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For release on delivery
Statement of J. L. Robertson, Vice Chairman
Board of Governors of the Federal Reserve System
before the
Subcommittee on Consumer Affairs
of the
House Banking and Currency Committee
on
H.R. 11601 and related bills
August 7, 1967
I appreciate this opportunity to present the views of the
Board of Governors on H.R. 11601, the ffConsumer Credit Protection
Act11, and the related bills being considered by this committee.
The Board believes that important social as well as
economic benefits may be expected to flow from a more effective
disclosure of credit costs to consumers.
As reasonable and
workable ways are found to accomplish this objective, the market
system should function more efficiently.
Existing trade practices
generally fall short of the kind of disclosure that is necessary
to enable potential borrowers to make informed judgments about the
use of consumer credit.
Providing consumers with the basic informa
tion they need to compare alternative credit plans and to compare
credit costs with returns on their savings should not only help
them in managing their money to better advantage, but should also
strengthen competition, with resultant benefits for the economy.
The price system is a fundamental attribute of a freeenterprise, competitive economy.
The sale of goods and services
in exchange for money is the method by which the vast majority of
transactions are consummated, and permits a degree of specialization-with its resulting
efficiencies--that otherwise would be impossible.
And for this system to function most effectively, it is necessary
that the prices at which goods and services are available be stated
by the seller, and known to the buyer, in standardized, meaningful
2
terms.
It is in this way that the buyer can be informed of his
options— among both competing sellers and competing services— so
that he may use his purchasing power in what to him is the most
desirable way.
Prices of goods and services are- usually stated in money
terms, but a meaningful price-comparison requires also some
knowledge about the service to be acquired^. namely, quantity and,
where applicable, quality and duration of use.
Whenthe service
to be acquired is the use of consumer credit» quantity and duration
of use- are the important variables.
Duration of use is the period
for which the credit is extended, of course, and quantity is the
amount of credit used .on average over this period.
It is-customary
in finance to standardize the time-period variable by stating price
in terms of charge per year, and the quantity variable by stating price per hundred dollars.
Now it would be possible to meet this price specification
standard by stating the price of credit as dollars and cents per
hundred dollars borrowed on average per year.
But this is a
complex form of statement, and it produces exactly the same result
as the use of a percentage rate.
That is, on a 1 year loan of
$1C0Q, payable in equal monthly installments and carrying a charge
of $60 (a so-called 6 per cent add-on loan), the charge per annum
on the average amount of loan available to the borrower may be
stated at the standardized rate of either $10.90 per hundred dollars
or 10.9 per cent.
-3-
The important point here is that the borrower has available
for use, over the life of the loan, not $1000 but an average of $542,
because each monthly payment includes repayment of principal as well
as interest,
the Board believes that to state the standardized
charge as applying to anything other than the average amount of
credit available to the borrower would distort the true relationship
between cost and benefit received,
the Board is also convinced
that it is preferable to state the charge in percentage rather than
dollar terms, and on an annual basis rather than for some other
period.
This would facilitate comparison with other financial
prices, such as the percentage charge on single-payment loans, the
interest rate paid on savings accounts, and the yield available to
investors on Government bonds and other securities,
thus, we are
in basic agreement with the provisions of H.R. 11601 in these
respects.
this year, for the first time since Senator Douglas
introduced his initial "truth in lending" bill in 1960, the Senate
has approved a credit cost disclosure bill,
the objective of S. 5,
as passed by the Senate, is to see that the consumer is provided
with the information that he needs to make up his own mind about
whether to borrow, and if so, where.
It does not purport to impose
rate ceilings or any other restraints on terms and conditions, but
only to assure full disclosure,
the Board agrees with this approach,
and favors enactment of S. 5, although in one important respect we
believe that the disclosure provisions of H.R. 11601 are preferable.
-4-
The provisions of H.R. 11601 relating to open end credit
plans ("revolving credit") offer important advantages, we believe,
over the comparable provisions of S. 5.
Under the Senate bill, an
annual percentage rate need not be disclosed for most revolving
credit plans; although the percentage rate per period must be
disclosed.
To guard against the possibility that existing forms
of ordinary installment credit might be converted to revolving
credit in order to escape disclosure of an annual percentage rate,
the Senate bill's exemption for revolving credit is limited to
plans that meet three tests.
