The CFPB employs thousands of highly-paid researchers, attorneys, etc. to study financial issues, issue new rules, and take enforcement actions against financial institutions it determines are skirting the law. But despite being among the best-paid federal workers, the agency’s methodology for many of its actions has been seriously questioned by outside observers.
Discrimination in Auto Lending
When consumers buy a car from an auto dealer, when it comes time to finance their purchase many opt to work with the dealership to identify various financing options. For many years, consumer advocacy groups expressed concern that African American car buyers were unfairly discriminated against in auto financing. To assess this claim and bring enforcement action against companies that may be violating federal law, the CFPB sought to determine whether minority car buyers were receiving less favorable financing terms than white buyers.
Federal law does not allow auto dealers to collect demographic data on auto loan applicants so the CFPB cannot simply compare financial offers made to consumers of different racial and ethnic groups. Instead, the CFPB developed a proxy methodology, known as “Bayesian Improved Surname Geocoding,” which uses consumers’ last names and zip codes to estimate their race.
Based on its estimates of consumers’ races, the agency asserts that “certain lenders that offer auto loans through dealerships are responsible for unlawful, discriminatory pricing.” The first lender targeted by the agency was Ally Financial, Inc., which paid $80 million in damages (to be paid to victims of Ally’s policies) and an additional $18 million in penalties.
A study of the CFPB’s methodology for estimating minority borrowers and auto finance lending practices prepared by Charles River Associates for the American Financial Services Association found that the agency overestimated the number of African American borrowers by 41%.
The study made several key conclusions, notably:
- “The methods commonly used by regulators to proxy race and ethnicity, including the recently applied Bayesian Improved Surname Geocoding (BISG) method, are conceptually flawed in their application and subject to significant bias and estimation error.”
- “The use of biased race and ethnicity proxies creates significant measurement errors, which likely result in overstated disparities and overstatements of alleged consumer harm.”
- “When appropriately considering the relevant market complexities and adjusting for proxy bias and error, the observed variations in dealer reserve are largely explained.”
Industries affected by the CFPB’s use of BISG approximations asked the agency to respond to the Charles River Associates’ study. While the agency disagrees with the study’s findings, it has yet to point out any specific flaws or problems with the study’s methodology or conclusions.
Payday Loan Rulemaking
New regulations of the payday loan industry was one of CFPB Director Richard Cordray’s first goals for the agency. In early 2015, the agency issued new rules requiring short-term lenders to consider a borrower’s ability-to-repay. Upon releasing the rules, Cordray commented: “Extending credit to people in a way that sets them up to fail and ensnares considerable numbers of them in extended debt traps, is simply not responsible lending.”
The rules require to lenders to: verify a borrower’s income, major financial obligations, and borrowing history; determine a borrower’s income is sufficient to cover both the proposed loan and the borrower’s essential living expenses; and will almost always need to provide a 60-day cooling off period between two short-term loans.
These requirements go far and beyond what is required for consumers who opt for other short-term ways to cover debts, notably credit card charges and bank overdraft fees. In enforcing these options, the CFPB notes it expects to nearly eliminate payday loan options for consumers–the agency estimates a volume decline of 60% to 84% for lenders that offer loans in compliance with the “ability to repay” rule.
Research has questioned the benefits of ability to repay requirements or payment-to-income ratio limits.
A March 2015 study, “Small-Dollar Installment Loans: An Empirical Analysis,” conducted by George Washington School of Business professor Dr. Howard Beales and Dr. Anand Goel of Navigant Economics analyzed over a million short-term installment loans made over a nearly two-year period. Among the study’s findings: enforcing “affordability criteria” reduces the availability of credit to small-dollar borrowers who often have few available alternatives, and is a poor metric for predicting loan repayment.
Another study, “Measures of Reduced Form Relationship Between the Payment-Income Ratio and the Default Probability,” by Peter Toth of the University of Texas at Austin, analyzed roughly 87 million loans and found no correlation between consumer defaults and rules imposing a particular payment to paycheck ratio.