Be a Prudent Lender

May 26, 2010

Everyone knows the expression, “If something seems too good to be true, it probably is.”

Yet, every year people are swindled. Many sophisticated individuals are taken in by massive Ponzi schemes that show signs of “too good to be true,” such as miraculous returns on investment. Even regulators were fooled by the $50 billion Ponzi scheme perpetrated by Bernie Madoff.

In the many years I’ve worked with credit unions, I’ve seen ideas that appear “too good to be true.”

One such idea was lease-like lending, which was intended to help credit unions compete with the captive auto financing companies and their ability to provide low-cost leasing programs.

These programs tried to mirror leasing programs, but they had a number of provisions that didn’t match pure leasing programs. Among the many differences:
The credit union didn’t have ownership of the car, as the car was held in trust by a third party.

The third party had the relationship with the dealer, and there were data processing issues wherein the accounting for leases did not readily translate into common data processing systems.

Needless to say these lease-like lending programs seemed too good to be true. They supposedly allowed credit unions to compete directly against seemingly unbeatable lease programs at the dealership. But they were too good to be true and many credit unions were badly burned.

What does this have to do with today? We’re going through extremely difficult times in lending, especially dealing with regulatory changes for open-end lending, credit cards, and electronic funds transfer overdraft programs.

I’m seeing a repeat of the too-good-to-be-true syndrome in nearly every regulatory change we’ve endured over the last year. For example, when the Credit CARD Act of 2009 was passed, it provided for a number of consumer protections, such as a prohibition on raising interest rates on existing balances except in limited circumstances.

The grapevine among lenders quickly lit up with clever ways to continue changing rates on existing balances. But these clever tactics were simply too good to be true—they violated the new rules.

Similarly, I’m seeing schemes that aim to circumvent changes to Regulation Z (Truth in Lending) regarding the process lenders must follow when making advances under open-end lending programs.

While the Truth in Lending regulations were changed substantially, some schemes would allow lenders to continue doing exactly what they did before with no real change to process. But as always, if the schemes seem too good to be true, they likely are.

The moral of the story? Be a prudent lender. If a lending scheme is too easy, too clever, or allows you to behave exactly as you did before despite substantial regulatory changes, the scheme is probably too good to be true.

Check with your lawyer and your league, and make sure you’ve thought through every aspect of a scheme. We’ve learned the hard way that if something appears too good to be true, it usually is just that.

Bill Klewin is associate general counsel for CUNA Mutual Group, Madison, Wis. Contact him at 608-231-7009.