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Fo r release on delivery Statement by Jeffrey M . Member, Bucher B o a r d of Governors of the Federal R e s e r v e S y s t e m before the S u b c o m m i t t e e on C o n s u m e r Credit of the C o m m i t t e e on Banking, Housing and U r b a n Affairs United States Senate M a y 17, 1973 O n behalf of the B o a r d of Governors, I wish to express oar appreciation for having this opportunity to c o m m e n t on the report of the National C o m m i s s i o n on C o n s u m e r Finance, entitled " C o n s u m e r Credit in the United States. n T h e C o m m i s s i o n w a s created by C o n g r e s s to ’’appraise the functioning and structure of the c o n s u m e r finance industry” and to consider, a m o n g other things, the ’’adequacy of existing arrangements to provide c o n s u m e r credit at reasonable rates. ” T h e subject is an important one, and the report merits careful attention. Because of the breadth of the report, the Board's c o m m e n t s will focus on those issues which appear of special importance or which bear directly on the B o a r d ’s activities. T h e first section of m y testimony will deal with the report's r e c o m m e n d a t i o n s a i m e d at strengthening competition. Following this discussion will be successive sections on interest rate ceilings, supervisory m e c h a n i s m s , the electronic funds transfer system, and Truth in Lending. Strengthening Competition A m o n g the n u m e r o u s r e c o m m e n d a t i o n s in the report are several that are linked to the p r e m i s e that the best m e a n s of assuring adequate credit for c o n s u m e r s at reasonable rates is to m a k e the - 2- m a r k e t s for such credit m o r e competitive. T h e C o m m i s s i o n concluded that s o m e of the laws and regulations designed to protect consumers, particularly at the State level, have had the unintended effect of inhibiting competition in the granting of c o n s u m e r credit and of needlessly segmenting credit markets. T h e C o m m i s s i o n therefore urges a careful review of present laws and regulations with a view toward eliminating impedi m e n t s to competition a m o n g suppliers of c o n s u m e r credit and achieving, insofar as consistent with other policies, the broadest possible penetration by all credit grantors in all fields of c o n s u m e r credit. T h e B o a r d shares the view stressed in the report that w e should rely basically on vigorous competition to provide optimal p e r f o r m a n c e in t e r m s of the price and availability of c o n s u m e r credit. This w a s an important consideration in the shaping of the 1970 a m e n d m e n t s to the B a n k Holding C o m p a n y Act, and the B o a r d has had this principle very m u c h in m i n d in carrying out its responsibilities under that Act. W e have authorized bank holding c o m p a n i e s to establish subsidiary finance companies, and w e have established procedures that encourage de novo entry. Applications for such entry are p r ocessed by the R e s e r v e B a n k s under delegated authority. They -3- are approved 45 days after the Res e r v e B a n k receives a copy of a notice of the proposal published in newspapers in the communities to be served, unless the Res e r v e Ba n k determines that adverse factors require m o r e careful scrutiny of the application. In that event, the application is processed under the procedures applicable to acquisition of going concerns, which require m o r e time to complete. A s w e read the report, it s e e m s to suggest that w h e r e the possibility for de novo entry exists, as is n o w the case for bank holding companies, entry by acquisition of an existing finance c o m pany should be prohibited. T h e B o a r d believes such an unequivocal prohibition would be unnecessarily restrictive, and inconsistent with the intent of Congress in enacting the 1970 a m e n d m e n t s to the B a n k Holding C o m p a n y Act. Although the Board's procedures encourage de novo entry, w e believe that acquisition of an existing c o m p a n y in specific instances m a y also be pro-competitive. We have denied applications to acquire existing c o m p a n i e s that c o m p e t e significantly with the applicant in geographical areas they already served. Perhaps because m o s t applicants are a w a r e of the Board's pro- competitive policies, however, m o s t of the applications that have c o m e before the B o a r d to acquire existing finance c o m p a n i e s have involved c o m p a n i e s that serve m a r k e t s geographically separated f r o m those - served by the applicant. 4- In the few cases approved that did involve an overlap, the co m p a n i e s acquired had m a r k e t shares so small as to rule out the possibility of an adverse effect on competition. W h e n no significant a m o u n t of existing competition would be eliminated, acquisitions of existing c o m p a n i e s can be procompetitive. F o r example, affiliation with the holding c o m p a n y m a y assist the acquired c o m p a n y in raising the funds it needs to compete m o r e vigorously for additional c u s t o m e r s and in recruiting and retaining competent, aggressive m a n a g e m e n t . Mo r e o v e r , once a bank holding c o m p a n y m o v e s into n e w territory via an acquisition, it m a y start de novo offices f r o m the foothold it has acquired. Thus, a bank holding c o m p a n y in North Carolina m a y gain the B o a r d ’s approval to acquire a c o n s u m e r loan firm in Texas, then might p r oceed to enlarge its subsidiary's operations in Te x a s through de novo expansion. a process. Substantial n e w competition can result f r o m such T h e B o a r d believes, therefore, that entry de novo and, under appropriate circumstances, entry by acquisition, should continue to be allowed in order to achieve the C o m m i s s i o n ' s goal of promoting competition. T h e B o a r d agrees with the C o m m i s s i o n that competition in c o n s u m e r lending m a r k e t s should be strengthened by permitting -5- savings and loan associations