Friday, May 14, 2010

Financial Protections, the Military, and Your Friendly Car Salesman

-- Posted by Neil H. Buchanan

An article in Wednesday's New York Times describes a provision in the Senate's financial overhaul bill that would apply new consumer protection regulations to auto dealers. Naturally, the dealers are not pleased. Just as naturally, given my public writings about the underhanded sales methods of car dealers (here, here, and here), I am quite encouraged. For the first time, it looks very likely that real consumer protections will be enacted to bring some sanity to the chaotic and high-stakes world of car sales.

The article describes some of the worst tactics that auto dealers use to cheat customers, including one that I had never heard of before: the "yo-yo deal." (I was actually surprised not to have heard of something so basic, because I once shared an apartment with a guy who worked as a new car salesman. His stories of how he was trained to cheat people were hair-raising. Even so, he quickly adopted the rationalization that "only stupid customers fall for our tactics, and they subsidize the smart customers." But I digress.) In the yo-yo deal, a person buys a car on credit, makes a down payment, and drives home. Later, the dealer calls and tells him that there is a problem, and he needs to return to the lot. On site, the sucker is told that the finance company has declined the loan, and he has to pay several thousand more dollars. If he refuses and tries to leave, he discovers that his car has been blocked in; and he either has to pay up or leave the car at the lot.

This is the kind of thing that can be exposed by enterprising reporters, of course, and the victim of the yo-yo deal in the Times's article had already settled for an undisclosed sum (which is itself a troubling detail, as was the 19.9% rate on the secured loan that he had originally signed). The dealership, meanwhile, claimed that it had done nothing wrong.

What makes the story especially interesting, however, is that the U.S. military has become involved in trying to combat the problem. The ugly fact is that the worst kinds of sales tactics are used against young, relatively uneducated, low-paid enlisted personnel in the U.S. armed services (including the victim in the Times's story). The Pentagon is so concerned about its personnel being victimized that it has contacted the U.S. Treasury to encourage it to do something about the scams. The military, quite sensibly, views such predatory tactics as likely to lower the morale of troops and thus to compromise military readiness.

As an interesting parallel, a Times business reporter, Diana B. Henriques, was a finalist for a Pulitzer Prize in 2005 for her coverage of the ways in which sleazy financial firms (payday lenders, etc.) were preying on U.S. military personnel. She revealed that even some drill sergeants and base commanders were being used by lenders to vouch for their services. This resulted in legislation, spear-headed by then-Sen. Hillary Clinton, to provide special legal protection for military personnel and their families against such exploitation. It was one of the best examples in recent years of how journalism actually matters, and how it can result in improvements in the public good.

Of course, payday lenders and their ilk are still free (loosely regulated in some states, entirely unregulated in others) to do their worst to low-income, poorly-educated victims who are not in the military. Extending the protections that are currently available to military personnel is, in fact, part of the proposed Consumer Financial Protection Agency's portfolio.

Happily, the proposed financial overhaul would impose the new regulations on all car dealers right away, not just those who deal with military personnel. Even so, the new regulations would have little chance of passing were it not for the military's intervention. For example, the House version of the bill did not extend the regulations to car dealers, whereas the Senate's did. The difference is that the Pentagon had not yet weighed in on the matter when the House approved its version of the bill late last year.

The Senate's version thus sets up yet another test of the political power of two heavyweights: car dealers versus the military. As last year's federal legislation requiring GM and Chrysler to arbitrate dealership closings demonstrated, dealers have more clout in Washington than automakers. (In turn, automakers have more clout than auto workers, whose contracts were torn up without a peep from the Beltway.) The question now is whether the local power politics of car dealers can outweigh the patriotic politics of "support the troops."

The power of the military in such matters should not be underestimated. One of the most important amicus briefs in the Grutter case (which unsuccessfully challenged the University of Michigan Law School's affirmative action policies), after all, came from retired military and political leaders who attested to the important impact that affirmative action can have on the quality of the armed forces. If such testimony can have such a potent impact on the U.S. Supreme Court, it will be interesting to see what impact it can have on elected representatives.