To qualify for exemption a plan must
require payment of at least 60 per cent of the amount of the credit
within one year, must not involve retention by the creditor of a
security interest in property, and must provide for crediting
prepayments immediately to reduce the balance due.
These compromise provisions were adopted in response to
criticism by representatives of a segment of the retail industry,
who argued that it would be unfair to require disclosure of an 18
per cent annual percentage rate for revolving credit plans under
which a monthly charge of 1-1/2 per cent was imposed, because that
would ignore the "free ride" period between the date the sale was
made and the last date on which the bill could be paid without
imposition of any finance charge.
Inclusion of the "free ride"
period--that is, calculation of the annual percentage rate from
the date of purchase rather than the date on which payment must be
made to avoid a finance charge--would, it is true, produce annual
rates below 18 per cent where a monthly charge of 1-1/2 per cent is
imposed.
But an 18 per cent annual rate is the exact equivalent
of a 1-1/2 per cent monthly rate and is a fair and meaningful figure
if one assumes that the credit begins at the end of the "free ride”
period.
We believe that this is the significant date from the
point of view of a customer who is considering whether to pay the
entire balance and avoid any finance charge.
In eliminating the revolving credit exemption, the
sponsors of H.R. 11601 have recognized the importance of providing
consumers with a standardized method of comparing credit costs,
and have avoided giving one type of creditor an unfair competitive
advantage over another.
In addition to rate information, knowledge of the
specific accounting practices employed by the store is necessary
for accurate comparison of credit costs in the case of open end
credits.
Though it is impossible to calculate in advance the
influence of such differing practices on effective finance charges,
the consumer should at least be alerted in clear and unambiguous
language to the differences that may exist.
Thus, the Board has
recommended, and both the Senate bill and H.R. 11601 require, that
information disclosed on all open end credit plans must include
the duration of any free period allowed, the method of computing
the balance against which the finance charge is imposed, and minimum
or special charges (if any).
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Such information would be disclosed in some detail when
the account is opened, and, in addition, a brief disclosure of the
essentials would be required in the monthly bill.
We believe that this information would give the credit
user a picture that is fair to the store, informative to the customer,
useful in comparing charges from store to store, and broadly comparable
to other rates charged for credit or paid on savings.
With the exception of the provisions on revolving credit,
however, the Board believes that the Senate-passed bill is preferable
to H.R. 11601.
As we see it, the major differences, insofar as
disclosure is concerned, relate to real estate credit, insurance
premiums, transactions involving small finance charges, and
effective date.
We believe first-mortgage loans on real estate should
be exempt, as provided in S, 5, because there is already reasonable
disclosure in this field and disclosure requirements developed
for relatively short-term credit are inappropriate for loans with
maturities of 20 to 30 years.
To require that the annual percentage
rate be recomputed to reflect costs incidental to the extension of
credit would involve particularly troublesome questions in first
mortgage lending because of the number and variety of the costs
assessed at closing, many of which would be incurred, in whole or
in part, by a prudent cash buyer if no credit was extended.
While
it would be possible to spread discounts and other credit-related
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costs over the life of the contract as a part of the annual rate
of finance charge, we feel that this might tend to mislead the
borrower.
Such charges are in the nature of "sunk cost" and are
borne in full by the borrower whether the loan is repaid in 1 year
or 30.
To require disclosure of total dollar finance charge,
including interest payable over the whole life of the contract,
might be more misleading than helpful.
The present value of a
dollar of interest to be paid 20 to 30 years hence is substantially
less than one dollar, and relatively few first mortgage contracts
appear to be carried all the way to maturity.
The Board does believe, however, that second mortgage
loans, land purchase contracts, and similar transactions should be
covered.
Such credits typically are extended for much shorter
terms than first mortgages, and discounts, fees, and charges can
make up a much larger proportion of total finance charges.
Moreover,
second mortgage credit is often obtained for purposes such as home
modernization, durable goods purchases, and debt consolidation-consumer transactions of the type usually financed with consumer
installment credit.
One of the issues that has proved troublesome during
consideration of disclosure legislation has been the question of
how to treat insurance premiums on policies taken out by borrowers
as a condition of, and covering the amount of, the credit contract.