and mutual savings banks to m a k e c o n s u m e r loans. Relaxing restrictions on the lending p o w e r s of thrift institutions would also i m p r o v e the stability of their earnings during periods w h e n rising m a r k e t interest rates m a y necessitate increases in the rates they m u s t pay on deposits. But in expanding c o n s u m e r lending p o w e r s for thrift institutions care m u s t be taken to avoid a serious shrinkage in the funds available for m o r t g a g e lending. This risk could be lessened by limiting the percentage of assets these institutions m a y devote to c o n s u m e r loans along the lines suggested by the C o m m i s s i o n , possibly with provisions for a gradual phasing-in of the broader lending powers. Besides encouraging entry by savings and loan associations, mutual savings banks, and finance companies affiliated with banks, the C o m m i s s i o n recognizes the need to stimulate stronger interest on the part of banks themselves in m a k i n g small personal loans. Although s o m e banks are active in this market, the industry as a whole has a clear opportunity to i m p r o v e services to c o n s u m e r s by m a k i n g m o r e loans of this type. This has been one reason w h y the B o a r d has denied applications by bank holding c o m p a n i e s to acquire finance c o m panies that would serve the s a m e m a r k e t as the subsidiary banks. It should be recognized, however, that banks are likely to sh o w only m i n i m a l interest in entering this business in States w h e r e appli cable rate ceilings are low relative to the cost of m a k i n g the loans. -6- Rate Ceilings Throughout the report, there is considerable e m p h a s i s on the unfavorable effects of rate ceilings in m a r k e t s for c o n s u m e r credit. T h e report’s pro-competitive r e c o m m e n d a t i o n s seek to achieve, through a series of related steps, a m a r k e t in wh i c h interest rates will be held to reasonable levels by competitive forces rather than legal ceilings. T h e B o a r d recognizes that judgments differed a m o n g C o m m i s s i o n m e m b e r s as to w h e n or whether rate ceilings should be raised or removed, but w e agree with the C o m m i s s i o n ' s r e c o m m e n d a t i o n that ’’Policies designed to p r o m o t e competition should be given the first priority, with adjust m e n t of rate ceilings used as a c o m p l e m e n t to expand the availability of credit. ” A s has been a m p l y demonstrated in the m o r t g a g e market, rate ceilings tend to divert funds a w a y f r o m the controlled sector of credit if they are too low relative to other m a r k e t rates. In implementing the B a n k Holding C o m p a n y Act, the B o a r d is encouraging entry of n e w lenders into the field, and w e can hope that as the n u m b e r of strong and viable competitors g r o w s through this and other m e a s u r e s , rate ceilings ultimately will b e c o m e u n n ecessary in s o m e States. If that proves to be the case, perhaps other States will be m o v e d to evaluate the competitiveness of their markets, as the report urges, and to consider whether modification or r e m o v a l of their ceilings could strengthen competition. -7- Supervisory M e c h a n i s m s T he report of the C o m m i s s i o n recognizes a growing public interest in obtaining fair and effective remedies for abuses in the c o n s u m e r credit field. Congress has responded to this public interest by enacting m e a s u r e s such as the Truth in Lending Act. The Board of G overnors supported this initiative in the belief that it not only protected consumers, but also helped to m a k e credit m a r k e t s m o r e responsive to competition. Needless to say, Congressional concern about c o n s u m e r p r o b l e m s is also reflected in the actions of agencies of government, including our Board. T h e Board's role in the conduct of m o n e t a r y policy reflects our concern for c o n s u m e r s in a broad sense, but w e are involved in m o r e direct efforts, such as in prescribing Truth in Lending regulations. M o r e o v e r , w e recognize the need to pay increasing attention to the interests of c o n s u m e r s in connection with the supervision of banks. T h e C o m m i s s i o n questions whether an agency that supervises banks, and thus tends to fucus on issues of maintaining soundness and solvency, is capable of broadening its outlook sufficiently to give proper consideration to consumers. T h e B o a r d believes it is entirely possible to reconcile the need to maintain sound, strong banks with the need to ensure that banks are treating their c u s t o m e r s fairly. W e recognize, however, that the C o m m i s s i o n ’s question is a valid one, shared by others w h o are concerned with c o n s u m e r protection, and it therefore deserves serious consideration. It m a y be useful in this connection to mention at this point a few e x a m p l e s of actions by the B o a r d to protect c o n s u m e r s and i m p r o v e the financial services available to them. T h e s e e x a m p l e s are not offered in a spirit of self-congratulation, although w e are proud of our record, but rather to indicate the strong similarities between the goals of the C o m m i s s i o n and those of the Board. Let m e first say a w o r d about the Board's implementation of the Truth in Lending Act. W e have been pleased over the years to have learned f r o m various m e m b e r s of C ongress of their satisfaction with the job the B o a r d has done under that legislation. T h e m o s t d e m a n d i n g aspect of this a s signment has been the drafting of appropriate regulations to i m p l e m e n t the Act. S o m e of the Board's actions have necessarily produced disagreement, and occasionally litigation. In one e x a m p l e of the latter, the B o a r d w a s extremely gratified recently w h e n the U. S. S u p r e m e Court upheld the "more-than-four-instalment under Truth in Lending. rule" issued Recognizing that the Act contained a potential loophole which permitted retail creditors to bury credit -9- costs in their cash