairly simple--short terms, amortizing loans. While rates can be quite high (for example, the 21% APR in Till v. SCS Credit Corp.), loan structures aren't the problem; interest only and payment option haven't caught on in this market, but they don't need to because there's lots of other ways to make money off of consumers.
Two features of the auto purchase market facilitate sharp practices:
First, there are high transaction costs in purchasing a car. The consumer has to figure out the type of car they want and then locate a dealer, and then physically go to the dealer and haggle over price (yes, I know there are some Internet options now, and maybe that will improve things). By the time the deal is closed, the consumer has spent a fair amount of effort. This makes consumers reluctant to walk away when confronted with an abusive practice, not least because they fear that the next dealership will be even worse.
Second, a typical auto purchase transaction involves multiple components (sale, trade-in, warranties, financing, and add-ons). These components are all governed by different regulatory regimes, and the consumer cannot know the total cost of the purchase until at the very end of the deal. Meaningful comparison shopping--on the total cost--is therefore frustrated, and that allows lots of predatory, rent-seeking practices. (Sound familiar? It should be. The fundamental move of frustrating total cost comparison shopping is the same as in credit cards and lots of areas of consumer finance.)
So what are the problems in the auto lending world? Here are some. I'm guessing I'll learn of some new ones in the comments. I'm also guessing that auto leasing has its own bag of tricks.
Bait and Switch. There are lots of variations on bait-and-switch with auto dealers. Here's one: the dealer gives the consumer a quote on a particular model and says that it is in stock. The consumer comes in and guess what--that model is still in stock, but only with a bunch of dealer-added features (hubcap locks, pinstripe, fog lights, etc.) that raise the cost of the car by more than the value given. Want to guess why I'm driving a Honda Odyssey with a "racing pinstripe" on it?
Hidden Fees. This is sort of self-explanatory, and is another bait-and-switch variation. The consumer bargains with the dealer over the price of the car and the financing and thinks that a deal has been reached. Then the consumer gets the final bill for the car and it has a bunch of previously unmentioned fees. The dealer says don't worry, we'll just increase the amount financed.
Dealer reserve kickbacks. These are the yield spread premiums of the auto world. The dealer often acts as a broker for a financing company that will finance the car purchase. The dealer is compensated for this service by getting a slice of the interest on the loan. The higher the loan rate, the larger the kickback. So the consumer qualifies for a loan at 10%, but the dealer steers the consumer into a 14% loan in order to get a larger dealer reserve payment. (One way to avoid being steered due to dealer reserve is to go in with a direct financing offer lined-up from an independent finance company; I wonder how many consumers do this, though.)
Loan packing. Overpriced and underused or frankly unnecessary products like credit life insurance and GAP insurance and rust-proofing get bundled in to the deal.
Overselling. Dealer's cuts on loans can give them an incentive to steer consumers into larger loans. One way to do that is to sell the consumer a more expensive car, which requires more financing. Of course the consumer still has to be qualified for the loan, and there have been problems in auto lending, just as with mortgages, of dealers (and borrowers) fudging the numbers on the paperwork to make borrowers look more creditworthy.
Spot delivery yo-yos. This is one of the sleaziest moves. The consumer buys a car with financing arranged through the dealer. The financing includes a nonrefundable deposit. The consumer takes the car home thinking that everything is in order. The dealer then calls the consumer the next day to say that the financing was denied in the end and the consumer has to return the car. And the dealer keeps the deposit.
Binding mandatory arbitration. This is a generic consumer finance problem.
Two concluding questions:
1. What explains the persistence of the auto dealer business model, which combines car sales with the sale of various financial products? Is this just a matter of path dependence? I don't see any inherent efficiency in this bundling. But there might be a very obvious answer I'm missing.
2. Why do these sharp practices persist in auto dealers? Why hasn't inter-dealer competition, reputational sanctions from consumers, and OEM reputational concerns gotten rid of sharp-practices?
I'd love to hear readers thoughts on these questions and on abusive practices at auto dealers in general. Comments are open.