Preventing a Boom from Turning Bust: Regulators Should Turn Their Attention to Starter Interrupt Devices Before the Subprime Auto Lending Bubble Bursts

Author:Kwesi D. Atta-Krah
Position::J.D. Candidate, The University of Iowa College of Law, 2016; M.B.A., Drake University, 2007; B.A., Drake University, 2004
Pages:1187-1222
SUMMARY

In recent years, the subprime auto lending industry has increasingly used starter interrupt devices ("SIDs") as a condition on loans. An SID is a technological device installed in a car that allows an auto lender to remotely disable a mortgaged car's ignition system and, if equipped with a global positioning system, communicate the location of the car to the lender for easy repossession. Notably, ... (see full summary)

 
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1187
Preventing a Boom from Turning Bust:
Regulators Should Turn Their Attention
to Starter Interrupt Devices Before the
Subprime Auto Lending Bubble Bursts
Kwesi D. Atta-Krah
ABSTRACT: In recent years, the subprime auto lending industry has
increasingly used starter interrupt devices (“SIDs”) as a condition on loans.
An SID is a technological device installed in a car that allows an auto lender
to remotely disable a mortgaged car’s ignition system and, if equipped with a
global positioning system, communicate the location of the car to the lender
for easy repossession. Notably, however, the SID is not an indicator of a
subprime borrower’s financial ability to make loan payments. The industry’s
reliance on SIDs in lieu of traditional creditworthiness metrics has contributed
to an increase in borrower delinquencies, and because auto lenders package
and sell these risky loans to secondary market investors, the risk of default
extends to other areas of the economy as well. Even though the subprime auto
lending industry constitutes only a fraction of the total economy in terms of
volume of credit extended, the ripple effects of a market failure could have
serious repercussions for the macro economy. This Note argues that subprime
auto lenders should refrain from using SIDs in their credit underwriting
process and as a condition for extending credit to subprime borrowers.
Further, federal and state regulators should ensure that subprime auto lenders
keep their credit and underwriting functions separate from their loan
servicing functions to protect individual borrowers, the auto lending
industry, and the macro economy from the adverse effects of SID-infected auto
loans.
J.D. Candidate, The University of Iowa College of Law, 2016; M.B.A., Drake University,
2007; B.A., Drake University, 2004. Thank you to my family, especially my wife Amy Gandhi for
her continued support. Also, thank you to the Iowa Law Review Volume 100 and 101 editors and
student writers for their hard work and efforts on this Note.
1188 IOWA LAW REVIEW [Vol. 101:1187
I. INTRODUCTION ........................................................................... 1189
II. STARTER INTERRUPT DEVICES AND THE SUBPRIME AUTO MARKET: A
REMNANT OF THE MORTGAGE CRISIS ......................................... 1191
A. STARTER INTERRUPT DEVICES AND THE SUBPRIME AUTO LENDING
INDUSTRY ............................................................................. 1191
1. How Starter Interrupt Devices Work: Power to Auto
Loan Lenders .............................................................. 1191
2. Auto Dealers and Financing Choices for the
Consumer .................................................................... 1192
3. Subprime Auto Loan Boom: Then and Now ............ 1195
B. MORTGAGE CRISIS: FAILED CREDIT RISK MANAGEMENT
PRACTICES ............................................................................ 1197
1. Careless Subprime Lending—a Major Cause of the
Crisis ............................................................................. 1197
2. Effects of the Mortgage Crisis .................................... 1197
C. THE CURRENT LEGAL LANDSCAPE: SIDS UNDER FEDERAL
REGULATIONS AND STATE LAW .............................................. 1199
1. Federal Regulation of Subprime Auto Lending ....... 1199
2. Legality of SIDs Under State Law ............................... 1201
i. Category One: States with Informal Advice ............... 1204
ii. Category Two: States Statutorily Approving the Use of
SIDs ........................................................................ 1205
iii. Category Three: States That Proposed but Did Not Pass
