House Committee Meeting Illustrates Bi-Partisan Concern about Access to Credit while Highlighting a Legislative Appetite for Rate-Caps and Other Burdensome Regulations
By Christopher Friedman and Preston Neel
On February 5, 2020, the House Financial Services Committee held part one of a two-part hearingentitled “Rent-A-Bank Schemes and New Debt Traps: Assessing Efforts to Evade State Consumer Protections and Interest Rate Caps.” The hearing was held, in part, to discuss the Veterans and Consumers Fair Credit Act, introduced as HB 5050. As discussed in a previous blog, HB 5050 creates a 36% all-in rate cap for consumer loans. The bill, effectively extends the Military Lending Act (MLA) to all consumer loans and imports the MLA’s method for calculating APR.
The committee also discussed the bank partnership model that, according to the committee memorandum, is used to “export high cost loans, such as small dollar ‘payday’ loans into states with lower interest rate caps.” Specifically, in 2015 the Second Circuit Court of Appeals, in Madden v. Midland Funding, held that the National Bank Act does not preempt state usury laws when applied to non-bank debt buyers. Notably, the Second Circuit declined to apply the “valid-when-made” doctrine, which states that a valid loan cannot become usurious when the loan is sold, assigned, or transferred to an entity in a jurisdiction where the loan would have been invalid under state usury law. Because this decision overturned a long-standing bedrock of lending law, in late 2019 the OCC and FDIC issued proposed rules that would effectively overturn Madden by adopting the valid-when-made doctrine.
Although the committee memorandum expresses skepticism, if not outright hostility, towards the OCC and FDIC’s proposed rule and support for HB 5050, the hearing itself revealed that both Republicans and some Democrats are concerned that a 36% rate cap, along with a retreat from the valid-when-made doctrine, would do more harm than good. Several House Democrats expressed concern that the rate cap bill would ultimately lower access to credit. For instance, Rep. David Scott (D-Ga.) noted – correctly – that “lender[s] must make larger loans in order to make the loan profitable.” Accordingly, if HB 5050 is enacted, “consumers may take up a larger loan than they need, which may place our consumers in a financially precarious position.”
Other lawmakers noted that a focus on APR is unhelpful with regards to short-term loans. Rep. Brad Sherman (D-Calif.) noted that “APR, I don’t think is the best way to evaluate the cost of short-term loans.” Rep. Blaine Luetkemeyer (R-Mo.) explained that “APR . . . if you are talking about a loan that is less than one year, is irrelevant” because the economic viability of short-term loans depends on charges that, while seemingly nominal in the context of a short-term small-dollar loan, amount to three-digit APRs when extrapolated. For instance, Rep. Barry Loudermilk (R-Ga.) cited a study showing that the breakeven APR for a $2,600 loan is 36%. This suggests that the rate cap proposed under HB 5050 would effectively eliminate short-term small-dollar loans under $2,600.
Similarly, there was legislative support at the hearing for the FDIC and OCC’s proposals to revive the valid-when-made doctrine. Rep. Patrick McHenry (R-N.C.), a ranking member of the committee, recognized that the valid-when-made rule “has existed for over 100 years until 2015 when the Second Circuit Court’s Madden decision decided that no, banks cannot be sure that their loans hold any value when sold.”
To be sure, some legislators expressed strong support for HB 5050 as well as sharp opposition to the FDIC and OCC’s proposals. However, it is encouraging to see that members from both parties understand the downsides associated with artificially low rate-caps and the uncertainty associated with the Madden decision. In particular, the apparently bipartisan concern about the wide availability of credit suggests that efforts by groups such as the CFSA and others to educate lawmakers have been fruitful. Nevertheless, there remains a political appetite for over-regulation of the industry. We will continue to monitor Congress and the relevant federal agencies for developments related to HB 5050, the FDIC and OCC’s proposals related to the valid-when-made doctrine, and all other issues affecting the financial services industry.
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