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FED E R A L R E S E R V E B A N K OF D A L L A S
Station K, Dallas, Texas 7 5 2 2 2

Circular No. 84-125
December 28, 1984

TO:

All member banks and others concerned in the Eleventh
Federal Reserve District

ATTENTION:

Chief Executive Officer

SUBJECT:

Proposal to amend Regulation AA —
Credit Practices

SUMMARY:

The Board of Governors of the Federal Reserve System
has requested comments on a proposal to amend its
Regulation AA to conform the regulation to the rules
adopted by the Federal Trade Commission (FTC).
The
FTC now prohibits certain debt collection practices,
contract
obligations
and
misrepresentations
of
cosigners liabilities.
The FTC's rules do not apply
to commercial banks.
However, the Federal Trade
Commission Act requires that the Board adopt a similar
regulation applicable to banks, unless the Board feels
the rules adopted by the FTC prohibit acceptable
banking practices. Interested parties are invited to
submit comments on the proposed amendments and whether
the FTC's rules should be applicable to
banks.
Comments, which must be received by January 28, 1985,
should be directed to Mr. William W. Wiles, Secretary,
Board of Governors of the Federal Reserve System,
Washington, D.C., 20551. References should be made to
Docket No. R-0006.

ATTACHMENTS:

Board's press release and material as published in the
Federal Register

MORE INFORMATION:

Legal Department, Extension 6171

ADDITIONAL COPIES:

Public Affairs Department, Extension 6289

Unfair or Deceptive

Banks and others are encouraged to use the follow ing incoming W A TS numbers in c ontacting this Bank: 1-800-442-7140
(in trastate) and 1-800-527-9200 (interstate). For c alls placed locally, please use 651 plus the extension referred to above.

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

FEDERAL RESERVE press release
• • W lr E :* '
sv

For immediate release

November 26, 1984

The Federal Reserve Board today requested comment on a proposal
to amend the Board's Regulation AA —

Unfair or Deceptive Credit Practices —

to apply to banks rules substantially similar to those recently adopted by
the Federal Trade Commission prohibiting certain debt collection practices
in consumer credit obligations.
The Board requested comment by January 28, 1985.
The rules adopted by the FTC prohibit creditors from using certain
practices:
1.

A creditor may not enter into a credit contract with a
consumer, directly or indirectly, that contains any of
the following:
— A "confession of judgment" clause, by which the
consumer agrees in advance to permit the creditor
to obtain a judgment in event of default without
giving the debtor prior notice or an opportunity
to be heard in court.
--A "waiver of exemption" by which the consumer waives
or limits state law exemptions sheltering the
consumer's home or other necessities from attachment.
— A provision by which the debtor assigns future wages
to the creditor in the event of default.
— A provision permitting creditors to repossess any of
the consumer's household goods beyond those for which
the creditor is extending credit.

2.

In addition to the prohibited contract provisions, the FTC rules

also forbid "pyramiding" of late charges, by which a charge arising from one
late payment is taken out of a subsequent timely payment, and can cause a
series of subsequent payments to be incomplete and subject to late charges.

- 2 -

3.

Finally, the rules prohibit misrepresentation of a cosigner's

liability and require that a creditor give a cosigner a notice informing the
cosigner of the nature of the obligation and potential liability.
«•

The FTC's action does not apply to commercial banks (or to savings
and loan associations).

The Federal Trade Commission Act requires that the

Board adopt within 60 days of the effective date of such an FTC ruling
(May 4, 1985 in this case) a substantially similar regulation applying to
banks, unless the Board finds that the rules adopted by the FTC are not
unfair or deceptive as engaged in by banks or that a similar regulation
applying to banks would seriously conflict with essential monetary or payments
policies of the Federal Reserve.
In issuing the proposal for comment the Board did not take a
position on these possible exceptions, and requested comment whether the
prohibitions should be applied to banks.
The Board's notice is attached.

Attachment

FTC's

ftd etal Begbtef / VoL 49„ Nat. 232 / Friday, November 30* 1S84 / Proposed Riries

47041

FEDERAL RESERVE SYSTEM
12 CFR Part 227
[Reg. AA; Doc. NO. R-0006]

Unfair or Deceptive Acts or Practices;
Credit Practices
AGENCY: Board

of Governors of the
Federal Reserve System.
ACTION: Proposed rule.
SUMMARY: The Board is publishing for
comment a proposed amendment to
Regulation AA (Unfair or Deceptive
Acts or Practices), The proposal would
implement,, as to banks, the credit
practices rule adopted by the Federal
Trade Commission. The Federal Trade
Commission Act requires the Board to
adopt a rule, subject to certain
exceptions, that is substantially similar
to the Commission’s rule. This rule
would prohibit banks from taking,
directly or indirectly, any consumer
credit contract that contains a
prohibited provision, from pyramiding
late charges, or from obligating a
cosigner without the required notice.
DATE: Comments must be received on or
before January 28,1985.
ADDRESS: Comments should be mailed
to Wltliam W. Wiles, Secretary. Board
of Governors of the Federal Reserve
System, Washington, D.C. 20551, or
delivered to Room B-2223, 2G& and C
Streets NW., Washington, D C between
8:45 a.m. and 5:15 p.m. weekdays.
Comments should1
include a reference to
Doc. No. R-0006. Comments may be
inspected hr Room B-1122 between 8:45
a.m. and 5:15 p.m. weekdays.
FOR FURTHER INFORMATION CONTACT:

