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.

Many 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 J. P. 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).