An exemption for auto lenders has led to a dangerous bubble.
There are undoubtedly some areas where the Dodd-Frank financial reform went too far. But as the Trump administration and Republican legislators look for what they can roll back, they should keep in mind one area where it didn’t go far enough: auto lending.
Back in 2010, when Congress adopted rules designed to limit the lending excesses that contributed to the 2008 financial crisis, auto dealers managed to carve out an exemptionfor themselves. As a result, their behavior since then offers a sort of counterfactual: How might lenders have acted if Dodd-Frank had never happened?
The evidence isn’t pretty. Subprime auto credit has boomed since mid-2010, exhibiting all the hallmarks of the mortgage bubble. Dealers are putting people into cars and loans they can’t afford, because there’s money to be made by bumping up balances and interest rates. Banks are buying the loans with little concern for borrowers’ ability to pay, because they can package them into securities for sale to investors desperate for yield. Fraud is rampant.
Although the amounts involved are much smaller than with subprime mortgages, the irresponsible lending will have consequences. Impossible interest payments are ending in repossession and driving families deeper into poverty. Artificial demand has set automakers up for a fall that may already be underway, with sales down about 8 percent in July from their most recent peak in December. Losses could ultimately destabilize markets, cutting off credit to worthy borrowers.
On the bright side, the episode has highlighted the usefulness of at least one part of Dodd-Frank: Section 942, which requires issuers to disclose the contents of asset-backed securities. Thanks to the added transparency, analysts and journalists have been able to do a better job of raising red flags — noting, for example, how Santander Consumer USA Holdings, one of the biggest subprime auto lenders, verified income on just 8 percent of the loans packaged into a $1 billion bond offering.
The exemption for auto dealers, though, has rendered regulators largely unable to respond. The Consumer Financial Protection Bureau, the watchdog agency set up by Dodd-Frank, has tried to act indirectly by leaning on financial institutions that provide credit to the dealers, and by cracking down on specific abuses at smaller, self-financing dealers. But this has done little to improve lending practices more broadly.
This should give pause to Republican legislators looking to curb the CFPB’s powers. Granted, some of the bureau’s rules on mortgage lending have weighed too heavily on lenders, particularly smaller community banks — a problem that should be remedied. But that doesn’t excuse what’s going on in the auto market, which regulators can’t address without the authority to oversee dealers and require verification of borrowers’ ability to pay.
In short, the example of the auto exception suggests that Dodd-Frank’s lending rules, despite their imperfections, are better than no rules at all. The auto-loan loophole should be closed.
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