If such insurance is required, the borrower bears a cost which
probably would not have been incurred if no credit’were obtained.
-
8-
Moreover, exclusion of insurance from the finance charge creates a
potential area of abuse, since some lenders may be encouraged to
promote high-cost insurance to compensate for a somewhat lower
finance charge.
The fact remains, however, that inclusion in the finance
charge of premiums for insurance that provides a benefit to the
borrower over and above the use of credit would overstate the actual
charge for credit.
Therefore, we think that such premiums are not
properly regarded as part of the finance charge, and should be
specifically excluded, as provided in S. 5. We do believe, however,
that the dollar amount of any such premiums included in the credit
extended should be itemized, again as provided in S. 5.
Another provision of S. 5 that is omitted from H.R. 11601
relates to closed end (installment) credit transactions involving
small amounts.
Presumably no one wants to press disclosure of
credit costs to the point where borrowers are denied access to
credit at any price.
But to require disclosure of an annual
percentage rate in small closed end credit transactions might have
just that result.
For credit of this kind, a high effective rate
may be justified to compensate the creditor for the relatively high
out-of-pocket costs of handling the transaction.
However, he may be
understandably reluctant to disclose a high annual percentage rate,
and might decide instead simply to discontinue this type of credit.
S. 5 would exempt transactions involving a finance charge of less
than $10 from the requirements of disclosure of an annual percentage
rate, although other disclosure requirements would still apply.
believe that some such exemption is needed.
We
*9^
Turning to the question of effective date, the Board
believes that in order to allow sufficient time for consultation,
preparation, and publication of regulations by the Board as well
as time for those subject to the regulations to study their
provisions, procure rate tables, and train their personnel in
the new procedures, disclosure requirements should not take effect
prior to one year after enactment.
The Senate bill provides for
additional time, so that State legislatures may have time to make
any necessary amendments to their existing statutes and to pass
similar disclosure legislation.
The Board shares the hope expressed
by the Senate committee that enactment of Federal disclosure
legislation will prompt the States "to pass similar legislation
so that after a period of years the need for any Federal legislation
will have been reduced to a minimum" (S. Rept. 392, p. 8).
In addition to the "truth in lending" provisions just
discussed, H.R. 11601 embodies provisions regulating credit
advertising that affects interstate commerce.
Since the information
available to the Board in this area is extremely limited, we have
little basis for comment on these provisions.
On their face, they
would seem in effect to prohibit advertisers from specifying rates
or other credit terms on radio or television, since it would be
impracticable to make the detailed disclosures that would then be
required.
Perhaps it is desirable to limit this kind of advertising
to generalities such as "easy credit available," but such a
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restriction might also operate to prevent creditors who offer lower
rates or other advantages from advertising that fact on the air,
thus inhibiting competition.
The bill would also prohibit creditors from advertising
"that a specified periodic credit amount or installment amount can
be arranged, unless the creditor usually and customarily arranges
credit payments or installments for that period and in that amount."
A determination of what terms are customarily and usually offered
by a creditor would pose considerable problems of investigation and
enforcement, and perhaps for that reason provisions are included in
the bill (section 209) for administrative enforcement which closely
parallel those now provided in section 5 of the Federal Trade
Commission Act.
No such provisions are included in S. 5; the Senate
committee report on the bill stated that the "committee has not
recommended investigative or enforcement machinery at the Federal
level, largely on the assumption that the civil penalty section
will secure substantial compliance with the act" (S. Rept. 392,
p. 9).
The bills before you provide for civil actions, in which a
creditor who fails to comply with the disclosure requirements would
be liable to the debtor for $100 or twice the finance charge, which
ever is greater (but not more than $1,000), plus attorneys' fees
and court costs.
The Board hopes that these civil remedies, supple
mented as they are by criminal sanctions, will prove adequate to
assure compliance with "truth in lending" requirements.
-11
Self-enforcement is probably less effective, however, in
the field of advertising.
An individual borrower could hardly be
expected to prove in a private law suit, for example, that a creditor
did not customarily and usually offer particular credit terms.
If
you determine that regulation of advertising is needed, we urge that
you place this responsibility in the Federal Trade Commission, which
has the benefit of years of experience in regulating advertising,
and has an investigative staff and established administrative
procedures for effective enforcement.