Steven Zeisel or Richard Garabedian,
Staff Attorneys, in the Division of
Consumer and Community Affairs,
Board of Governors of the Fiederal
Reserve System, Washington* D.C.
20551, at (202) 452-3867 or (202) 4523667. Regarding the initial regulatory
flexibility analysis, contact: Robert
Kurtz. Economist, Division o f Research

47042

Federal Register / Vol. 49, No. 232 / Friday, November 30, 1984 / Proposed Rules

and Statistics, Board of Governors of the
Federal Reserve System, Washington,
D.C. 20551, a t (202) 452-2915.
SUPPLEMENTARY INFORMATION:

(1) General
The Board is publishing for comment a
proposed amendment to Regulation AA
(12 CFR Part 227). The proposal would
implement, as to banks, the Credit
Practices Rule adopted by the Federal
Trade Commission (FTC), effective
March 4,1985 (49 FR 7740, March 1,
1984). Under section 18(f)(1) of the
Federal Trade Commission Act (15
U.S.C. 57a(f)(l)), the Board must adopt,
subject to certain exceptions,
regulations substantially similar to those
adopted by the FTC under section
18(a)(1)(B) of the Act (15 U.S.C.
57a(a)(l)(B)). The Board must act within
60 days of the effective date of the FTC’s
rule. This rulemaking scheme was
established by section 202(a) of the
Magnuson-Moss Warranty—Federal
Trade Commission Improvement Act (15
U.S.C. 57a).
The Board is not required to adopt a
rule if it finds that such acts or practices
of banks are not unfair or deceptive or if
adoption of similar regulations would
seriously conflict with essential
monetary and payment systems policies
of the Board. This proposal is intended
to generate comment on the text of the
rule and to give the Board more
information on which to base a final
determination of whether to adopt a rule
or to make any modifications. It is not
intended to suggest that the Board has
decided to adopt a substantially similar
rule.
The rule adopted by the FTC prohibits
a creditor from including certain creditor
remedies in consumer credit contracts or
from purchasing contracts that contain
the prohibited clauses. The rule also
prohibits an accounting practice
regarding late charges, prohibits
misrepresentation of cosigner liability,
and requires a disclosure to be given to
cosigners. The prohibited contractual
provisions are the following: (1) A
confession of judgment clause; (2) a
waiver or limitation of statutory
exemption from attachment, execution
or other legal process; (3) an assignment
of wages; and (4) a non-purchase money
security interest in household goods.
The prohibited late charge practice
prevents the deduction from a timely
payment of a late charge applicable to
an earlier payment, thus causing the
timely payment to be delinquent
because of non-payment in full. The
cosigner rule prohibits
misrepresentation of a cosigner’s
liability and requires that a notice be

given to the cosigner to disclose the
nature of the obligation.
The test used by the FTC to find an
unfair act or practice requires that the
injury that flows from the act or practice
must be (1) substantial; (2) not
outweighed by any countervailing
benefits to consumers or competition
that the practice produces; and (3) an
injury that consumers themselves could
not reasonably have avoided.
(2) Historical Overview
In 1975 the FTC was given explicit
authority by the Magnuson-Moss
Warranty—Federal Trade Commission
Improvement Act to adopt rules that
define and prevent unfair acts or
practices. On April 11,1975, the FTC
proposed the first Credit Practices Rule
(40 FR 16347) that identified certain
unfair and deceptive practices of
creditors in consumer credit contracts
and effectively prohibited such acts or
practices. The Board, pursuant to its
statutory mandate, published a similar
rule for comment on May 5,1975 (40 FR
19495). No final rule was ever adopted
by the Board or the FTC based on the
initial proposal. The FTC subsequently
held hearings on the proposal and
revised the rule in 1980. The rule went
through further revisions until adopted
by the FTC in February 1984. The final
rule and the FTC’s statement of basis
and purpose and its regulatory analysis
may be found at 49 FR 7740 (March 1,
1985). In response to this final action of
the ihrC, the Board is publishing a
similar rule for comment.
(3) Particular Issues for Comment
The Board is required to adopt a
substantially similar regulation to
address the acts or practices in the
FTC’s rule unless it finds that (1) such
acts or practices of banks are not unfair
or deceptive, or (2) adoption of a similar
regulation would conflict with essential
monetary or payment system policies of
the Board. This statutory scheme raises
a list of issues on which the Board
solicits comment. Since the Board can
adopt the rule in part, or modify it to
reflect the unique situation of banks,
responses should focus separately on
each of the provisions of the rule.
(1) To what extent do banks either use
such practices in their own contracts or
purchase contracts that contain
prohibited practices?
(2) What is the burden of reviewing
purchased contracts for the removal of
provisions permitting such practices?
(3) Are any of the specified acts or
practices not unfair as engaged in by
banks?
(4) To what extent did modifications
in the final rule satisfy concerns of the