prices and thereby defeat the congressional purpose of the Act, the B o a r d amplified the A c t ’s definition of c o n s u m e r credit by requiring Truth in Lending disclosures in any obligation repayable in m o r e than four instalments. T h e Board's action in this regard w a s criticized by s o m e persons as reflecting an unduly paternalistic attitude toward the consumer. But the B o a r d felt the rule w a s needed, and w e are naturally pleased to see that view vindicated. Although our p r i m a r y responsibility is the issuance of regulations implementing the Act, w e have also felt that an important corollary to the rulemaking function is public education. Two special educational efforts are worth mentioning here, one being the production and distribution of the pamphlet, " W h a t Truth in Lending M e a n s to You. ” O v e r three million copies of this pamphlet have been distributed in the English language version, another half million in a Spanish language edition. T h e B o a r d also has available for distribution without charge an informational package on Truth in Lending that has been extremely popular with schools, both at the high school and college level. - 10 - Aside f r o m Truth in Lending, however, there are other activities of the B o a r d on behalf of c o n s u m e r s which I believe are too often overlooked. In acting on holding c o m p a n y formations and acquisitions, for example, one of the crucial decisional factors is the extent of public benefits which can be expected to flow f r o m each application. T h e B o a r d is very m u c h a w a r e of the importance of such decisions in fostering a competitive banking s y s t e m that will serve c o n s u m e r s better. It m a y be helpful, as well, to cite e x a m p l e s of specific B o a r d actions to correct abuses or i m p r o v e financial services to the public. Recently, the B o a r d ruled (1973 Bulletin 19) that applications by a bank holding c o m p a n y to underwrite credit life and credit accident and health insurance will be approved only if the applicant demonstrates that benefits to the c o n s u m e r or other public benefits will ensue. Such a showing normally is m a d e by a projected reduction in rates, or increase in policy benefits, due to bank holding c o m p a n y p e r f o r m a n c e of this service. In 1970, in an action to help savers, the B o a r d issued an interpretation to its Regulation Q (1970 Bulletin 279) requiring m e m b e r banks to inform their c u s t o m e r s w h o maintain time or savings accounts of the m e t h o d s used in the computation and p a y m e n t - of interest on those accounts. 11- T h e interpretation provides that if a m e m b e r bank m a k e s a change in its m e t h o d s that will be less favorable to the depositor, then notice of the change should be m a i l e d to each depositor at his last k n o w n address. M o v i n g to the C o m m i s s i o n 1s r e c o m m e n d a t i o n s in the supervisory area, the report proposes that Con g r e s s create a B u r e a u of C o n s u m e r Credit Mto issue rules and regulations and supervise all examination and enforcement functions under the C o n s u m e r Credit Protection Act, including Truth in Lending. 11 This proposal would entail overlapping responsibilities, potentially b u r d e n s o m e to financial institutions and troublesome for m o n e t a r y policy and the evolution of the p a y m e n t s m e c h a n i s m . A s an alternative, the B o a r d r e c o m m e n d s that a single bank supervisory agency be given the responsibility to write c o n s u m e r protection rules affecting banks and other federallysupervised financial institutions. T h r o u g h their long experience with the unique character of the institutions under their supervision, the Federal banking agencies possess the necessary background and expert knowledge to formulate rules sensitive to the c o m p l e x roles of these institutions in the national e c o n o m y while still providing protection for c onsumers. - 12 - If C o n g r e s s disagrees with this approach, however, the B o a r d believes it would be better to place the consumer-protection rule-writing authority affecting banks in an agency w h i c h deals with credit p r o b l e m s exclusively, such as the B C C , rather than extending the authority to an agency with m o r e diverse c o n s u m e r protection responsibilities such as the Federal T r a d e C o m m i s s i o n . T h e B o a r d r e c o m m e n d s against the C o m m i s s i o n ' s suggestions that the B C C have authority to "supervise all examination and enforce m e n t functions under the C o n s u m e r Credit Protection Act, including Truth in Lending" and that the B C C be authorized to intervene in agency actions on m e r g e r s , acquisitions, and other applications. Both of these proposals would be duplicative of functions n o w being p e r f o r m e d by the Federal bank supervisory agencies. T h e practical effect would be to slow d o w n the decisional process, and add to its cost. In addition, as you know, the Justice D e p a r t m e n t has statutory authority to offer c o m m e n t s on bank m e r g e r and holding c o m p a n y cases, and thereby supplements the Board's o w n strong interest in the questions of concentration and competition. Holder-in-due-course Doctrine T h e C o m m i s s i o n r e c o m m e n d s that the holder-in-due-course doctrine (HIDC) and waiver-of-defense clauses in c o n s u m e r credit -13- transactions be prohibited. It also proposes subjecting a lender to all claims and defenses of the b o r r o w e r arising f r o m the purchase of goods with the proceeds of a loan, if the b o r r o w e r w a s referred to the lender by the vendor and he extended the credit pursuant to a continuing business relationship with the vendor. Although there are differences of view a m o n g m e m b e r s of the B o a r d on the broad issues raised by these recommend a t i o n s , w e would like to c o m m e n t on the narrower question of h o w they should apply to credit cards. T h e B o a r d is seeking to encourage development of electronic transfer systems that will result in a m o r e efficient p a y m e n t s mechanism, reducing the need for costly check handling. T h e credit card will probably play a key role in such a transfer system, and any limitations on the H I D C doctrine to protect c o n s u m e r s should be adopted with care so as not to impair the usefulness of the credit card as a m e a n s of payment. T w o general principles m a y be useful in accomplishing this objective. First, for small transactions w h e r e credit cards are used as a convenient substitute for cash, w e should avoid enlarging the purchaser's rights simply because he uses his card. Second, the liabilities of card issuers should bear s o m e reasonable relationship to their ability to monitor p e r f o r m a n c e by - m e r c h a n t s w h o s e sales they finance. 