One provision of H.R. 11601, not included in the bill that
passed the Senate, prohibits any creditor, in extending credit to
an individual, from demanding or accepting any finance charge in
excess of (1) the limit under State law, if any, or (2) 18 per cent
per year, whichever is less.
The Board is sympathetic with the
apparent purpose of this provision, which is to prevent lenders
from overcharging their customers.
Nevertheless, we strongly urge
that it be deleted from the bill.
Our objections to a statutory interest rate ceiling relate
principally to its inflexibility.
A single ceiling cannot take
account of the widely varying circumstances surrounding individual
credit transactions, such as amount of credit, costs of handling,
purpose of loan, quality of collateral, and credit standing of the
borrower.
Hence we fear that potential borrowers, with legitimate
and often compelling needs for credit, would be refused accommodation
within the rate ceiling set by law.
-12-
The selection of an appropriate ceiling rate also would
pose very serious problems for the Congress.
A maximum of 18 per
cent might seem generous— overly so, in the view of many--but it
probably would not cover lender costs in some types of transactions.
For a small loan, the finance charge may need to be very high-expressed in percentage terms--since many costs incident to the
transaction are more or less fixed, regardless of the size of the
loan.
Moreover, collection costs can be very substantial on some
classes of loan, and these too bear little relation to the amount
of credit extended.
Indeed, almost all states now have special small
loan laws, in recognition of the impossibility of providing some
types of credit to consumers within the ordinary usury ceiling.
For
companies chartered under these laws, permissible finance rates run
as high as 42 per cent per annum in some States.
Effective enforcement of a ceiling finance charge also
could be very difficult to achieve.
There is a strong possibility
that many consumers, refused credit from legitimate sources within
the statutory ceiling, would turn to illegal lenders (the so-called
loan sharks) and other unethical sources of credit.
Some retail
merchants, dependent chiefly on credit business, would be tempted
to avoid the ceiling simply by inflating the price of goods sold.
Under-the-counter agreements and devices to conceal part of the
finance charge would flourish.
As is often the case, the stronger
the incentives to circumvent a restriction, the more difficult it
is to enforce.
-13-
And as you know, in some situations, there is a tendency
for ceilings to become floors as well.
I am sure none of us would
like to see a Federal ceiling rate operate to raise borrowing costs.
For all of these reasons, the Board strongly urges deletion
of this provision.
We prefer to see the problem attacked through the
disclosure requirements of the bill, in the belief that informed
consumers will be in a better position to choose among the various
financing options available to them in their particular circumstances.
H.R. 11601 contains sections not in the Senate bill that
prohibit garnishment of wages and use of any documents, in connection
with the extension of credit, authorizing the confession of judgment
against the debtor.
It is abundantly clear that both procedures are
subject to serious abuse in the hands of unscrupulous creditors.
An unwary consumer can sign away most of his rights to legal defense
against creditor claims and, upon failure to make a payment, may find
his wages attached without prior notice.
Indeed, in many States he
may be deprived of the major share of his current income, with
obvious consequences for the continued well-being of his family, and
often the fact of garnishment may jeopardize his job.
These considerations raise serious questions as to whether
such practices should be condoned from the standpoint of public
policy.
The Board is not prepared to comment on the legal points at
issue, or on the social consequences involved in continuation or
prohibition of these practices.
But we should bear in mind that
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these devices, by increasing the security of the creditor, make him
willing to extend credit to borrowers that he otherwise might not
accommodate.
We have no estimate of the number of credit contracts
that would not be made in the absence of wage garnishment and
confessions of judgment.
But it is obvious that there must be many
small borrowers with relatively poor credit records who have little
in the way of security to offer the lender other than the right to
quick legal action and attachment of wages.
As you know, the President has directed the Attorney
General, in consultation with the Secretary of Labor and the Director
of the Office of Economic Opportunity, to make a comprehensive
study of the problems of wage garnishment.
The Board believes that
a decision on this matter, and on the related problem of confessions
of judgment, should be deferred until the Attorney General's report
and recommendations become available for your consideration.
Section 207 of the bill assigns the Board broad authority
to prescribe regulations governing the extension and maintenance
of margin requirements on commodity futures contracts.
