Category: Credit Policy & Regulation

  • OCC Preemption at Supreme Court

    Posted by

    Bob Lawless

    Here is one that sounds like a yawner but actually is not. The Supreme Court has on its docket a case called Watters v. Wachovia Bank, NA, in which the Court has been asked to decide, "Is interpretation of the Comptroller of the Currency that 12 C.F.R. 7.4006 preempts
    Michigan’s laws regulating mortgage lending as applied to State chartered,
    nonbank, operating subsidiaries entitled to judicial deference under
    Chevron USA Inc. v. Natural Resources Defense
    Council    , 467 U.S. 837 (1984)?"

    Although the case may appear to present only a narrow question of federal banking law, Credit Slips readers may want to keep an eye on this one. It has not yet scheduled oral argument, but the Supreme Court’s decision could have important effects on the ability of the states to enforce consumer protection laws related to credit and perhaps in other areas as well. Not unlike the Court’s 1978 Marquette National Bank decision, which also involved a federalism issue under the National Bank Act leading to an effective deregulation of consumer interest rates, the Watters case could have vast unintended consequences.

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  • Strategic Credit Reporting

    Posted by

    Ronald Mann

    I thank the people at Credit Slips for asking me to guest blog this week.  It has been a great sounding board.  I want to close by highlighting a part of Charging Ahead about which I am not at all sure: my praise of the American credit reporting system.  As I explain there, you can say that our credit reporting system works well compared to systems in most other countries because it is private, centralized, voluntary and technologically advanced.

    But as lending decisions become ever more standardized, I wonder if the incentives to game the process are starting to undermine it.  In particular, increasingly the hot-button disputes about credit reporting are not the inevitable problems about the hassle of correcting unintentional errors.  Rather, what we now see is a set of problems that relate to whether the system is sufficiently complete.  For example, Capitol One and Target want to keep the information about their credit limits private, because disclosing that information would make it easier for other lenders to poach their customers.  Credit card issuers in general have pressed the national bureaus to ignore available information about bankruptcy discharges.  As far as I can tell, most of the strategies move in one way — keeping "positive" information out of the system to make credit scores lower.

    The natural response of many consumer groups, of course, is to try to force more information into the system.  But there are serious costs to an unbounded drive to gather all information into the credit reporting system.  In general, the added information is going to make it easier for lenders to identify and serve riskier sections of the market.  There also are serious privacy concerns, and not just for people of Euro-centric sensibilities.  Here, as in insurance rate-setting, do we really want a system with complete information?  Should the interest rate on my mortgage depend on the grocery store at which I shop?  The items I buy when I go there?

    On the flip side, the recent growth of fringe lenders suggests that increased access to this information presents some real value to the lower middle class.  If the credit bureaus had as much information about those people as they have about the swath of the middle class that has a dozen credit cards and two mortgages per household, the rates charge in the markets in which those people borrow well might fall significantly from the levels that are so easily challenged as "unconscionable."

    I don’t yet have a good answer to this.  Banking groups oppose regulatory intervention, claiming that smaller lenders will drop out of the system.  And our voluntary system obviously would be undermined if a significant group of lenders dropped out.  Still, I can’t accept the idea that lenders’ incentives are properly aligned with those of borrowers, so I question whether lenders should be allowed to decide what and how much to report.  Farewell!

  • Credit to the Blogosphere

    Posted by

    Bob Lawless

    A few things catching my attention that might be of interest to Credit Slips readers:

    • An interesting post over at Underbelly about the relationship of debt and trust
    • On SSRN, "Turning a Blind Eye: Wall Street Finance of Predatory Lending" by Cleveland-State law professor Kathleen Engel and U. of Connecticut law professor Pat McCoy. Those payday and other subprime lenders are big business for Wall Street, and Professors Engel and McCoy offer some solutions. This paper deserves a lengthier post, if only someone would give me the extra hour in the day! In December, look for Professors Engel and McCoy as Credit Slips guest bloggers.
    • A blog post at The Carpetbagger Report about efforts by some congressional members to head off restrictions on the ability of payday lenders to prey on members of the military. Our guest blogger, Ronald Mann, this week discussed a DoD report about the payday lending industry targeting military personnel (see also Katie Porter’s post on the DoD report). I agree with Mann’s conclusion that payday lenders are not just a problem for the military, and Congress should consider broader legislation. I’ll take what is politically feasible, however. We work with public policy with the Congress we have, not the Congress we want.

