CHOICE Act would let debt buyers raise interest rates
GOP bill that would repeal Dodd-Frank is set for a vote in the House
Expert on consumer credit laws and regulations
Debt buyers, and collectors who work for them, could ratchet up the interest they charge consumers without regard to state rate caps, under a sweeping GOP-backed deregulation bill.
The measure is part of the Financial CHOICE Act, written by Texas Rep. Jeb Hensarling, the chairman of the House Financial Services Committee. His bill, which aims to repeal and replace large parts of the 2010 Dodd-Frank consumer protection law, is set for a vote in the House sometime this week, House Speaker Paul Ryan said Monday.
Attention has focused on how the bill would roll back Dodd-Frank consumer protections and Wall Street rules designed to end bank bailouts. But one sentence in the 600-page measure would have the most direct impact on consumers' wallets.
The provision, mildly titled "Protecting Consumers Access to Credit," allows debt buyers to charge the highest contract interest rate on a bank loan after it is sold or transferred, "notwithstanding any State law to the contrary."
Industry legal experts say the provision merely affirms that debt buyers inherit the rights in the original lender's contract. "The direct impact on the debt buying industry is minimal," said Donald Maurice, a financial services attorney at Maurice Wutscher in Flemington, New Jersey.
interest hikes and legal loopholes
But consumer advocates said the sweeping dismissal of state interest rate caps would allow hikes of interest on existing unpaid debt held by buyers, which totals somewhere in the tens of billions of dollars. Perhaps more important, it also creates a loophole for high-cost lenders to operate in states where they are currently restricted, by partnering with a bank willing to originate loans for them.
"This language has the potential to eviscerate or override state laws that protect people in states from predatory and abusive lending practices," said Lisa Stifler, deputy director of state policy at the Center for Responsible Lending. More than 30 states have restrictions on high-cost installment loans, and 24 ban or restrict high-cost payday loans.
High-rate lenders have tried in the past to partner with legally privileged entities, such as Indian tribes, in order to get around state rate caps. "We think this language would be a green light for that kind of arrangement to happen again," she said.
The business of debt
Debt buying is a big business, although just how big is difficult to measure.
Industry analyst Larry Berlin at First Analysis Securities Corp. in Chicago estimated that banks sell off $1.2 billion in credit card debts per year, of which some expires, is collected or written off over time. The three largest publicly traded debt buyers, Midland Capital, Encore Capital Group and PRA Group, parent of Portfolio Recovery Associates, each spend more than $400 million a year buying delinquent credit card and other debts.
Those numbers suggest that millions of consumers who borrowed from banks now owe the money to a collection-oriented company instead of their original lender. Debt buyers work the back-end of the lending system, using collection agencies and lawsuits to get payments from people who couldn't or wouldn't repay the bank.
The National Bank Act gives banks a pass from state interest rate caps, which range from lows of about 6 percent to highs that are unlimited in some states. Banks throughout the U.S. can charge interest up to the legal limit in their home state. That explains why New York's Citibank, Wells Fargo and dozens of other banks locate their credit card units in South Dakota, where loans made under a contract – such as a card agreement – face no limit on the rate they can charge.
Court: Debt buyers
But are debt buyers entitled to the same exemption from rate caps as the original lender? While the industry says the loan contract should remain in force, a 2015 decision in a federal appeals court in New York disagreed.
After Saliha Madden defaulted on her Bank of America card, the bank sold her approximately $5,000 debt to debt buyer Midland Funding, which tried to collect 27 percent interest as permitted under BofA's card agreement. Madden filed a class-action lawsuit saying New York law only permitted it to continue charging the 25 percent that BofA had charged, New York's highest legal rate.
The second circuit court of appeals sided with Madden. Debt buyers are not necessarily entitled to charge the maximum contract amount, because they are not agents of the bank, the court ruled. The law in other districts conflicts with the decision, but the Supreme Court declined to hear Midland's appeal in October 2016. That left the Madden ruling intact in the New York district – the seat of the U.S. banking industry.
