The Car Loan Loophole: How Auto Dealers Dodged Financial Reform

The fat lady hasn’t sung yet, but the country’s auto dealers have been exempted from the financial reform bill now in its final stage in Congress. Given that the purpose of the bill is to protect Americans from harmful manipulation by the people selling them financial products, this is a pretty stunning development. The nation’s auto dealers either provide or broker most of the $850 billion worth of currently outstanding car loans across America. That’s a pile of financial product: It’s more than household credit card debt and second only to home mortgages.

bad_credit.jpgMany of the home finance industry’s unethical practices were mirrored by the nation’s auto dealers, but the regulatory response has left the car loan market untouched.

Every year, 50 million people buy a car, and 94 percent of those sales are loan-financed, to an average tune of over $28,000 for a new vehicle. At both new and used lots, a good number of those loans involve unethical and fraudulent practices. Like the mortgage industry, dealers have pushed credit and pricey products on people who couldn’t afford them, and then fudged paperwork to make it appear they could. They offered "zero interest and no money down" and extended loan terms from what was until recently an average of three or four years to seven and even eight years, leaving huge numbers of car owners "upside-down" on their loans — which is to say, owing more than their car is worth.

More egregiously, their business innovations — not advertised as such, of course — include such activities as “power-booking” (reporting to lenders that a car is equipped with non-existent options, thereby raising the amount of the loan) and “yo-yo financing” (a form of bait and switch, in which car buyers leave a down payment or trade in their car, drive off the lot, and then are falsely told that the financing "fell through" and that they have to pay a higher interest rate, often under threat of repossession or arrest).

The list goes on. Dealers regularly get kickbacks and markups from other lenders. Car loans have been packaged and dangerously securitized, just like home mortgages. Dealers encouraged many car buyers to use home equity loans to make their purchases, obliterating whatever cushion they had when home prices plummeted. It’s a jungle on the lot for consumers, especially the poor and those with poor credit.

In a recent New Yorker article, James Surowiecki seeks to explain how the auto dealer exemption could have happened when it is so opposed to the public interest, and when powerful actors like Citibank and JP Morgan did not escape regulation. He sees it as mostly a public relations coup, with the dealers presenting themselves as Main Street plain folks, virtually victims of the financial system themselves. They also played up the number of jobs dealerships provide in communities across the nation (how those jobs would dry up if dealers had to make an honest living was not made clear).

But what wasn’t noted is the power of the car dealers over the press itself.

The auto industry is the single largest advertiser in America’s newspapers, magazines, and television stations. It is the economic backbone of those media, and this helps explain the minimalist coverage, and the general lack of backbone in coverage, of this issue as the bill worked its way through Congress. Over the past several months, the loophole opened, then seemed to close, and then opened again. The media could have been educating the public on what the automotive loophole will cost them, day in and day out. Instead, they kept their focus on other sources and forms of lending abuses.

And when dealers are called “small businesspeople,” that may suggest they are in the same boat with the local embroidery shop owner or restaurateur, but dealers are often the largest business in a community, and many are part of large chains, like AutoNation. The auto dealer is a little guy like the beachfront mansions of Long Island are cottages, but PR-produced confusion has worked to the dealers’ advantage.

It isn’t just the financial reform bill that has left the real little guy, the car buyer, exposed to the avarice of auto dealers. Americans are at risk of ending up indentured to their car purchases because they can’t escape from the car system itself. While the car is often presented as a vehicle of opportunity, getting people to work and new life chances, in reality it locks people into a costly lifestyle, creating more inequality in America than almost anything else besides access to quality education. While that’s a topic for another post, it is a key reason why transit and bikeable, walkable communities are so desperately needed — to create a loophole car dealers can’t drive through.

Catherine Lutz, an anthropologist at the Watson Institute at Brown University, and Anne Lutz Fernandez, a former marketer and banker, are the authors of Carjacked: The Culture of the Automobile and its Effect on our Lives (Palgrave Macmillan).

20 thoughts on The Car Loan Loophole: How Auto Dealers Dodged Financial Reform

  1. Thanks Catherine and Anne for an excellent post. How indeed could we have let the car financiers escape scrutiny and regulation?

    Just ordered my copy of “Carjacked”!

  2. “But what wasn’t noted is the power of the car dealers over the press itself.”

    Testify! Looks like Streetsblog is wading out further into the water here. Car dealers are also often the largest political donors on the local level, next to the public employee unions, and the largest source of sales tax revenues.

    The power of the real estate industry over the media is no different, due to the value of real estate advertising. During the housing bubble, articles about the reality were sometimes found in the business section, which no one reads, while the real estate section was little more than an extension of the PR machine.

    There aren’t many jobs in America where you can get paid to tell the truth, and there are limits to how much you are paid to do so.

  3. Thank you for writing this – really shows how corrupted our political & economic system is by dominant special interest groups at all levels of gov’t and even the press.

    Much of working class America thinks that a new automobile are the key to getting to that next rung of the socio-economic ladder of society, when in reality it is an albatross around their necks. They can afford the payment (at first) and even the gas (when prices are low), but then they don’t factor in the costs of routine servicing or buy cheap insurance that doesn’t cover collisions or has a super-high deductible. These unexpected costs continue to crop-up with automobile ownership. New cars are so sophisticated that few mere mortals can hope to make even minor repairs. The thousands of dollars spent on new automobiles takes a toll in many unseen ways – less savings, more financial stress, family problems. And from a societal perspective, these seemly cheap loans lock people into where they choose to live, work, shop, etc. and then may leave them stranded far away from transit or other transportation options.