For their part, the auto dealers had better hope that they can win this one behind the scenes. They are a deeply unpopular group, and their defenses (at least as rehearsed in the article in the Times) are embarrassingly weak. It is predictable, I guess, that they are rolling out the old excuse that the problem is not the lack of laws, but enforcement. Dealers, of course, make strenuous efforts to reduce or eliminate enforcement of the few laws that are on the books. This specious defense is unlikely to sway anyone.

More interestingly, the chairman of the national auto dealers group is trying out what might be called the "hurt feelings defense." My former housemate used to tell me that, when caught in a lie, a salesman was supposed to look shocked and ask: "Are you saying I'm lying?" The idea, apparently, is for the most shameless people in the world to appeal to their victims' humanity. Similarly, the man who has risen to the top of heap among all car dealers argued: "We frankly find it offensive, this charge that auto lending has something to do with military readiness." He is offended, you see. The Pentagon must be wrong, because the nation's car dealers are offended. Case closed.


bullfighter said...

I think what car dealers typically exploit is not so much customers' "stupidity" (or financial illiteracy) as their reluctance to offend. Most Americans are brought up to be highly averse to actions like calling someone's BS or walking out of a conversation. I am in favor of regulation, but I predict its effects will disappoint as long as our children are brought up for Mayberry instead of Brooklyn.

Neil H. Buchanan said...

Very well said, bullfighter! I rejected my housemate's "stupidity" characterization, too, for that very reason. People are just not wired to negotiate in the way that theories of efficient markets (or contract formalism) require.

Many people do not even want to pursue claims against wrongdoers after it has become clear that wrong has been done. For example, Michael Dorf's father once did a study for NYS that found (if I recall correctly) that only 1 in 10 cases of actual medical malpractice resulted in a lawsuit. People are generally "nice" in ways that simply defy academic theories.

That said, I may be more optimistic about regulation than bullfighter is. No regulation can "solve" the problem, but it can change the norms such that consumers do not have to be willing to pick a fight in order to avoid being ripped off.

C.E. Petit said...

The biggest problem with the regulation system that we have right now is that it's a "pure data" disclosure system. That is, the disclosures provide no context at all.

Consider, for example, a TILA disclosure for an automobile loan. At the top of the page (on the standard forms, anyway), it lists an APR; a total amount financed; a total of all payments; a total of all finance charges; and a monthly payment amount and number of payments. Sounds like a lot of information, right? Now put yourself in the shoes of a 22-year-old E-4 who is now senior enough to move off base, and will need/want a car to get back and forth to the base, to the grocery store, etc.* If he sees the following numbers:
APR: 13.9%
Amount financed: $17,410
etc., etc., etc., he has no way of knowing whether this is a good deal or not. TILA only requires disclosing the numbers themselves -- not their context.

I'm not suggesting that dealers should be obligated to show the actual invoice and entire pricing list to every customer. I do, however, suggest that TILA disclosures should include the median and mean APRs for both that dealer and the SMSA for the preceding 90 days for comparable transactions (that is, new cars compared to new cars).

And, too, dealers should be prohibited from offering financing from companies with common ownership or control with the dealer (for cars or for anything else that's durable); virtually every one of those arrangements is inherently abusive, and that's the nicest thing I can say about them. See, e.g., 150 F.3d 689 (7th Cir. 1998); 112 F.3d 283 (7th Cir. 1997).

* One cannot rely on public transportation for military duty: It tends to favor 9-to-5, five-day-a-week jobs. I'm being polite.

Neil H. Buchanan said...

C.E. Petit's comments about the Truth-in-Lending Act are sobering. This problem extends beyond car sales to home sales as well. Anyone who has tried to understand the "disclosures" that they must sign at closing knows how little light they shed on the deal. Before I went to law school, I was stunned as an economist by the legally required document that, by design, miscalculates the implied interest rate on the mortgage. (In essence, the law requires the combining of apples and oranges in computing the rate.)

As C.E. Petit points out, more information is not the same as greater clarity.