Debt buyers howled. The decision "threatens to cause chaos" in the debt market, Midland Funding argued in its appeal to the Supreme Court. The CHOICE Act would override the court's decision, which lenders say puts a chill in the market for routine sales of nondelinquent debt as well as unpaid debt.
What will it cost
For Madden, the debt buyer only charged 2 percent more in interest than her card issuer – but that doesn't mean others would be so lucky. Debt buyers could charge much more, depending on the interplay of state law and the contract governing the loan. For example, many credit card agreements allow penalty rates of 24 percent or 28 percent for late payers. But many states set the maximum rate for nonbanks much lower, such as 17 percent for consumer loans in Arkansas and just 8 percent for contract-governed loans in Minnesota.
Would debt buyers jack up rates to the contract maximum? Jan Steiger, executive director of the industry group Receivables Management Association, and other industry experts said that most larger debt buyers have ceased trying to charge any interest on unpaid debts, for business and legal reasons following regulatory crackdowns on debt buyers' practices.
"The interest is a mess; it's a nightmare," said Berlin, the industry analyst at First Analysis Corp. In many state courts, the debt buyer must produce contract documents showing it has the contractual right to charge the lender's rate of interest.
Moreover, debt buyers usually purchase unpaid debts for about 5 percent of the face value, on average, meaning they can reap significant profits just by offering debtors a settlement for a portion of the principal amount. Financial disclosures filed by Encore Capital for 2012 indicated that it expected to collect just $843 million on its $11.4 billion face value of purchased consumer bank debt, over time. That's only about 7.4 percent of the total debt due. But having bought the debt for only 4.2 percent of face value, profits would still amount to a hefty $364 million.
Regulatory shift in
Of course, Saliha Madden's case shows that debt buyers don't always skip charging interest. Consumer advocates expect that debt buyers would use their newfound power to collect more money from the small fraction of debtors who have resources to pay. Demands for interest don't have to hold up in court to be effective in pressuring debtors to settle sooner, and for larger amounts than they might otherwise be willing to pay.
"If this bill is enacted, my guess is that the price and desirability of junk debt will increase, because junk debt will become much more profitable for debt buyers," said Peter Holland, a consumer lawyer with expertise in debt-buyer issues.
The CHOICE Act's preemption of rate caps isn't happening in a vacuum, he noted. The American Legislative Exchange Council, a free-markets group, is pushing state legislatures to allow debt buyers' business records as proof of their claims in debt collection cases, instead of requiring the higher standard of original contract documents.
At the federal level, a regulatory changing of the guard under the new administration is shifting toward less regulation on business practices.
At the Office of the Comptroller of the Currency, for example, Thomas Curry, who instituted guidelines for banks to restrict the use of their sold-off debt in order to protect consumers, has been replaced by a bank industry lawyer, acting comptroller Keith Noreika. The Obama-appointee heading the Consumer Financial Protection Bureau, Richard Cordray, is facing a challenge to his tenure by a big mortgage lender. And in a case before the Supreme Court, debt buyers may get an exemption from collection laws that protect consumers from harassment and deceptive tactics. Taken together, the shifts in the legal and regulatory climate may encourage debt buyers to charge interest that they waived in the past.
Bill faces rocky path
While the CHOICE Act is expected to pass the House, it is unlikely to get through Congress – at least in its current form. It needs at least eight Democratic votes in the Senate to avoid filibuster – an unlikely prospect. Democrats have lambasted the bill in House hearings as a bundle of bad ideas, and Sen. Sherrod Brown, ranking member of the Senate Banking Committee, has vowed to fight it.
Some Senate Republicans advocate passing the bill through the budget reconciliation process, which would require only a simple majority vote. However, that would further complicate efforts for tax reform, and Senate Banking Committee Chairman Mike Crapo has consistently said Dodd-Frank reform needs to be bipartisan in order to be lasting and meaningful.
However, the catchall bill could be broken up with some parts going separately. Language similar to the debt buyer provision has appeared previously in a 2016 bill written by Rep. Patrick McHenry, who has said he plans to reintroduce an updated measure this year. With backing from financial services companies and industry groups, a bill to override state debt caps is likely to find its way through Congress in some form, industry sources said.
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