banking industry expressed in the
rulemaking record?
(5) To what extent would the cost or
availability of credit be affected by the
rule?
(6) What nonregulatory alternatives
exist to any rulemaking?
(7) To what extent should a delayed
effective date be provided for any or all
of the rule that may be adopted?
(8) What is the potential impact of the
rule on large and small banks, and those
banks located in low- and moderateincome communities?
(9) How frequently do banks take nonpurchase money security interets in
household goods? In what types of
obligations? What percent are “blanket”
security interests? To what extent would
restrictions on these security interests
increase credit costs or reduce credit
availability? Is there any unfairness if
banks specifically itemize the household
goods being taken as security?
(10) What percent of banks “pyramid”
late charges? How clearly is this
practice disclosed to consumers? What
percent of consumers are aware of the
amount due (including accumulating late
charges) at each payment?
(11) Do banks inform cosigners of
their liability before they sign? Do banks
always see the cosigner before obtaining
the cosigner’s signature? How often do
banks attempt to collect from cosigners?
How often are cosigners obtained in
default situations?
The text of the Board’s proposal is
identical to the FTC’s rule except for
editorial and organizational changes
designed to adapt the rule to the format
and style of the Board’s regulations. In
particular, the proposal clarifies that the
rule does not apply to transactions for
the purchase of real property. None of
these changes is intended to be
substantive. If the Board finally adopts
the rule, some additional editorial
changes may become necessary to
interweave the rule with the current
provisions of Regulation AA.
(4) Initial Regulatory Flexibility Analysis
A. Statement o f Purpose
The FTC Act provides in section 18(f)
that whenever the FTC prescribes a rule
prohibiting unfair practices, the Board
shall promulgate substantially similar
regulations prohibiting similar practices
by banks, unless the Board finds that
such practices of banks are not unfair or
that implementation of similar
regulations with respect to banks would
seriously conflict with essential
monetary and payments systems
policies of the Board.

Federal Register / Vol. 49, No. 232 / Friday, November 30, 1984 / Proposed Rules_______ 47043
This initial economic impact
statement is based primarily on an
examination of information in the FTC
rulemaking record, which consists of
quantitative studies, consumer and
creditor surveys, expert testimony, and
anecdotes of specific consumer injuries
and creditor experience. Banks
participated fully in the FTC proceeding,
even though they are not under FTC
jurisdiction, in anticipation of Board
consideration of their coverage under
section 18(f). The record is examined for
differences between banks and
institutions under FTC jurisdiction in
their use of creditor remedies and
potential injury to their customers;
differences which might affect a
determination of unfairness. The
rulemaking record was compiled over a
period of approximately 10 years. The
last opportunity for the public to present
its views was in June 1983, when the
FTC invited prior rulemaking
participants to make oral presentations.
Among the participants were the
Consumer Bankers Association,
American Bankers Association,
California Bankers Association,
Independent Bankers Association, the
Consumer Federation of America, and
the Federal Reserve Board.
B. Background
In 1972, the National Commission on
Consumer Finance (NCCF) reported the
results of its examination of the
consumer credit market, including an
analysis of creditor remedies. In
response to NCCF findings the FTC
Bureau of Consumer Protection (BCP)
conducted an investigation to determine
whether the use of certain collection
remedies was an unfair practice under
§ 5 of the FTC Act. Based on the BCP
staff report, the FTC initiated in April
1975 a proceeding for the promulgation
of a trade regulation rule designed to
abolish or limit the use of 11 credit
practices. In March 1984, the FTC
determined that the use of six credit
practices was unfair.
C. Economic Implications *
1. Theory. Economic analysis of the
loan offer function suggests that legal
restrictions on creditor remedies would
tend to increase loan rates. Restrictions
on creditor remedies would increase
creditors’ per-unit cost of supplying
credit in either of two ways. First,
remedy restrictions may increase the
risk of delinquency and default on the
loan by reducing the borrower’s
incentive to repay. Second, creditors
may respond to the increased default
risk by incurring additional costs for
screening applicants, monitoring and
collecting loans, and for administrative