14- T h e s e principles suggest that credit card issuers should be subject to cardholders1 claims and defenses against m e r c h a n t s only w h e r e the transaction exceeds a dollar limit and takes place within the m a r k e t area served by the issuer. Electronic F u n d s Transfer S y s t e m ( E F T S ) T h e C o m m i s s i o n ' s concern about the possibility of restraints of trade e m e r g i n g as the p a y m e n t s s y s t e m evolves t o w a r d the electronic transfer of funds is well taken. T h e B o a r d shares this concern, and has taken positive steps to m a k e its views k n o w n to C o n g r e s s and the public. T h e B o a r d has outlined three general principles it believes should apply. First, so far as public participation and support are concerned, the B o a r d believes there should be a single, integrated nationwide m e c h a n i s m for efficient transfer of funds. system, T h e existing using checks and drafts, and functioning through c o m m e r c i a l banks and the Federal R e s e r v e Banks, is substantially of that character. Second, even allowing for the existence of private clearing arrangements, the B o a r d believes that the public s y s t e m using check or electronic transfers of funds f r o m one institution to another should - 15- be such as to insure that the conditions of entry into a general clearing a r r a n g e m e n t are fair, and that equitable treatment is assured for institutions with similar po w e r s and responsibilities. T h e presence of a public agency, such as the Federal Reserve, in any cooperative a r r a n g e m e n t for transferring funds between institutions is one w a y of insuring the public interest will be taken into account, and that no private clearing a r r a n g e m e n t m a y be used to protect or enhance the m a r k e t position of the participating banks at the expense of others. In taking this position, the B o a r d recognized, as did the C o m m i s s i o n , that whatever public action is taken, the innovative capabilities of banks and other financial institutions to i m p r o v e m o n e y transfer services should be recognized and given opportunity for development. Finally, the costs of the transfer s y s t e m and the benefits of participating in it should be equitably distributed a m o n g all of the institutions involved. T h e B o a r d believes in c o m p a r a b l e treatment for financial institutions having like powers, does not m e e t this standard. but the existing situation S o m e institutions, namely, banks w hi c h are not m e m b e r s of the Federal R e s e r v e System, have a competitive advantage because the reserves they m a y be required to carry are effectively earning assets: G o v e r n m e n t obligations and correspondent - balances. Reserve, 16- R e s e r v e s maintained by m e m b e r banks with the Federal on the other hand, are nonearning assets. Nevertheless, n o n m e m b e r banks are accorded certain Federal R e s e r v e check clearing services d e e m e d essential to the public’s need for p r o m p t m o n e y payment. If, in the future, extensive m o n e y transfer p o w e r s are developed for savings institutions, the extension of the benefits of the p a y m e n t s m e c h a n i s m , whether conventional or electronic, to such institutions, without their a s s u m i n g a fair share of the costs, would increase existing inequities. Truth in Lending W e are gratified that a n u m b e r of the C o m m i s s i o n ’s suggestions m i r r o r r e c o m m e n d a t i o n s m a d e by the B o a r d in its annual report to Congre ss on Truth in Lending. F o r example, the B o a r d has r e c o m m e n d e d for s o m e time that large extensions of credit for agricultural purposes should be exempt, they involve a security interest in real property. even though Other business credit is exempt, and creditors argue that the very nature of m a n y agricultural credit transactions (which often involve advances and p a y m e n t s for w h i c h both the time and a m o u n t are u n k n o w n at the time of the initial agreement) m a k e s t h e m unsuited for meaningful disclo sure. The C o m m i s s i o n recommends, as the B o a r d tentatively suggested, that a m o u n t s over $25, 000 should be exempt. - 17- O n the other hand, there are other r e c o m m e n d a t i o n s with w hich w e disagree. For example, the C o m m i s s i o n would permit those w h o offer open-end credit, such as revolving charge accounts, to advertise only the periodic (monthly) rate and the annual percentage rate. T h e B o a r d has outstanding a proposal which would trim the requirements of disclosure for open-end credit, but there are differences between the Board's proposal and the C o m m i s s i o n ' s r e c ommendation. Fo r example, the B o a r d thought the present statutory requirement that any "free-ride" period be s h o w n is a good one, but the C o m m i s s i o n would not include this requirement. Again, various revolving credit plans m a y feature the s a m e annual percentage rate yet, because of differences in the calculation of finance charges, one plan m a y be m o r e costly than another, so the B o a r d has reservations about the value of disclosing the rate alone. A n appendix is attached