A decision filed October 19, 2022 by the Fifth Circuit Court of Appeals has vacated a payday lending rule put in place by the Consumer Financial Protection Bureau (CFPB). The rule was put in place to prevent predatory lending practices and unfair practices in their collection. The court decision was not based on the rule being unconstitutional but rather based in how the bureau is funded. The decision has overreaching implications on the future enforcement of CFPB rules.
What is the CFPB?
The CFPB was authorized by the Dodd-Frank Act, which was proposed in response to the 2008 financial crisis. The Dodd-Frank Act was enacted by Congress in 2010 to promote the financial stability and strengthen the US economy to prevent another financial crisis from happening again. The CFPB similarly has authority to enforce the act to protect consumers and the economy. The CFPB can also issue opinions like the FTC and enforce those opinions or rules against those in violation. An example of this is their recent opinion that requires consumer reporting agencies apply reasonable procedures to prevent false information being reported by the institution.
Payday Lending Rule
The payday lending rule (12 CFR Part 1041) was put in place 2017 in response to unfair practices present in the lending industry. The main focus was on payday loans but it also applies to other loans and any loan that features balloon payments, or loans that increase their monthly payments dramatically later in the term of the loan. The rule first requires that lenders underwrite the loan before offering the loan to the consumer. The underwriting is intended to ensure that the consumer is able to financially support the loan with their income (debt to income ratio). Next, the rule prohibits prohibitions of certain payment transfer attempts. For example, if you give approval for automatic payments from your account and the payments come up non-sufficient funds twice or more, the debt collector cannot try again. Rules like these seem legitimate ways to protect consumers who are unable to make sound financial decisions or who fall on hard times.
You may be asking yourself, who would dispute these rules and practices? Enter the Community Financial Services Association of America (CFSAA), which includes many of the short term (payday) loan companies as members. The CFSAA found issue with the payment provisions that prevented the loan companies from continually trying to withdraw funds from consumer accounts despite a lack of funds. They raised multiple constitutional challenges, but the most notable arguments were for violation of the APA and the source of funding for the CFPB.
The District Court case and the Appeal
In 2018 the CFSAA filed suit in the Western District Court of Texas alleging first that the CFPB violated the Administrative Procedure Act that governs regulatory actions of federal agencies, and second that the source of funding for the CFPB is unconstitutional. The APA puts forth general guidelines for administrative action but, more specifically, enables federal courts to vacate regulations that are “arbitrary and capricious, an abuse of discretion, or otherwise not in accordance with the law.” Both the district court of Texas and the 5th circuit court agreed that the payday rule does not violate the APA. The second part of the payday rule has a causal relationship with injury to consumers using payday loans. Loan payments automatically taken from a consumers account can prevent them from paying other bills or could lead to other issues. The CFPB also supported their rule with empirical evidence which the both the appellate court and the district court found compelling. As such the CFPB rule was not found to be arbitrary and capricious.
The CFSAA then argued that the source of funding for the CFPB was unconstitutional because it is funded directly by the federal reserve. The district court did not find this compelling, but the 5th circuit court found that the funding was enough to vacate the payday loan rule. Congress has the power to control the Treasury and appropriations of funds from the Treasury. There isn’t an express bar on directly using funds from the Federal Reserve, but the court found this fact enough to find the CFPB authority unconstitutional and to vacate the payday loan rule.
Impact on the CFPB and its Enforcement
The Federal Circuit is the highest court in the US before the Supreme Court, so the CFPB either needs to accept the decision or appeal to the Supreme Court. There has been no announcement whether the bureau will appeal the decision, but I find it very likely that they will appeal. The CFPB is unable to enforce the payday loan rule after the rule was vacated and therefore lending companies can continue the practices regulated by the rule. There is also a likelihood that lenders will use the ruling to raise new constitutional challenges to their current rules. Two plaintiffs have already applied the argument using the 5th circuit case as precedent. It is unknown whether the courts found the arguments or CFPB’s response persuasive, but either way it could signal future litigation against the bureau unless they appeal to the Supreme Court. This could impact all of the regulations they have put forth to regulate the lending industry. The CFPB was created to prevent another financial crisis and it doesn’t bode well that companies are successfully making constitutional challenges against it. We can only hope that the Supreme Court clarifies the situation before more challenges are filed against the bureau.