activities. Consequently, creditors
would offer a given quantity of credit
only at a higher price, i.e., the loan
supply curve would shift upward. At the
same time, restrictions on creditor
remedies reduce the cost of default to
the consumer. Thus, consumers may be
willing to pay a higher price for a given
quantity of credit, i.e., the demand curve
would shift upward. (It is possible that
the loan could be less attractive, if
elimination of a remedy raiseS'the
probability of invoking a more onerous
remedy.)
Market forces discourage creditor
remedy clauses in contracts when the
price consumers are willing to pay
creditors to restrict creditor remedies
cover the cost to creditors from
foregoing the remedies. However, there
may be information problems that may
lead to market failures in the case of
creditor remedies. These problems are
consumers’ imperfect knowledge of the
effects of creditor remedies and
asymmetric information on default
probabilities.
Consumers who do not comprehend
the implications of the creditor remedies
in contracts they sign, might accept
unknowingly creditor remedies that they
would have been willing to pay to avoid.
Therefore, government restrictions on
creditor remedies could result in
contracts that these consumers would
have selected if they had been better
informed. Thus, consumers who do not
understand the consequences of creditor
remedies may benefit from the rule.
Consumers and creditors might not
have the same information on which to
evaluate deficiency and default
probabilities. This asymmetric
information could cause an adverse
selection problem. That is, within any
group of consumers that creditors judge
to be equally creditworthy, there might
be some misclassified individual
consumers who are less creditworthy
than the others. Therefore, if a creditor
offers a particular group contracts
containing creditor remedies less
onerous than those in the contracts of
competitors, the creditor is more likely
than its competitors to attract the
misclassified higher, risk consumers who
are aware of the true deficiency and
default probabilities. Adverse selection
would discourage creditors who are
willing to eliminate particular creditor
remedies from doing so.
Benefit from restrictions on creditors
remedies may not be shared equally by
all groups of consumers. While some
individual consumers benefit, others
may be harmed, e.g., credit may become
unavailable to consumers who had been

marginally creditworthy before
restrictions were imposed.
2. Evaluation o f the FTC Rulemaking
Record. The FTC rulemaking record is a
compilation of empirical evidence on the
possibility that market failures occur
and on the benefits and costs of
restrictions on creditor remedies. It is an
extensive record consisting of
econometric studies measuring the
impact on credit prices and availability
of restrictions on creditor remedies;
surveys of creditors about the
prevalence and use of various creditor
remedy clauses in contracts; surveys of
legal aid attorneys and consumers about
their experience with and attitudes
toward creditor remedies; and several
hundred opinions on the potential
economic effects of the provisions. The
considerable effort by proponents and
opponents of the rule in the rulemaking
procedure has not resulted in precise
measurement of potential net benefits,
even though the results of their effort
are, perhaps, the most that can be
expected. The lack of precision is due to
significant methodological and data
problems in the econometric studies
caused by the complexity of the issue,
low survey response rates, and the
subjective nature of many of the
potential benefits to consumers.
However, some general observations are
possible.
The econometric evidence in the
record suggests that the overall impact
on credit cost and availability from
restrictions on creditor remedies may be
relatively small. The major econometric
study, prepared for the FTC by the
Bureau of Social Science Research,
concluded that the rule would increase
credit costs by 19/100 of one percent.
However, both proponents and
opponents of the rule recognized that
the shortcomings of the econometric
studies were too great for
decisionmakers to rely on the results for
more than gross estimates of the rule’s
effects. The record becomes much less
persuasive when it is necessary to
discount econometric evidence, which
tries to minimize the effect of opinion
and subjective perceptions on the
decisionmaking process.
Small impacts of the rule on all
consumers as a group do not mean that
certain subgroups of consumers would
not be affected significantly. Public
comments and survey opinions of legal
aid attorneys suggest that the
probability of injury from the subject
credit remedies may be greatest for
lower income, less educated consumers.
These consumers may be less likely to
comprehend the implications of the
various contracts clauses or to

47044

Federal Register / Vol. 49, No. 232 / Friday, November 30, 1984 / Proposed Rules

understand their rights to legal
protection when they become deficient
or default on a loan. On the other hand,
these consumers may be adversely
affected by reductions in credit
availability as a result of the rule,
because they have few, if any, assets to
offer as collateral besides their
household goods and future wages; both
types of collateral are restricted to some
extent by the rule.
In its determination of unfairness, the
FTC considered the potential benefits to
consumers from eliminating
pychological injuries, such as
embarrassment, humiliation and anxiety
caused by the creditor remedies and
practices addressed in the rule.
Attempts to value these subjective
benefits by estimating consumers’
willingness to pay to avoid certain
creditor remedies were unsuccessful.
Other subjective benefits considered by
the FTC include procedural due process
protections, the opportunity to assert
valid claims and defenses, less
interference in employment relations,
retaining personal possessions and
household goods, and protection against
coerced settlements.
There are some statistics in the record
and testimony by both opponents and
proponents of the rule to indicate that
banks use the subject remedies less than
finance companies. Consequently, the
probability of injury is lower for bank
customers than for others. Even though
the probability of injury may be lower
for bank customers, it does not follow
automatically that bank customers
would benefit less from the rule. It is
conceivable that bank customers fear
injury from particular remedies more
than customers of other institutions and.
therefore, more highly value the benefits
of restrictions on creditor remedies.
D. Provisions o f the Rule
The provisions of the rule include a
disclosure requirement and prohibit an
accounting practice and four contract
clauses.
1. Consigners. This provision requires
that, before the contract is signed,
creditors provide cosigners with a
disclosure document explaining
cosigners' obligations. There are few
jurisdictions with statutes requiring
creditors to make such disclosures.
Legal aid attorneys asserted in a
National Consumer Law Center survey
that 80 percent of cosigners who use
legal aid service do not understand the
nature and extent of their obligation;
some cosigners believed they were
merely acting as a reference for the
principal debtor. Relatively few of the
legal service clients obtain bank credit.