  • Sam’s Bank

    Posted by

    Ronald Mann

    As I come to the end of Pietra Rivoli’s engaging book on the Travels of a T-Shirt in the Global Economy, I learn that the principal reason that clothing imports into this country have been restricted so successfully is that apparel manufacturers, concentrated in specific congressional districts, have much more influence over Congress than Wal-Mart.  So, on the seemingly unrelated question whether Sam Walton’s children can acquire a bank, I guess it should be no surprise that the protests of the independent community bankers, the regulated constituency of federal banking regulators, can derail Wal-Mart’s application.

    But this is a more interesting story than it first appears.  For one thing, there is a substantial "level playing field" argument that supports the regulators’ position.  If Wal-Mart can ask pointedly "Why should Target get a bank if we can’t have one," CitiGroup can just as well ask why Wal-Mart should be able to own banks with no regulatory supervision while CitiGroup must endure the red tape of supervision by the Fed.  There also is a considerable public-choice narrative.  If the exception for ILCs that would permit Wal-Mart to buy a bank without federal supervision rests only on the power of Utah legislators in Washington, then who needs it?

    The intriguing side of the problem, however, relates (of course) to payment systems.  {You might wonder what this has to do with consumer credit, but they shouldn’t have asked me to guest blog if they didn’t want me to write about payment systems.}  The market for consumer payment systems in our country is dominated by a pair of national networks, whose market shares have grown rapidly over the past 30 years.  During those thirty years, the price of the product — which is at its core a sophisticated information processing service — has remained stable even as Moore’s Law has halved the cost of information processing time after time after time after time.

    For obvious reasons, it is enormously difficult to challenge Visa and MasterCard.  We might better ask (as I do in Charging Ahead) how Visa and MasterCard ever succeeded in establishing their networks in the first instance!  If we were to look for a challenger, and if we look past the possibilities of Google and PayPal (who essentially piggyback on Visa/MC), Wal-Mart certainly would be the most formidable competitor.  Wal-Mart has a network of almost 4000 locations in the United States, with tens of millions of devoted customers.  Wal-Mart is highly skilled at designing products to meet the desires of mainstream American consumers.  A payment system designed by Wal-Mart, accepted at all of its stores, could penetrate the consumer consciousness more effectively than any product since the credit card.

    And if the purpose of Sam-Pay was to lower the costs of payments — cost-cutting being Wal-Mart’s core competency — then it presumably would shift spending from credit cards, which would slow the financial distress associated with credit card use.  To be sure, there is always the possibility that Wal-Mart could follow the lead of Target and transform itself into a consumer-credit operation with an in-house retailing arm.  Wal-Mart’s efforts to open full-service banks in Mexico show that this is at least a possibility.  But, my prediction is that Wal-Mart will focus on cost, as it has with the check-cashing services and money orders that are offered in its stores in most states.

    In the end, I think we can rely on the lobbying power of the independent bankers to keep Wal-Mart out of the consumer credit business.  So putting the question squarely — should we craft a regulatory exception for banks specializing in consumer payments? — count me in!

  • Our Indebted Military

    Posted by

    Ronald Mann

    Payday borrowing by the military has been a hot topic since an August 2006 DoD report estimated that as many as 17% of military personnel use payday loans.  But the spin surrounding this report has missed some troubling points.

    First, I do not find it useful to accuse payday lenders of "targeting" military families by responding to demographics.  Military personnel always have been ideal customers for check-cashers.  They have relatively low salaries, and thus are persistently cash-poor.  They are unlikely to be laid off or to have their payroll checks late or dishonored.  So, it should surprise nobody that check-cashing stores, and the payday lending stores that have grown out of them, appear near military bases.  We might just as well say that bars "target" college students because they proliferate near the campuses that house their most profitable customers.  If there is a link between financial distress and payday lending, it affects both civilian and military populations.  And, I haven’t seen any evidence that military personnel are more susceptible to cognitive biases than the immigrants and other low-income civilians who routinely use these products.

    Second, the report does not acknowledge a more significant disparity between civilian and military personnel — that the credit reporting system disadvantages those who do not own homes.  Because the credit bureaus collect very little information about non-mortgage expenses, they assign lower credit scores to families that make regular rent and utility payments, but not mortgage payments.  {Some make similar claims about payday transactions, but access to this data would only identify payday loan borrowers as potential customers for other subprime and fringe products.}  Unfortunately, the unstable location of military families makes them more likely to rent and less likely to own than similarly situated civilian families.  So military families as a group will have a harder time gaining access to intermediate and long term credit products.  In general, then, they will be more likely to use short-term products like payday loans.

