Imperfect Competition in Auto Lending : Subjective Markup, Racial Disparity, and Class Action Litigation

While the market for auto lending at first appears to be highly competitive, many consumers lack the ability to obtain accurate information about price. In many markets, uninformed consumers can free ride off the knowledge of informed consumers. However, the market for auto lending differs from traditional markets because price ultimately depends upon both the credit worthiness of the individual borrower and the details of the auto loan (e.g. term length, payment-to-income ratio, etc.). Auto dealers in this market act as agents of both consumers (identifying suitable auto lenders for them) and auto lenders (identifying prospective borrowers). Given the asymmetric information about prices facing consumers, this market has been characterized by a wide disparity in the prices paid by consumers. This disparity comes about through a mechanism whereby auto dealers are quoted a risk-based interest rate from the lender and are then authorized to subjectively mark up this rate and charge what the market will bear. While the majority of auto loans are written without any markup, some consumers are charged thousands of dollars in addition to the risk-based interest rate. While charging different prices to different consumers is not illegal, one of the apparent consequences in auto lending is that minority consumers - African-Americans and Hispanics in particular - have systematically been charged a higher markup on auto loans than White borrowers. It is this fact - coupled with federal laws outlawing discrimination in credit markets - that led to a series of lawsuits against auto lending institutions. This paper reviews the theory and evidence of subjective markups on auto loans and examines how class action litigation has changed the auto lending market