Testimony in the record based on
creditor experience suggests that the
cost of providing cosigners with the
required disclosures would not be great.
Most creditor concerns about Cost
focused on cosigner provisions proposed
but not adopted into the final rule. The
concept of informing cosigners of their
obligations was not a major concern,
because disclosure does not cause
serious inconvenience to creditors in
making cosigner loans nor significantly
affect credit availability to
inexperienced borrowers, who must
depend on cosigners.
2. Late Charges. This provision
prohibits a bank "pyramiding” late
charges, i.e., assessing multiple late
charges based on a single late payment
that is subsequently paid in full on or
before the next timely payment. The late
change subtracted from the next timely
payment causes that payment to be
short, hence delinquent. The process
continues with each subsequent
payment. The cumulative impact of
repetitive late charges can be
substantial.
The extent of pyramiding cannot be
ascertained from the current record.
Pyramiding is prohibited in the states
that have adopted the Uniform
Consumer Credit Code. The problem is
most serious in situations where the
debtor becomes aware of pyramiding
late charges only when the final
payment is made. For example, some
consumers are given a book of coupons
at the time credit is extended rather
than a periodic statement. Bank
customers usually are given periodic
statements indicating the amount of late
charges as they accrue. No banks who
participated in the FTC proceedings
defended the use of pyramiding late
charges.
3. Confessions o f Judgment
(Cognovits). A confession of judgment is
a legal device whereby a debtor agrees
in the loan contract to a judgment
against hiniself in the event of default.
The debtor waives the right to notice
and the opportunity to be heard in court
before judgment is entered. Such a
waiver is constitutional, if the waiver is
made voluntarily, knowingly, and
intelligently. Therefore, the benefit of
the provisions accrues to those
consumers who waive their rights to due
process out of ignorance or inability to
effectively shop for credit on the basis
of contract clauses. The record contains
statements by legal aid groups that
lower income consumers, especially, are
unaware of the legal implications of the
cognovit clause, partly because it
conflicts with the common

understanding of basic due process
rights.
Few creditors and consumers would
be affected by the provision, because
most states restrict the use of
confessions of judgment. The use of this
creditor remedy is limited almost
entirely to Ohio, Illinois, Pennsylvania,
and Louisiana. The record does not
provide a precise measurement of the
extent cognovit clauses appear in
contracts. The Consumer Bankers
Association (CBA) surveyed its
membership and found that 20 percent
of the respondents included cognovit
clauses in a majority of their contracts,
where permitted by law. An NCLC
survey of legal aid attorneys indicated
that cognovit clauses were used, where
permitted by law, in 16 percent of bank
contracts. 21 percent of finance
company contract, and 300 percent of
contracts over all. Cognovits may reduce
costs somewhat because it is more
costly for the creditor to file suit in the
event of default, than to file a confession
of judgment.
4. Wage Assignments. A wage
assignment is a contractual transfer by a
debtor to* a creditor of the right to
receive wages directly from the debtor’s
employer. A wage assignment clause
can be invoked in the event of default
and the creditor is not required to obtain
a prior court judgment, as is the case
with wage garnishment. Most states
prohibit or restrict the use of wage
assignments in order to provide
consumers some protection. However,
the protections often fall short of
providing the consumer with a hearing
and an opportunity to assert defenses or
counterclaims.
Small loan and finance companies are
the primary users of wage assignments.
The NCCF reported that wage
assignments were included in 13 percent
of personal loan contracts of finance
companies and 3 to 4 percent of bank
contracts.
Garnishment is a more costly
substitute for wage assignments because
of court cost. The increased cost could
make the smallest loans to marginal
consumers unprofitable. However, bank
associations stated in the record that
they do not anticipate significant impact
from a prohibition on wage assignments.
5. Security Interests in Household
Goods. This provision prohibits the use
of nonpossessory security interests in
household goods, other than a purchase
money security interest. Consumers are
not prevented from borrowing on the
equity in their homes or pledging stocks,
bonds, liquid financial assets, or certain
other valuable assets excluded from the
definition of household goods, if the