    What can be done?  The FTC’s plan to increase the reporting of rent and utility information is a start, but DoD’s responses are less useful.  The military would take away the product that the military personnel are using without either addressing the conditions that make the product attractive or facilitating a more reasonably priced alternative.  While a well-designed rollover ban would limit reliance on payday loans for intermediate credit needs, the 36% rate caps will make the national chains inaccessible to military families.  If enacted, we could expect to see those families depending more heavily on subprime credit cards, pawn shops, rent to own providers, and unlicensed payday lenders, all which in the long run will be worse for those families than the prohibited payday loans.

    I understand that the military (as a large employer) has a real need to control the spending and borrowing activities of its employees.  But financial distress is not limited to the military.  Congress should view the military as an illustration of a general problem, not as a special case of activity that in other settings is benign.  As Jim Hawkins and I explain in a working paper, the policy issues are complex and deserve thoughtful consideration.

  • Small Business or Consumer?

    Posted by

    Bob Lawless

    Leslie Eaton of the N.Y. Times today reports on the state of small business in New Orleans, one year after Hurricane Katrina. It is a great article, exploring the relationship of small business both to the social fabric and economic health of a community. In the article are stories about the financial decisions small-business owners have made in recovering from Katrina’s devastation. A restaurateur expresses hope that he has not made a "foolish decision" by using all of his savings to reopen his restaurant. To cover losses stemming from months when her store was closed and slow sales since reopening, a shopkeeper has "mortgaged her house to the hilt" and borrowed from in-laws.

    Whether these are reasonable risks or foolish decisions, these stories illustrate that "consumer" credit policy presents subtle and highly textured issues. First, I highlight "consumer" because one wonders how to classify the financial decisions of these business owners. Are these consumer debts or business debts? If the restaurateur now begins to rack up credit card debts for his daily living expenses because his savings are sunk into the business, how do we count that? Is the shopkeeper’s home mortgage a business debt? For a significant segment of the public, their financial affairs are in a gray area between consumer and business. About one out of every seven bankruptcies, for example, is someone that is or recently was self-employed. Most every small-business owner’s personal and business affairs are intertwined and interdependent.

    One might wonder why these small-business do not incorporate or form a limited liability company, to separate business and personal affairs. The answer is that they may have done do so, but why does it matter if they have put their personal credit at risk to finance the business? Even if they have not, that can be a rational decision. With the press of all the other demands of a small business, the time and expense it takes to incorporate may not seem worth it if you have put your personal credit on the line anyway. Regardless of the fiction of legal separateness, small-business owners cannot financially walk away from a failed business.

    When we think about "consumer" credit policy, we are thinking about different groups, and small-business owners comprise one of these groups. Often, however, consumer credit policy thinks about consumers monolithically. The monolithic image that often results is the irresponsible, overspending, unsophisticated consumer, and we end up with rules that are unsuitable for large portions of the public. An example is the new bankruptcy requirement that all individual filers undergo consumer credit counseling. If the New Orleans business owners mentioned in the N.Y. Times article later end up in bankruptcy court, query what credit counseling would tell them. Don’t take business risks? The credit counseling requirement is just one example. Last year, I taught a seminar where looked at a host rules that looked great for consumers or looked great for big businesses but did not work well for small business owners.

    Credit and bankruptcy laws directed at consumers will sweep in small-business owners. At that point, another law may come into play–the law of unintended consequences.

  • Are Interest Rate Caps Patriotic?

    Posted by

    Katie Porter

    The DOD recently issued a report on predatory lending, concluding that "predatory lending undermines military readiness, harms the morale of troops, and adds to the cost of fielding an all volunteer fighting force." The DOD defined predatory lending broadly, including in its sweep common practices such as refund anticipation loans and car title lending. The report builds on academic research by Christopher Petersen and advocacy work by the National Consumer Law Center and the Center for Responsible Lending.

    The report is shocking for two reasons. First, note that the federal government is advocating a usury law, which is quite a departure from its usual position on consumer credit policy. The DOD recommended a 36 APR cap on all extensions of credit to military servicemembers and their families. The DOD explicitly rejected suggestions that "education, counseling, assistance from [military] aid societies" and other alternatives are "sufficient" to curb predatory lending. Second, the report’s proposals may have political traction. The interest rate cap was included as part of a comprehensive military bill that passed the Senate in June. It is currently pending in a House-Senate conference commitee. If it becomes law, it will provide a natural, nationwide experiment on the effects of interest caps on moderate and low income families, and could be used to build support for a similar law that applies to all consumers.