to this statement c o m m e n t i n g further on the C o m m i s s i o n ' s proposals on Truth in Lending. Conclusion It is perhaps inevitable that judgments will differ regarding any set of proposals as wide-ranging as those of the C o m m i s s i o n . But disagreement on specific proposals should not obscure the fact - 18- that the report represents a thoughtful and constructive effort to achieve a goal on which perhaps w e can all agree--adequate flows of credit to c o n s u m e r s on t e r m s that are fair and reasonable. APPENDIX I. Several suggestions made by the National Commission on Consumer Finance mirror recommendations made by the Board in its Annual Report to Congress for 1972, More-than-four-instalment Rule The Commission supported the Board's recommendation that the Act be amended to clarify its application to transactions which involve more than four instalments where there is no identifiable finance charge. The validity of the rule was recently upheld by the Supreme Court in Mourning v. Family Publications Service Inc., (4 CCH Consumer Credit Guide 1[ 99,034) Agricultural Credit The Commission recommended that exempted transactions (Section 104) of the Truth in Lending Act should include credit transactions pri marily for agricultural purposes in which the total amount to be financed exceeds $25,000, irrespective of any security interest in real property. In its latest Annual Report, the Board noted that the problems cited in previous Annual Reports relating to the coverage of agricultural credit under the Act continue to exist. Creditors argue that the very nature of many agricultural credit transactions (which frequently involve advances and payments for which both time and amount are unknown) makes them imsuited for meaningful disclosure. Furthermore, frequently it has been argued that since agriculture is a business, it should be exempt from coverage of the Act, just as other business credit is exempt. On the other hand, associations representing agricultural interests have a diversity of views regarding continued coverage of agricultural credit. -2The Board again recommended that credit primarily for agri cultural purposes in excess of an appropriate amount should be exempt from the provisions of the Act, irrespective of any security interest in real property. This recommendation, if adopted by Congress, would have the effect of removing from coverage large extensions of credit, where borrowers are more sophisticated and less in need of the disclosures, while still providing the benefits of disclosure to the smaller borrowers, who presumably are more likely to benefit from such disclosures. Such an amendment would benefit creditors in reducing the number of disclosures to be made. While the Board indicated that it believed an exclusion of transactions above $25,000 would alleviate the problem, it noted that opinions legitimately may vary about the appropriate amount. Liens Arising by Operation of Law The Commission supported the recommendation of the Board that Congress amend the Truth in Lending Act specifically to include under Section 125 security interests that arise by operation of law. The courts have considered the question whether the right of rescission applies to such liens and have held that it does.“ ^ Nevertheless the Board recommended that Congress amend the-Act to clarify the coverage of these transactions under section 125. 1/ Gardner and North Roofing and Siding Corp. v. Board of Governors, D. C. Cir. 1972, 464 F2d 838; N.C. Freed Co. v. Board of Governors, 2nd Cir. 4 CCH Consumer Credit Guide # 99,079. -3Time Limitation on Rescission Right The Commission supported the recommendation of the Board that Congress amend the Truth in Lending Act to limit the time the right of rescission may run where the creditor has failed to give proper disclosures. Section 125 of the Act, implemented by section 226.9 of Regulation Z, provides that in some consumer credit transactions in which a security interest in the customer's residence is involved, the customer has three business days in which to rescind the transaction. To start the three-day rescission period, the creditor must notify the customer of his right of rescission and provide a form which may be used in exercising that right. The law does not set any limit on the length of time that the right continues where the creditor has failed to notify the customer of his right. Also, even though the required notice is given, there is a question whether the rescission period may continue where the other required dis closures of credit terms are given but are incorrect. As a result, the titles to many residential real estate properties may become clouded by uncertainty regarding unexpired rights of rescission. The Board recommended that Congress amend the Act to provide a three year limitation on the time the right of rescission may run. Class Actions and Civil Liability The Commission recommended adoption of the two suggestions of the Board pertaining to class action suits and of the clarification of the definition of "transaction.11 Class Actions The trend of the cases is away from allowing class actions for the enforcement of Truth in Lending. Very likely, this trend is an outgrowth -4of judicial concern over the possible magnitude of recovery by a large class, given the statutory minimum of $100 per person. While the Board indicated it shared this concern about possible liability, which might in some cases run into millions of dollars and may be disproportiate to any conceivable injury sustained by consumers, it also said it believed that potential class action liability is an important encouragement to the voluntary compliance which is so necessary to insure nationwide adherence to uniform disclosure. It believes that any inquiry into the justification for class actions should not be restricted to whether the possible liability in such suits exceeds the actual damages incurred by the class members. Equally important, in the Board's view, is the prophylactic effect of the threat of class action exposure. That threat elevates a possible Truth in Lending law suit from