Subprime auto lending has been the dragon of the consumer-finance world for decades. Now, state attorneys general, including Massachusetts AG Martha Coakley, are taking up their swords to fight, supported in part by Dodd-Frank provisions that authorize states to investigate and bring civil actions to enforce its provisions, as well as Consumer Financial Protection Bureau regulations under the UDAAP provision (Unfair, Abusive or Deceptive  Acts or Practices). The AGs are bringing civil claims alleging  violations of UDAAP and other federal regulations.

Coakley’s office has subpoenaed Santander Bank seeking information on its underwriting and securitization of subprime auto loans. Coakley spokesman Brad Puffer noted the AG’s concerns about trends showing “an increase in the prevalence of sub-prime auto loans at the same time that more borrowers fall behind on their payments.”

Puffer confirmed that Coakley’s office is only one of “various” AGs’ offices said to have subpoenaed Santander; Santander also acknowledged a civil subpoena from the U.S. Department of Justice requesting similar information and said in the filing that it is complying with those requests. Puffer said Coakley’s office is also investigating a number of other auto lenders but didn’t name them. He also cautioned that a subpoena does not imply wrongdoing.

A Necessary Evil

To be fair, subprime auto lending is a necessary part of the American economy. If the same standards were applied to auto loans as they are to today’s qualified mortgages, many people with below-par credit would have no means to get to their jobs, or probably, anywhere else. The subprime  rates may not be attractive, but those pricier loans allow borrowers to keep their economic  lives together – as long as they can satisfy  and exit  the loan before needing another vehicle – and, hopefully, retain some trade-in value on their old beater, even if it’s only a couple of hundred bucks.

Subprime isn’t necessarily the basic cause of the problem – auto loan inflation is. It began decades ago, in the mainstream.  First, there were four-year new-car loans instead of three-year, starting in the early 1980s. Today we’re seeing seven-year loans and higher, expanding the market for higher-ticket vehicles in the $40,000 and up range. Automakers have historically pushed dealers to sell more higher ticket vehicles for maximum profit.

The line between basic and high-ticket has become harder to maintain. Cars today have many improvements, both necessary and elective, that drive up costs, especially for consumers in high-pressure sales situations who have neither the knowledge nor the assertiveness to hold the line on what they need to spend versus what they want to spend (whether they should be buying used instead of new is an equally important point, with many of the same financing issues).

Many buyers are just looking at the monthly payments, not the entire package. That’s not new either, and that’s what has caused the auto-loan business to become as overblown as the tires on a demolition derby tractor.

So now, subprime borrowers are more likely to still owe money on their vehicles when they return to the showroom, and lenders are willing to roll the outstanding balance into the new loan – and more likely to do that if it’s for a new vehicle. That’s somewhat like the home refinancing excesses of the housing bubble. Fine, if you don’t mind living in your car.

So, back to the legal discussion. States have targeted national banks and an auto lender, as well as other consumer-related lenders and financial firms. By subsuming federal pre-emption of state consumer finance laws, Dodd-Frank puts more power back into the hands of the states. The standards are described as “subjective” by legal specialists, including Benjamin Saul and W. Kyle Tayman of Goodman Procter – standards such as the UDAAP provision determining that specific lending practices are “likely” to be abusive or misleading to consumers, as well as being abusive if it interferes or takes advantage of “a consumer’s ability to understand a consumer financial product or service.” That’s a lot broader than many state laws – and states can sue across state lines and engage regulators, not just fellow AGs, in bringing suit.

States are sharing more information and coordinating more with the CFPB, report Saul and Tayman, but there’s a catch. Collaboration with federal law enforcers opens the door to have state cases moved to federal courts, where local knowledge holds less sway.

So, the fight on the part of the state AGs’ offices is being waged with a double-edged sword. But it’s a necessary fight on behalf of borrowers who have no choice other than to finance a car to help them deal with the basics of economic life.