Federal Register / Vol. 49, No. 232 / Friday, November 30, 1984 / Proposed Rules_______47045
assets are specifically encumbered in
the contract. The prohibition is to
protect debtors from the threat of losing
or the actual loss of property deemed
essential for a minimum standard of
living. Nearly all concern expressed in
the record by proponents of the rule
focused on blanket liens on household
goods. Repossessions seldom occur.
Legal aid attorneys have asserted that
their clientele have been injured by
“psychological harassment” in the form
of threats to repossess household goods.
The anecdotal information includes
cases in which consumers have agreed
to economic arrangements, such as debt
refinancing, only out of fear of losing all
their household goods.
Most states have enacted statutes
restricting installment sellers to a lien
on the goods sold, but few states have
similar restrictions on consumer loan
transactions. There appears to be
widespread use of non-purchase money
household goods as collateral by finance
companies, especially small loan
companies, which are licensed to lend
no more than a few hundred dollars. A
National Consumer Finance Association
survey of some 10,000 consumer
accounts held by finance companies
showed that household goods were
taken as collateral in over 60 percent of
personal loans. Although there are no
statistics in the record, there is
agreement between proponents and
opponents of the rule that banks use this
creditor remedy to a much lesser extent
than finance companies. Moreover,
unlike finance companies, banks seldom
engage in the practice of taking blanket
security interests in household goods,
according to testimony from the
American Bankers Association (ABA),
Creditors confirmed in the record that
household goods usually have little
resale value. Therefore, taking a security
interest in household goods is unlikely
to reduce creditors’ losses in the event
of default. However, because of the
significant value consumers place on
their own household goods, such
collateral functions as a deterrent to
default and as a signal to creditors of a
potential borrower’s good faith.
Creditors perceive that the potential
economic and psychological cost to
debtors of losing their houehold goods is
an effective deterrent to default.
Consequently, it is consumers who have
nothing other than household goods to
pledge as collateral, who are at risk of
losing access to credit from finance
companies and banks or paying higher
prices for unsecured personal loans.
6. Waivers o f Exemption. There are
statutes in most states that exempt
certain real or personal property from

judicial seizure in the event of default, in
order to allow debtors and their families
to retain basic necessities. This
provision of the rule would prohibit the
use of contract clauses waiving such
protective rights, unless the waiver
applies solely to property subject to a
security interest executed in connection
with the obligation.
The prohibition of waiver of
exemption clauses is likely to encourage
the taking of security interests in
property, to the extent permitted by the
“household goods’’ portion of the rule.
Creditors can seize secured property
without obtaining a judgment; unlike
unsecured property. Therefore, to the
extent security interests are encouraged,
collection costs might be reduced.
Apparently, some creditors find
waiver of exemption clauses to be an
effective tool in preventing default, if the
debtor is unaware of what property is
exempt from judgment under state law
and incorrectly assumes that basic
necessities may be lost. The record
shows that some creditors include
waiver of exemption clauses in
contracts even when state law makes
the clause unenforceable.
E. Potential Impact on Small Banks
The evidence in the record does not
indicate that the rule will have a
disproportionate effect on smaller
banks. In 1977, the ABA surveyed its
members in order to establish a profile
of consumer credit practices used by
banks. The ABA reported the results
from over 800 banks in testimony before
the FTC. The ABA testified that the
survey results were similar for small
and large banks, where small banks
were defined as those with less than
$100 million in deposits. However, the
results about small banks were not as
reliable statistically, because the
response rate was only 18 percent,
compared to 48 percent for large banks.
F. Summary and Conclusions
Banks participated fully in the FTC
rulemaking proceedings, in anticipation
of Board consideration of a similar rule
for banks,'as required jpy section 18(f) of
the FTC Act. The rulemaking record is
extensive. However, the considerable
effort by proponents and opponents of
the rule has not resulted in precise
measurement of potential net benefits.
The lack of precision is due to
significant methodological and data
problems in the econometric studies,
low survey response rates, and the
subjective nature of many of the
potential benefits to consumers.
The rule restricts creditors from taking
or receiving from consumers obligations
that constitute or contain a confession