the ineffective "nuisance" category to the type of suit which has enough sting in it to insure that management will strive with diligence to achieve compliance. While the Board believes that the class action vehicle in some form should be preserved for appropriate Truth in Lending suits, it is conscious of the difficulty of formulating an equitable rule which will preserve its effectiveness without, at the same time, exposing legitimate business to unwarranted claims in frivolous law suits. In its Annual Report the Board suggested that the best way to meet this problem was to set an upper limit on the aggregate amount of possible class action recovery (the greater of $50,000 or 1 percent of net worth is suggested in the Board's recommended amendment), while, at the same time, giving -5the courts the authority to set the amount of actual recovery within this limit in light of the circumstances of the particular case--for example, the severity of the violation and the size of the offender. "Good Faith Reliance11 One of the legitimate concerns of creditors who have attempted to comply in good faith with the requirements of Truth in Lending is that, although they have followed Regulation Z, a court may conclude that the Regulation is invalid and that different disclosures or procedures were mandated by the Truth in Lending Act itself. At present, the civil liability provisions of section 130 do not necessarily preclude a finding of liability where the creditor has followed regulatory requirements which subsequently are held invalid. In order to avoid this inequity, a "good faith reliance" provision was suggested for inclusion in the Act. Definition of "Transaction" A final problem with section 130 of the Act is ambiguity as to the meaning of "transaction" to which the $100 minimum liability attaches where proper disclosures have not been made. While it is highly likely that the opening and use of an open end credit account or an entire credit con tract would be considered a single "transaction" for purposes of this section, the Board said that Congress should clarify this term to preclude its application to each separate extension of credit under an open end credit plan, or to each periodic statement or other single component of a consumer credit contract. - II. 6- A number of the Commission's recommendations are construc tive, although they would have to be studied carefully prior to adoption. Appraisal Fees and Credit Reports The Commission recommended that Section 106(e) of the Truth in Lending Act be amended to delete as excludable from the finance charge appraisal fees and credit reports. The Act contains several specific exclusions from the finance charge for fees charged by the creditor in connection with a real property transaction. reports." Among these excluded charges are "appraisal fees" and "credit Such charges are specifically included in the finance charge in non-real property transactions. The Commission suggests that this exclusion be removed so that such fees will uniformly be treated as a portion of the finance charge. The Board supports this recommendation in theory, but notes that the effect of this change on the APR would be so minimal as to raise questions whether it is worth the reprinting of forms and restructuring of disclosure procedures which it would entail. -7- Oral Disclosures The Commission recommended that the Truth in Lending Act be amended to provide that the Act and Regulation Z apply to oral disclosures. A continuing source of problems has been the practice of some creditors of quoting add-on or discount rates in response to consumer requests for information about the cost of credit. approximately one-half the annual percentage Since such rates are rate, their use may severely hamper a consumer's ability to shop for the best credit terms by way of telephone. The Board is sympathetic to this recommendation, and its staff is presently attempting to draft a formal Board interpretation of the Regulation which would discourage the use of any rate other Reducing Advertising Requirements The Commission recommends that the items required to be disclosed once full disclosure in an advertisement is "triggered" should be reduced in both closed-end credit and open-end credit. The Board has seen no indication that the amount of information presently required to be disclosed in closed-end credit is burdensome or -s- discourages meaningful advertising and should be reduced. On the other hand, the Board has outstanding a proposal which would trim back the requirements for open-end credit under Regulation Z. The Commission's proposal selects a few different items for inclusion in an open end credit advertisement, and deletes some which the Board thought important in its proposal. For example, the Board thought that the present statutory requirement that any "free-ride" period be shown is a good one. Commission would not include this requirement. The The Commission would require disclosure of the minimum periodic payment required, whereas the Board's proposal would not. The Board supports the thrust of the Commission's recommendation that the advertising disclosures in open-end credit (but not closed end credit) be reduced, with the reservation that it would not select the same items for inclusion in such advertisements as would the Commission. Preemption of State Law The Commission recommended Federal preemption of State laws which are inconsistent with the Federal Truth in Lending Act or which require disclosures which might tend to confuse the consumer or contradict, obscure, or detract attention from disclosures required by the Truth in Lending Act and Regulation Z. The Commission notes that some State statutes require disclosures which may be different from the Federal statute and that the two sets of disclosures may be confusing to the consumers. Since one of the unfortunate features of Truth in Lending is the complex nature of the disclosure statement, the Board favors action which would tend to reduce the complexity of the disclosures. It might be noted that the Commission's recommendation -9is largely reflected in section lll(a) of