  4. “The thousands of dollars spent on new automobiles takes a toll in many unseen ways – less savings, more financial stress, family problems.”

    What did Americans get from the shift to a two-income household? A second car, more square footage at home, more purchased meals — and other additional expenses associated with two parents at work.

    I’m not saying women should return to the kitchen. I am saying that by deferring car ownership and never having more than one, my wife and I were both able to work part time when the kids were young, and save afterward.

  5. OK, so, clearly, this is bad for society, is unethical, and needs to be changed. But … just to play the devil’s advocate/gadfly for a moment … how is making driving more expensive bad for Livable Streets?

  6. @vnm

    It doesn’t make driving more expensive, it just makes people believe they can afford more car than they really can, which then means more people purchase cars than otherwise would, even though it winds up causing them financial hardship down the line.

  7. Yes, that’s right Patrick. These loans “bait and trap” people into an automobile lifestyle. Imagine someone in Astoria who has worked hard all their life and taken mass transit decides “you know what, I’m done with mass transit, I’m buying a car.” Well, he goes to the lot and looks at prices he could afford based on the monthly payment. He signs a piece of paper that says he’ll pay X dollars a month for the car…sweet, he can now thumb his nose at the MTA. Unfortunately that is only 1/3 or less the cost of owning a car. He has to go buy insurance, fill the gas tank a few times of week, take the car in for servicing a few times a year and is now burning time trying to find a spot a few days a week. Eventually he get fed up with the Alternate Side parking dance that he decides to move to Long Island where he can get more house for the money. Then his wife is going to need a car too and the kids need to be driven everywhere and his family lives a half hour away…except he can’t blame a faceless public entity like the MTA, he can only blame himself and that day he went to the car dealer lot.

  8. Car-free all my adult life. I don’t earn much but I put the legal maximum into my tax-deferred retirement fund and enjoy a trip to Europe every year. I never worry about parking, insurance, maintenance, repairs, or dying behind the wheel (though dying under the bumper is a distinct possibility). The IRT is an extension of my apartment — I can practically sleepwalk through it to most of the places I care about. I talk up car-free living to everyone who speaks to me for more than 10 minutes. Half of them say they envy me and tell me how much they hate their commute; the other half give me funny looks and change the subject as fast as possible. The realities of peak oil being what they are, the time is coming when car-free households will grow, and not far behind that is the time when we will become the majority.

  9. I’m currently in Tel Aviv, a city where transit consists of slow, ridership-bleeding buses*, and pedestrian and bike amenities are poor. While the city is dense and car ownership is still far below US Sunbelt standards, I get the feeling that there aren’t many people who are voluntarily car-free. I just saw a post on the back of a transit van saying, “Today you take a taxi; tomorrow you can drive a car,” advertising job placement.

    The entire marketing strategy of cars is like that – cars as freedom, cars as prosperity, etc. Part of it comes from the American idea of entrepreneurialism as part of government failure; while it’s not stated explicitly, or else people would advocate better government instead, there’s definitely a notion in both the US and Israel that anything public is irredeemable, used only by those who can’t afford anything better.

    It actually makes me a little bit fearful, since Indian capitalism has similar attitudes. (On the other hand, the Delhi Metro is popular across the board… but this is now, when Delhi’s car ownership is still tiny.) It’s nothing like the attitude you see in Singaporean (or Chinese) capitalism, which holds that the government must be ultra-competent and provide the private sector with basic infrastructure.

  10. If vehicles cost the same as a down payment — which is completely feasible with existing technology capable of producing much more practical and sensible mobility — most of this financing would not be needed; over three-quarters of a trillion dollars is tied up just for financing alone.

    This is but one example of the entrenched industries perpetuating the monopoly of transportation systems based on cars; some of the worlds largest: Insurance and big oil are obvious others.

    Just follow the money.

    This monopoly is perpetuated locally by the dangers of transportation systems based on cars.

  11. “…leaving huge numbers of car owners “upside-down” on their loans.”

    Call me unsympathetic, but anyone expecting to remain afloat on a loan for an item that is guaranteed to depreciate quickly (like a car for example), is stupid for signing on the dotted line. And if you have to take a loan out for 8 years on car that you don’t even keep for that long, or if you have to leverage the equity on your home to purchase it, then quite frankly you deserve to get your money taken from you for not knowing better.

  12. The * in my above comment was a footnote about declining frequencies that got cut. Line 5, my original route to middle school, used to come every 3-4 minutes at the peak and 5-10 off-peak, and was so crowded it was the favorite target for suicide bombings. That was in 2000. A few days ago, I spotted a bus stop putting the line’s headways at 5-8 minutes peak and 10-20 off-peak.

    Moral to governments: if you don’t build good alternatives to the car, everybody will regard the car as a necessary status symbol.

  13. Just picked up my copy of Carjacked. Had to go to two Barnes & Nobles and two Borders. B&N, which was sold out, would have had it filed under sociology. Finally I found a Borders that had it, categorized somewhat incongruously under “General Automotive.”

  14. All this after a huge bailout of GMAC by taxpayers. Time to put an end to the auto and sprawl subsidies. The worst one is the artificial tariff on public transit.

    I seem to remember the first general manager of this company took all the money from the students and just disappeared with the cash.

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