of judgment or an assignment of wages,
primarily in order to assure consumers
of legal due process protection of a
hearing and an opportunity to assert
defenses of counterclaims. In addition,
restrictions are imposed on creditors
regarding waivers of exemptions and
nonpossessory security interests in
househould goods other than a purchase
money security interest, primarily to
protect delinquent debtors from losing
or from the threat of losing goods
considered to be basic necessities.
Finally, the rule prohibits the accounting
practice of “pyramiding” late charges
and requires creditors to disclose
cosigners’ rights and obligations.
Most comments in the FTC
rulemaking record received from the
banking industry addressed provisions
which have been eliminated or modified
in the final rule. FTC modification of the
security interest provision satisfied
many of the economic objections
expressed by creditors by permitting
purchase money security interests and
security interests in other than
household goods. However, bankers’
associations still express concern about
this provision. A potential benefit of the
provision is the elimination of the
"psychological” injury experienced by
delinquent debtors who lose or are told
by creditors that they might lose
household goods considered to be basic
necessities. Bankers’ associations argue
that the FTC exceeded its authority
when it considered “psychological”
injury in its determination that taking
non-purchase money security interests
in household goods is an unfair practice.
In addition, some bankers are concerned
that their lower income consumers with
no collateral to pledge other than
household goods will be restricted to
more expensive, smaller, unsecured
personal loans, if they qualify for credit
at all. Banks generally do not take non­
purchase money security interests in
household goods, according to ABA
testimony given to the FTC in 1978.
Nearly all comments in the record about
the potential costs and benefits of
restrictions on security interests focused
on blanket security interests, where all
of a debtor’s household goods are
subject to seizure and the potential
impact is greatest. The ABA testified
that, unlike finance companies, banks in
general seldom take blanket security
interests. Evidence in the records not
indicate whether there are subcategories
of banks, e.g., small or rural banks,
which depend on taking blanket security
interests to a significant extent.
The record suggests that the
probability of injury from creditor
remedies and practices addressed by

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Federal Register / Vol. 49, No. 232 / Friday, November 30. 1984 / Proposed Rules

the rule is lower for b^nk customers
than for customers of finance
companies. Finance companies are the
most frequent users of the creditor
remedies that would be prohibited by
the trade regulation rule. In general,
banks use the subject remedies less.
Furthermore, bank customers may better
comprehend contract terms and may be
more knowledgeable of legal
protections, if we assume that their
greater educational attainment, incomes,
and assets lead to more financial
sophistication.
List of Subjects in 12 CFR Part 227
Banks, Banking, Consumer protection.
Credit, Federal Reserve System,
Finance.
(5) Text of Proposed Revision
Pursuant to the authority granted in
section 18 of the Federal Trade
Commission Act (15 U.S.C. 57a), the
Board proposes to amend Regulation
AA, 12 CFR Part 227, by adding a
Subpart A consisting of the current
provisions and adding a new Subpart B,
as follows:
PART 227—UNFAIR OR DECEPTIVE
ACTS OR PRACTICES
Subpart A—Consumer Complaints
f
t

*

*

*

+

Subpart B—Credit Practices Rule
Sec.

227.11 Authority, purpose, and scope.
227.12 Definitions.
227.13 Unfair credit contract provisions
227.14 Unfair or deceptive practices
involving cosigners.
227.15 Unfair late charges.
227.16 State exemptions.
Authority: 15 U.S.C. 57a.

Subpart A— Consumer Complaints

Subpart B—Credit Practices Rule
§ 227.11

Authority, purpose, and scope.

(a) Authority. This subpart is issued
by the Board under § 18(f) of the Federal
Trade Commission Act, 15 U.S.C. 57a(f)
(section 202(a) of the Magnuson-Moss
Warranty—Federal Trade Commission
Improvement Act, Pub. L. 93-637).
(b) Purpose. Unfair or deceptive acts
or practices in or affecting commerce
are unlawful under section 5(a)(1) of the
Federal Trade Commission Act, 15
U.S.C. 45(a)(1). This subpart is intended
to define unfair or deceptive acts or
practices of banks in connection with
extensions of credit to consumers.
(c) Scope.'This subpart applies to any
bank that is insured or eligible to

become insured under the Federal
Deposit Insurance Act (12 U.S.C. 1811 et
se<7.). Compliance is to be enforced by:
(1) The Comptroller of the Currency,
in the case of national banks and banks
operating under the code of laws for the
District of Columbia;
(2) The Federal Deposit Insurance
Corporation, in the case of state banks
that are not members of the Federal
Reserve System; and
(3) The Boards, in the case of state
banks that are members of the Federal
Reserve System.
§227.12 Definitions.

For the purposes of this subpart, the
following definitions apply:
(a) “Consumer” means a natural *
person who seeks or acquires goods,
services, or money for personal, family,
or household use other than for the
purchase or real property.
(b) (1) “Cosigner” means a natural
person who assumes liability for the
obligation of a consumer without
receiving goods, services, or money in
return for the obligation.
(2) “Cosigner” includes any such
person whose signature is requested as
a condition to granting credit to a
consumer, or as a condition for
forbearance on collection of a
consumer’s obligation that is in default.
The term does not include a spouse
whose signature is required on a credit
obligation to perfect a security interest
pursuant to state law.
(3) A person who meets the definition
in this paragraph is a “cosigner”
whether or not the person is designated
as such on the credit obligation.
(c) “Earnings” means compensation
paid or payable to an individual or for
the individual’s account for personal
services rendered or to be rendered by
the individual, whether denominated as
wages, salary, commission, bonus, or
otherwise, including periodic payments
pursuant to a pensions, retirement, or
disability program.
(d) “Household goods” means
clothing, furniture, appliances, linens,
china, crockery, Jcitchenware, and
personal effects of the consumer and the
consumer’s dependents. The term
"household goods” does not include:
(1) Works of art;
(2) Electronic entertainment
equipment (other than one television
and one'radio);
*(3) Items acquired as antiques, that is
items over one hundred years of age,
including such items that have been
repaired or renovated without changing
their original form or character; and
(4) Jewelry (other than wedding rings).
(e) “Obligation” means an agreement
between a consumer and creditor.