the existing statute which provides that "This title does not annul, alter, or affect, or exempt any creditor from complying with, the laws of any State relating to the disclosure of information in connection with credit transactions, except to the extent that those laws are inconsistent with the provisions of this title or regulations thereunder and then only to the extent of the inconsistency.11 Assignee Liability The Commission recommended that the Truth in Lending Act be amended as necessary to assure that subsequent assignees are held equally liable with the original creditor when violations of the Truth in Lending Act are evident on the fnce of the credit agreement or disclosure statement. While the present language is ambiguous, section 131 of the Act may already place such liability upon an assignee. This section could, however, stand clarification and the Board is inclined to support this recommendation. Injunctive Relief The Commission recommended the adoption of legislation to permit private suits seeking injunctive relief for false or misleading advertising. While the courts, may, themselves, be willing to grant such relief under the present statutory provisions, the clear legislative grant of such authority would assist to enforcement. Advertising Rates Other Than the APR The Commission recommended that sections 143 and 144 of the Truth in Lending Act be amended to make clear that there may be no expression of a rate in an advertisement of closed-end credit other than the annual percentage rate as defined in the Truth in Lending Act and Regulation Z. -10It appears that the Commission was referring to advertisements of the discount or add-on rate. The use of such rates would specifically be prohibited by the Board's outstanding proposal to amend Regulation Z, and the Board supports the recommendation. Closing Costs The Commission has alternatively recommended that a full statement of all closing costs to be incurred be presented to a consumer prior to his making any downpayment or at the time the lender offers a commitment or not later than a reasonable time prior to final closing of a consumer credit real property transaction. At present, the Act requires disclosures to be made "before the credit is extended." The Regulation attempts to be more specific by requiring that disclosures be made prior to "consummation" of the transaction, which is defined as a time when a contractual relationship arises between the parties. In some real estate transactions, "consummation" may not- occur until closing, and it is at that point, for the first time, that the prospective borrower receives his disclosures. that disclosures at closing It is generally believed in such a complicated transaction do not give the consumer an adequate opportunity to use them to assess the terms of the transaction. The Board has outstanding a proposal to require disclosures 10 days prior to closing. While the comments on the proposal indicate that a fixed 10 day period is impractical and burdensome to both creditors and consumers, the Board supports the concept of early disclosure in real estate transactions. - 11- Under the Act, a statement of "closing costs" is not presently required to be given with the Truth in Lending disclosures, unless such charges are financed--i,eM not paid in cash at the time of closing. Thus even if a pre-settlement disclosure rule were adopted under the present statutory scheme, it would still not meet the Commission's concerns. The Board indicated in its Annual Report that in order to be more meaningful to the consumer any disclosure prior to settlement should also include "closing costs" and it supports the concept behind this proposal. Publication of Statistical Data The Commission recommended that the a statistical series showing an average Board regularly publish (and possibly a distribution) of annual percentage rates for at least three major types of closed end consumer instalment credit: new automobiles, mobile homes, and personal loans. The Commission report argues that publication of these interest rate statistics would help consumers to shop more wisely for credit and possibly enhance the role of Truth in Lending as a tool of economic stabilization as consumers observe and react to changing credit costs. Data now published by the Board at the request of the Commission on Interest and Dividends--in the G.10, J.3, and G.ll releases--meet the substance of this recommendation. III. The Board has questions about several of the Commission's recommendations. Credit Life Insurance The Commission recommended that creditors be required to disclose the charge for credit insurance both in dollars and as an annual percentage -12rate in the same manner as the finance charge is required to be disclosed. Additionally, where credit insurance is advertised, the Commission recommended that the premium be required to be expressed as an annual percentage rate. While the recommendation is not entirely clear, the Commission is apparently suggesting that a second APR (a function of the amount of coverage, the premium, and the period of coverage) be added to the Truth in Lending disclosures. The Board believes that this recommendation may not be in the consumerfs best interest. The Truth in Lending disclosures are already exceedingly complex, and the addition of a new rate would simply further complicate them and would probably detract from the disclosures already being made. Moreover, the purpose for showing an APR is to enable the consumer to use this information to shop for better terms and, since one cannot separately shop for credit insurance, the rationale behind rate computation is not applicable to these insurance premiums. Under the existing statutory provisions, the dollar cost of the insurance must be disclosed. Public Utility Exemption The Commission recommended the repeal of section 104(4) of the Truth in Lending Act which exempts public utility transactions from disclosure requirements. Section 104(4) of the Truth in Lending Act exempts most public utility bills from its coverage, even though they may provide for a discount for early payment