It is stated
that the purpose of such regulation is to prevent excessive specula
tion in, and use of credit for, trading in such contracts with
undesirable effects on prices.
There may well be need to attempt through regulation to
dampen some of the speculative movements in commodity futures markets,
with their possible repercussions on spot commodity prices.
The
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Board recognizes that the futures markets perform a valuable
economic function in permitting producers and users of cbffitnoditifes
to hedge their operations against near«term price changes, and thst
speculators are an essential part of the futures market in balancing
the supply of and demand fox’ futures contracts.
But we also recognize
that speculative sentiment at times can be so massive and one«sided
that it constitutes a disruptive force in the functioning of markets.
In any event, however, we feel that the Department of
Agriculture, rather than the Board, would be much the more appropriate
agency to administer any such commodity market legislation.
The
formulation of workable regulations, as well as their administration,
requires close and continuing contact with the futures markets and
a knowledge of present and prospective demand and supply conditions
in the spot commodity markets underlying them, which the Board simply
does not have.
Furthermore, the principal concern of the Federal Reserve
is with credit conditions, and it is our belief that relatively
little credit is used in connection with futures trading.
The margin
in such trades, as we understand it, is in the nature of "earnest
money" assuring completion of the contract by buyer and seller at a
later date.
Unlike the stock market, title to property does not
change hands; there is no immediate payment and hence no need for
credit.
-16-
The statutory purpose of margin regulation as applied to
stocks is to prevent the excessive use of credit in stock market
trading.
Since rapid growth of credit-financed margin purchases
can contribute to destabilizing speculative advances in stock
prices, one indication that use of stock market credit may be
becoming excessive is a rapid growth in margin credit coincident
with sharp increases in stock trading activity, and substantial
gains in the stock price averages.
At such times the Federal
Reserve may increase margin requirements in order to slow the rate
of stock market credit expansion.
But the governing purpose is not
to affect stock price movements, either for individual stocks,
groups of stocks, or the market in general.
Regulation of stock
market credit, not stock prices, is the goal.
We understand that the Department of Agriculture is
currently studying the advisability of applying margin requirements
to trading in those commodity futures markets under the general
supervision of the Commodity Exchange Authority.
The Board
would like to reserve judgment on this matter pending completion
of the Department's study.
Section 208 of the bill would give the Board, upon a
Presidential determination that a national emergency exists,
authority to impose selective controls on the use of consumer
credit.
This could be done either directly, by limiting the terms
on which credit is made available to individual borrowers, or
-17-
indirectly, by limiting the ÜBfe o£ funds by creditors to finance
consumât crédit: opérations.
There is clearly no need to activate
stich controls at present, in our view, but it is possible to visualize
a combination of economic circumstances in which this authority could
prove a useful supplement to our general instruments of monetary
and credit control.
We do question, however, whether an authorization for
standby selective credit controls properly belongs in an Act
intended to provide greater protection for consumers in their use
of credit.
Standby credit controls would only remotely--and
fortuitously--protect the consumer in his individual use of credit.
The object of such controls, activated only in a national emergency,
would be to limit the consumer's recourse to credit for purposes of
national economic stabilization.
The Board cannot conceive of the
use of these controls to protect the consumer against himself by
denying him overly liberal credit terms or excessive use of credit
relative to his means.
The use of selective credit controls is a controversial
matter.
There are always bound to be differences of opinion as to
when such controls should be invoked, how broad their coverage
should be, how they should be administered, and when they should be
suspended.
Furthermore, there is some question as to the desirability
of singling out this one area for standby authority, rather than
considering the whole array of special actions that might prove
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necessary or desirable in a national emergency.
We therefore
respectfully suggest to the Committee that it would be preferable
to consider the question of selective consumer credit controls in
a broader context and to delete this provision from the pending
bill.
In summary, let me express the hope that your Committee
will act favorably on S. 5, with an amendment eliminating the^
revolving credit exemption.
The Board of Governors believes there
is a need for this legislation, and while we have no special
qualifications for the function of writing regulations to implement
it, we will do our best to carry out this responsibility if the
Congress assigns it to us.
If, however, you determine that there
is a need for additional measures, such as regulation of advertising
or trading in commodity futures, to protect consumers, responsibility
for their administration and enforcement should be assigned elsewhere.
@FedFRASER