Laws Regarding SIDs .............................................. 1207
iv. Assessing the State of the Law ................................... 1207
III. SIDS FUELING A POTENTIAL SUBPRIME AUTO “BUBBLE” ........... 1208
A. THE VULNERABILITY OF THE SUBPRIME AUTO BORROWER....... 1208
B. A PICTURE OF HOW SIDS ARE FUELING A SUBPRIME AUTO
INDUSTRY BUBBLE ................................................................. 1209
C. SUBPRIME AUTO LOAN INVESTMENTS AND THE ECONOMY ....... 1212
D. EVIDENCE THAT SUBPRIME AUTO LENDING PROBLEMS ARE
“HEATING UP ...................................................................... 1214
E. LACK OF STEADY SID REGULATION IS HURTING CONSUMERS .. 1216
IV. CFPB SHOULD PROVIDE TARGETED SID SUPERVISION OF SUBPRIME
AUTO LENDERS AND STATES SHOULD PASS APPROPRIATE AND
TARGETED REGULATIONS ON SIDS ............................................. 1217
A. SUBPRIME AUTO LENDERS SHOULD KEEP THE SID OUT OF THEIR
CREDIT DECISION MAKING PROCESS ....................................... 1217
2016] PREVENTING A BOOM FROM TURNING BUST 1189
B. THE CFPB SHOULD PERFORM A MORE TARGETED EXAMINATION OF
SIDS FOR NONBANK “PARTICIPANTS THAT FALL UNDER ITS
SUPERVISION ......................................................................... 1219
C. STATES SHOULD PASS APPROPRIATE AND TARGETED REGULATION
ON SIDS ................................................................................ 1221
V. CONCLUSION .............................................................................. 1222
I. INTRODUCTION
A boom in the subprime auto lending industry is making headlines. Auto
lenders issued over $145 billion in subprime auto loans in the first quarter of
20141 compared with only about $120 billion in all of 2013.2 Subprime auto
lenders are using technology to fuel this lending boom. Specifically, they
require subprime loan applicants to install starter interrupt devices (“SIDs”)
in their cars as a condition of getting a car loan.3 SIDs enable the auto lender
to remotely disable the ignition system of a borrower’s car if the borrower
defaults. When equipped with a global positioning system (“GPS”), the SID
also communicates the location of the car to the lender, facilitating
repossession. Recent news reports provide evidence that the unregulated use
of SIDs negatively affects subprime borrowers4 and their families. For
example, one subprime auto lender remotely shut off a woman’s car while she
was driving her ten-year-old asthmatic daughter to the emergency room.5
1. Michael Corkery & Jessica Silver-Greenberg, Miss a Payment? Good Luck Moving Th at Car,
N.Y. TIMES: DEALBOOK (Sept. 24, 2014, 9:33 PM), http://dealbook.nytimes.com/2014/09/24/
miss-a-payment-good-luck-moving-that-car/?ref=technology.
2. Matt Robinson et al., Auto Loans: A Subprime Market Grows in the Shadows, BLOOMBERG
BUS. (Oct. 2, 2014), http://www.businessweek.com/articles/2014-10-02/auto-loans-a-subprime-
market-grows-in-the-shadows.
3. Sometimes also referred to as “Payment Assurance devices.” Jeff Karg, Choosing the Right
GPS & Payment Assurance Device Provider, AUTOMOTIVE DIG., http://automotivedigest.com/
2012/10/choosing-the-right-gps-payment-assurance-device-provider (last visited Jan. 13, 2016).
4. “A subprime borrower is an individual with a less-than-perfect credit rating.” Glossary:
Subprime Borrower, LENDINGTREE, https://www.lendingtree.com/glossary/what-is-subprime-borrower
(last visited Jan. 13, 2016). Characteristics of a subprime borrower include an individual with:
(1) “[a] FICO score below 660;” (2) “[t]wo or more 30-day delinquencies in the last 12 months;”
(3) “[a] foreclosure in the last 24 months;” (4) “[a] bankruptcy in the last 60 months;”
(5) “[d]ebt-to-income ratio of 50 percent or more;” and (6) “[t]rouble paying for month-to-
month living expenses.” Id. FICO sta nds for Fair Is aac Corporation and is a company that creates
credit scores. FICO “use[s] information provided by one of the th ree major credit reporting
agencies—Equifax, Experian or TransUnion” and “uses it to create scores that help lenders
predict behavior, such as how likely someone is to pay their bills on time (or not), or whether
they are able to handle a larger credit line.” Gerri Detweiler, What Does FICO Stand For? What Is a
FICO Score?, CREDIT.COM (Sept. 19, 2013), http://www.credit.com/credit-scores/what-does-fico-
stand-for-and-what-is-a-fico-credit-score.
5. See infra notes 180–81 and accompanying text.

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