or a charge for a late payment. There has been some - 13- question whether such billings should be subject to some form of disclosure, particularly translation of the discount or late charge into an annual percentage rate. A recent study by a committee of the National Association of Regulatory Utility Commissioners recommends that State regulatory commissions "adopt a 'full disclosure' policy regarding utility billing." This policy includes, among other disclosures, the disclosure of an effective annual rate if the bill is not paid when due. The Board believes that the suggestion of this committee for State-required disclosures may be preferable to simply removing the utility exemption from the Federal Act for two reasons. First, even if utility bills are subject to Truth in Lending, the annual percentage rate would not be required to be disclosed on many of them, by reason of the small transaction exemption. Second, Regulation Z provides that bona fide charges assessed for delinquent payments are not finance charges subject to the disclosure requirements. It appears that the charges imposed by many utility companies would meet the "late payment charge" exemption in the Regulation and therefore would not be considered finance charges subject to annual percentage rate translation. The dollar amount of the lost discount is already shown on utility bills, and little would be gained by simply having it labeled a "finance charge." Advertising Only the APR in Open-End Credit The Commission recommended that creditors offering open-end credit be permitted to advertise only the periodic rate and the annual per centage rate. As. presently written, if the annual percentage rate is advertised in open-end credit, this "triggers" the advertising provisions which require that the creditor give additional information about the credit plan -14in the advertisement. However, the rate may be advertised by itself in closed-end credit advertising. The Board presently has outstanding a proposal for restructuring the open-end credit advertising section of Regulation Z. In connection with the preparation of this proposal, the staff specifically rejected the change suggested by the Commission. It did so in the belief that while the rate, by itself, is a meaningful term in closed-end credit, it is not meaningful in open-end creditc For example, a variety of creditors may all advertise an 18% APR when there may be vast differences which make one plan much more costly than the other. One creditor may use the "previous balance method" where payments and credits are not taken into account before assessing the finance charge. Another may use the "adjusted balance" method in which all payments and credits are taken into account. Another creditor may have an additional transaction charge which would not be reflected in the rate quoted in an advertisement- The Board questions the wisdom of this recommendation. More- Than -Four-Instalment Advertising The Commission recommended that the Truth in Lending Act should be further amended to require creditors who do not seperately identify the finance charge on credit transactions involving more than four instalments to state clearly and conspicuously in an advertisement offering credit: "THE COST OF CREDIT IS INCLUDED IN THE PRICE QUOTED FOR THE GOODS AND SERVICES." -15- The need for this required Federal language in such advertisements seems highly questionable. Where the creditor advertises his price, the consumer may be concerned as to whether he has been told the full price but it is doubtful that he will care whether the credit charge is pre sumed to be included in the price or whether no charge for credit is claimed. To him, the price is the price. The Board suggests caution in adopting this recommendation. Seller's Points The Commission recommended that the Truth in Lending Act be amended to make clear the presumption that all discounts or points, even when paid by the seller, are passed on to the buyer and hence must be included in the finance charge. The Truth in Lending Act provides that all charges, including "points" and "discounts" payable directly or indirectly by the borrower and imposed directly or indirectly by the creditor are finance charges. This raises the issue whether points paid by the seller should be disclosed as a portion of the finance charge since they are often paid indirectly by the purchaser as an increase in the purchase price of the house. Seller's points are particularly common in FHA or VA mortgages where by law only one point may be charged directly to the purchaser, and the FHA and VA rate ceilings may be below prevailing market rates. In order to insure an appropriate yield, commonly the seller of the property will be assessed points by the lender. -16At present, the Board's position is that if seller's points are, in fact, added to the purchase price and therefore indirectly paid by the borrower, they must be shown as a portion of the finance charge. 12 C.F.R. § 226.405). (See However, if the purchase price is not so inflated (and apparently it not always is) the seller's points need not be shown as part of the finance charge. The problem is knowing whether such points are in fact built into the purchase price of a particular house (although under the Board's interpretation, for convenience, a creditor may presume that all seller's points are indirectly paid by the buyer). This uncertainty has undoubtedly prompted the Commission's recommendation. Unfortunately, when seller's points are considered part of the finance charge, this results in some very complicated disclosures. On the assumption that simplifying disclosures may be more important than adhering to a theoretically precise postion that all charges--no matter how indirectly imposed--miist be included in the finance charge, the Board's staff is reviewing the question whether it might ultimately be more beneficial to take the position that seller's points need not be included in the finance charge. Therefore.the Board is not presently prepared to support the Commission's recommendation. 5/14/73
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