(f) “Person" means an individual,
corporation, or other business
organization.
§ 227.13 Unfair credit contract provisions.

In connection with the extension of
credit to consumers, it is an unfair act or
practice for a bank to enter into or
purchase a consumer credit obligation
that conbtains any of the following
provisions:
(a) Confession o f judgment. A
cognovit or confession pf judgment (for
purposes other than executory process
in the State of Louisiana), warrant or
attorney, or other waiver of the right to
notice and the opportunity to be heard
in the event of suit or process thereon.
(b) Waiver o f exemption. An
executory waiver or a limitation of
exemption from attachment, execution,
or other process on real or personal
property held, owned by, or due to the
consumer, unless the waiver applies
solely to property subject to a security
interest executed in connection with the
obligation.
(c) Assignment o f wages. An
assignment of wages or other earnings
unless:
(1) The assignment by its terms is
revocable at the will of the debtor:
(2) The assignment is a payroll
deduction plan or preauthorized
payment plan, commencing at the time
of the transaction, in which the
consumer authorizes a series of wage
deductions as a method of making each
payment; or
(3) The assignment applies only to
wages or other earnings already earned
at the time of the assignment.
(d) Security interest in household
goods. A nonpossessory security interest
in household goods other than a
purchase money security interest.
§ 227.14 Unfair or deceptive practices
involving cosigners.

(a) Prohibited practices. In connection
with the extension of credit to
consumers, it is:
(1) A deceptive act or practice for a
bank to misrepresent the nature or
extent of cosigner liability to any
person; and
(2 ) An unfair act or practice for a bank
to obligate a cosigner unless the
cosigner is informed prior to becoming
obligated of the nature of the cosigner’s
liability.
(b) Disclosure requirement. (1) To
prevent the unfair or deceptive acts or
practices defined in this seciton, a
disclosure statement shall be given to
the cosigner prior to becoming obligated.
The disclosure statement shall consist of
a separate document that contains the
following statement and no other:

Federal Register / Vol. 49, No. 232 / Friday, November 30. 1984 / Proposed Rules
N otice to C osigner

You are being asked to guarantee this debt.
Think carefully before you do. If the borrower
doesn’t pay the debt, you will have to. Be
sure you can afford to pay if you have to, and
that you want to accept this responsibility.
You may have to pay up to the full amount
of the debt if the borrower does not pay. You
may also have to pay late fees or collection
costs, which increases this amount.
The creditor can collect this debt from you
without first trying to collect from the
borrower. The creditor can use the same
collection methods against you that can be
used against the borrower, such as suing you,
garnishing your wages, etc. If this debt is ever
in default that fact may become a part of
your credit record.
This notice is not the contract that makes
you liable for the debt

(2) In the case of open-end credit, the
disclosure statement shall be given to
the cosigner prior to the time that the
agreement creating the cosigner's
liability for future charges is executed.
(3) A bank that is in compliance with
this paragraph may not be held in
violation of paragraph (a) of this section.
§ 227.15 Unfair late charges.

(a) In connection with collecting a
debt arising out of an extension of credit
to a consumer, it is an unfair act or
practice for a bank to levy or collect any
deliquency charge on a payment, when
the only delinquency is attributable to
late fees or delinquency charges
assessed on earlier installments, and the
payment is otherwise a full payment for
the applicable period and is paid on its
due date or within an applicable grace
period.
(b) For the purposes of this section,
collecting a debt means any activity,
other than the use of judicial process,
that is inteded to bring about or does
bring about repayment of all or part of
money due (or alleged to be due) from a
consumer.
§ 227.16 State exemptions.

(a) General rule. (1) An appropriate
state agency may apply to the Board for
a determination that:
(1) There is a state requirement or
prohibition in effect that applies to any
transaction to which a provision of this
subpart applies; and
(ii) The state requirement or
prohibition affords a level of protection
to consumers that is substantially
equivalent to, or greater than, the
protection afforded by this subpart.
(2) If the Board makes such a
determination, the provision of this
subpart will not be in effect in that state
to the extent specified by the Board in
its determination, for as long as the state
administers and enforces the state
requirement or prohibition effectively.

(b )
Applications. The procedures
under which a state agency may apply
for an exemption under this section are
the same as those set forth in Appendix
B to Regulation Z (12 CFR Part 226).
By order of the Board of Governors of the
Federal Reserve System, November 26,1984.
W illiam W . W iles,

Secretary of the Board.
[FR Doc. 84-313SS Piled 11- 29- 8 * 8*5 am]
e&LING CODE 6210-0 t-M

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Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102